Commercial mortgages

Owner occupied and investment are different products

Everything in commercial lending starts with one question: who occupies the building. If you trade from it yourself, the lender is really lending against your business and taking the property as security. If you let it to somebody else, the lender is lending against the income that tenant produces.

Owner occupied. The lender looks at your accounts, your sector, your order book and your management figures, and asks whether the trading profit will comfortably cover the loan payments alongside everything else the business has to pay. It will also ask whether the building suits the operation, and how transferable it would be to another occupier.

Investment. Here the building's income does the work. The lender examines who the tenant is, what the lease says, how long is left to run, whether there is a break clause, and what would happen to that income if the tenant left. Your own position still matters, but it is secondary to the covenant.

Accounts, add-backs and management figures

For a trading business, expect the lender to want filed accounts covering several years, recent management figures, and an explanation of anything unusual in them. Reported profit is the starting point rather than the answer.

Underwriters routinely adjust the reported figure by adding back items that are not really operating costs. Depreciation, existing finance interest that the new facility will replace, directors' remuneration that is a matter of tax planning rather than a cost of running the business, and genuinely one-off items are all commonly added back. Rent currently paid on premises you are about to buy is another, since it disappears once you own the building.

The presentation of that adjusted figure is where a broker earns their fee. An underwriter working from raw filed accounts and no narrative will reach a lower number than one who has been shown, clearly and with evidence, what the business actually earns. We prepare that, and we would rather your accountant checked it before it goes anywhere.

Debt service cover, as a concept

Whichever route your case takes, the lender applies a cover test: the income available has to exceed the cost of servicing the debt by a margin. On a trading case the income is the adjusted profit; on an investment case it is the rent.

Two things about that test catch borrowers out. The lender does not test against your actual payment — it tests against a payment calculated at a rate above the one you will pay, so that the loan still works if rates move. And it applies its own margin, which differs between lenders and between property types, so the same building and the same income can support materially different loans at two lenders.

That is the useful part of running these cases through underwriters directly. We can establish how a particular lender will treat your income before an application exists, rather than finding out at the end.

Tenant covenant and what the lease actually says

On an investment purchase the lease is the asset. Two buildings with identical rent can be valued and lent against quite differently because of what is written in their leases.

• Who the tenant is, how long it has traded and what its own accounts look like
• How long the lease has left to run, since a short unexpired term brings the re-letting risk forward
• Whether there is a tenant break clause, and how soon it can be operated
• Whether the lease is on full repairing and insuring terms, or leaves obligations with the landlord
• Rent review provisions, and whether the passing rent is above or below what the space would let for today
• Whether one tenant carries the whole income, or the income is spread across several
• Arrears history, and whether any concession or rent-free period is still running

A guarantee from a parent company, or a rent deposit, can strengthen a weaker covenant. So can a tenant who has been in the building a long time and has fitted it out at their own expense, because the cost of moving makes them more likely to stay.

How easily could the building be re-let

This is the question lenders ask most and borrowers consider least. A lender's downside is that it ends up holding the building. So it wants to know how many other occupiers could use it.

A plain office, warehouse or shop in a normal location has a wide pool of potential occupiers. A building fitted out for one specialist use — heavy plant fixed in place, a purpose-built clinical or leisure fit-out, an unusual configuration, or a rural or isolated location with little local demand — has a narrow one. A property with only one plausible use is harder to fund than one that could be re-let to almost anybody, whatever the current income says.

Valuation practice reflects the same point. Where a building's worth is bound up with the business trading from it, a valuer may report on a trading basis rather than on bricks and mortar, and the lender will often lend against the lower figure. That can change the borrowing available without changing the price you have agreed.

Why commercial cases are declined

Declines usually come from the property's re-lettability or from the tenant, and the borrower is the last person to be told which. The conversation you are having is about your accounts; the conversation the lender is having is about who else would take the building.

Personal guarantees, and what a director is signing

Most commercial lending to a company is supported by personal guarantees from the directors or shareholders. It is worth being blunt about what that means: if the company cannot pay, the lender can pursue you personally for the amount guaranteed, and pursuing the company first is not always required.

Read what is in front of you and take your own legal advice on it. The points that matter are whether the guarantee is capped or unlimited, whether it is joint and several with other directors so that one person can be pursued for the whole amount, whether it survives your resignation or the sale of your shares, whether it extends to future borrowing, and whether any charge over your own home is being taken alongside it.

Guarantees are normal and usually unavoidable. Signing one without knowing which of the above applies is not.

Valuations take longer and cost more

A commercial valuation is a full inspection and a written report, not a desktop exercise. It costs more than a residential valuation, it takes longer to arrange and produce, and the fee is yours whatever the outcome.

Comparable evidence is also much thinner than on residential property. It is not absent — valuers have transaction records, letting evidence and market data — but there are far fewer directly comparable sales, buildings differ from one another far more, and much commercial evidence is not in the public domain. Two competent valuers can therefore reach different figures on the same building and both be defensible.

Where an environmental report, a specialist survey or a report on a specific building element is required, that adds time again. We would rather set that expectation at the start than apologise for it later.

Regulation, and where the line falls

Most commercial lending is outside the Financial Conduct Authority's mortgage regime. Whether a particular loan is regulated depends on how much of the building is occupied as a home by you or by an immediate member of your family.

The threshold is a substantial proportion of the building being used as a dwelling by the borrower or an immediate family member — not any residential occupation at all. A flat above a shop that you let to a tenant does not make the loan regulated. A building you largely live in, with a small trading element, may well. Because it turns on the actual split in the specific building, we confirm the position on your case rather than assuming it.

This type of lending is not usually regulated by the Financial Conduct Authority. On unregulated lending you do not have the protections of the mortgage conduct rules and cannot refer a complaint about the lending to the Financial Ombudsman Service.

How we handle a commercial case

Specialist enquiries reach Nik Mair, our managing director, on the working day they arrive, and we place these cases direct with lenders rather than through a packager.

• We establish first whether the case is owner occupied or investment, because the two are underwritten differently
• We prepare the income position properly, including add-backs, and check it against your accountant's view
• We look at the lease and the tenant before the valuation, not after
• We ask openly how easily the building would re-let, because the lender will
• We tell you what guarantees are likely to be required before you are asked to sign anything
• We confirm whether the loan is regulated on the facts of the building, and set out every cost in writing including our own fee

What we charge

Our fee is typically £495, though complexity moves it, and it is always disclosed in writing before you apply. Each stage of the fee is earned when that stage is reached and is not refundable after that point. Separately, you have the right to cancel within 14 days, as set out in our Terms of Business. We are usually also paid a procuration fee by the lender.