Financing a commercial property

General information, not tax or legal advice. The numbers here are illustrative. Talk to your lawyer and accountant before you act on them.

What lenders look at

• The income. Net operating income from real leases.
• Debt service coverage. How comfortably the income covers the mortgage payments. Lenders set a minimum ratio.
• Loan to value. How much they’ll lend compared with the appraised value. Commercial lenders usually want more down than on a home.
• The tenants and leases. Who pays, for how long, and how risky the income is.
• You. Your experience, net worth and, for owner-users, your business’s finances.

Types of lenders

Banks, credit unions, insurance companies, private lenders and some programs for owner-users. A commercial mortgage broker can compare them for you. Sometimes the seller will lend part of the price too: see vendor take-back mortgages.

Your financing condition

Give yourself enough time in the offer for the lender’s appraisal and review. Ask the lender early what documents they need.

Worked example (illustrative only)

A property with $100,000 a year in net operating income, and a lender that wants the income to cover the mortgage payments 1.25 times, would allow yearly mortgage payments of up to $80,000. The interest rate and amortization then set how big that loan can be.

Tenant agreements your lender may ask for

On a leased building, lenders often want tenants to sign an agreement that does three things: puts the lease behind the mortgage, lets the tenant stay as long as they aren’t in default even if the lender takes the building, and has the tenant accept a new owner as landlord. Check whether your leases already require tenants to sign one. Collecting them takes time, so start early so it doesn’t hold up funding.

Run the break-even number

Before you buy, work out the occupancy the building needs just to pay its bills. Add the yearly operating costs to the yearly mortgage payments, then divide by the rent the building would collect if it were fully let at today’s rents. That gives you the break-even occupancy.

The lower that number, the more room you have if a tenant leaves. Multi-tenant office tends to lose tenants in waves when the economy turns, so a building that only works when it’s nearly full is a risk. More equity, net leases and tenants with staggered expiries all bring the number down. I run this with you before we write an offer.

Questions people ask

How much do I need down for commercial property?

Usually more than for a home. It depends on the property, the lender and your finances.

What is a debt service coverage ratio?

Net operating income divided by yearly mortgage payments. Lenders set a minimum.