We’ve recently again experienced an increase in enquiries for commercial bond finance. Many clients think the process is similar to that for residential property finance, but unfortunately, nothing could be further from the truth. Let’s take a closer look at what has stimulated this interest in commercial property and how investing in this asset class can be detrimental to your cashflow.
Interest in commercial property has been fuelled by the all-time low rental stock vacancies and the profitability shown by listed funds, for example loan stocks and property unit trusts. What the average property investor doesn’t grasp, is that these listed funds are investing in huge property projects, further affecting market conditions and price inflation, and not in individual sectional title units and warehouses, which remain very volatile to fluctuating market conditions.
There are advantages to purchasing your own premises, for example:
- You are your own landlord and can’t be evicted from your property
- Occupancy costs will be reduced as you repay your loan
- You’ll have an added tax benefit of deducting holding costs, such as rates and taxes, insurance, monthly interest and other maintenance costs.
- However, the disadvantages could cripple many a profitable enterprise, the biggest of which is the upfront acquiring costs and the financial burden of repaying the relevant loan.
FINANCING COMMERCIAL PROPERTY
The Loan Amount
If you are thinking that you can obtain a 100% bond on your commercial property – think again! Commercial property loans currently range from 60% to 75% of the banks valuation or the purchase price, whichever is the lowest and in most instances the banks valuation takes preference. Perhaps, with substantial added security, the bank may consider up to a 90% bond, but this seldom happens.
The VAT portion of the purchase price is excluded, meaning that you have to be prepared to finance the VAT until SA Revenue Services refunds your claim – at the very least 3 months after transfer of the property. Furthermore, very few banks finance bonds of less than R1.5 million and those that do are well aware that your options are limited.
Buyers would be well advised to look at financing from specialist banks such as GBS for their business property financing. The major difference being that such banks know the commercial property game as opposed to normal channels which means you get clear parameters, advice and a better chance of financing.
The Term
Unlike with residential property where you can obtain finance over a period of 20 and even 30 years, a commercial property mortgage bond has to been repaid over a period of 10 years. There are some financial institutions that will consider a 15-year repayment period, obviously with certain limitations and restrictions. For example, you must avail yourself of a fixed interest rate over a period of 5 years, during which, you are authorized to repay only the interest portion of the loan. Is this a profitable option? Depends which side of the transaction you’re on. Alternatively, they will consider extending the repayment period, if you are considered a “high profile client” and the commercial property is “owner occupied”.
The Interest Rate
Interest rates of prime less 1% normally expected from residential property loans are almost unheard of in the commercial property sector. You can expect to pay prime, sometimes prime plus, at the very least prime less .5% and only a very few selected corporates, will enjoy prime less 1%.
The Valuation
Normally the latest purchase price depicts the market value of the property, right? Not for commercial bond financiers, who determine the value of the property based on capitalization (Cap) rates and the average rental per square meter in the area. As you can see, it has very little to do with the “bricks and mortar” and more with profitability. A professional valuation will be done and other factors such as tenant profile, rental growth and the vacancy rate, will be taken into account when considering the loan.
The Security
Let’s talk about signing your life away! Your loan will more than likely be conditional to:
Where applicable, cession of all lease agreements
Unlimited surety of all directors, shareholders or members
Unlimited surety by the trading entity
Only with very strong, well-substantiated motivation will the banks consider waiving any of the above conditions.
The Fees
The banks charge an initiation / administration fee, which is normally 1% of the loan amount, but at times, this can be higher. You will also be charged a valuation fee for a professional assessment of the property.
IN CLOSING
If you are a business owner, there might be some solid reasons to look to owning rather than renting but for general property investment, our opinion, albeit a conservative one, is that you should stick to what you know and leave commercial property to the experts. Investing in this asset class requires a substantial amount of liquidity.
Commercial property investment requires a lot more knowledge and consideration and for this reason we have not tried to treat it lightly with simple articles on this website.
However, if you are interested in diversifying your investment portfolio, we would be happy to consult further with you. There are without a doubt, high return opportunities in the market, particularly in certain specific with it’s expectant high economic growth rates.
For those who regularly invest in Commercial property, we always have excellent stock on our books as well as upcoming opportunities.
Relevant Articles
Property Investment Advice from Professionals
Key Considerations in Investing
Investing in Commercial Property
Rental vs Buying
Professional Property Management
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