Two buyers can look at the same $1,200,000 commercial property and get very different loan offers. The difference often has nothing to do with their income or deposit. It comes down to the lease already sitting on the property, and whether it gives a lender confidence the rent will keep coming in.
Why lenders look at the lease before the borrower
Residential lending is assessed mostly on the borrower’s income. Commercial loans work differently, because the property itself is often expected to help service the debt through rental income. A lender reviewing a commercial loan application will ask for a copy of the current lease before it asks much else about the security property.
What the lender wants to know is simple: how reliable is this income, and for how long is it locked in? A tenant on a 10-year lease with a national retailer reads very differently to a tenant on a rolling month-to-month arrangement, even if today’s rent is identical.
The lease details that actually move the numbers
Four things get scrutinised on almost every lease-backed commercial application. The remaining lease term is the first, since a lender extending a 15-year loan against a lease with 18 months left is taking on more risk than one matched to a longer term. The tenant’s covenant strength is the second, meaning whether the business paying the rent looks financially stable enough to keep paying it.
Rent reviews and any ratchet clauses come third, because a lease that only allows rent to increase (never decrease) is viewed more favourably than one exposed to market rent resets. Outgoings arrangements are the fourth, since a net lease where the tenant pays rates, insurance and maintenance leaves more of the rent available to service the loan than a gross lease where the landlord absorbs those costs.
What if there’s no existing lease at all?
Vacant commercial property is assessed on a hypothetical market rent, usually estimated by a valuer rather than taken from an actual tenancy. Lenders tend to apply a more conservative loan-to-value ratio (LVR) in this scenario, often 5 to 10 percentage points below what they’d offer against the same property with a strong tenant already in place.
How a short lease term changes what you can borrow
A short remaining lease term is one of the most common reasons a commercial application gets a lower offer than the buyer expected. If 12 months remain on a lease and the tenant hasn’t signalled a renewal, a lender may discount the rental income used in its serviceability calculation, or ask for a shorter loan term to match the lease exposure.
Some buyers negotiate a lease extension with the tenant as a condition of the purchase contract, specifically to strengthen the finance application before it’s submitted. This is worth raising with a broker early, since it can be the difference between a 65% LVR offer and a 70% one on a $2,000,000 purchase, a swing of $100,000 in required deposit.
Buying to occupy your own business changes the assessment
Owner-occupied commercial purchases work differently again. If a business owner is buying the premises their own company will operate from, there’s no external tenant and no lease to assess. Instead, the lender looks at the business’s financial accounts to confirm it can service the debt from its own trading income.
This can actually work in the buyer’s favour on LVR, since owner-occupied commercial security is often viewed as lower risk than a purely investment purchase reliant on an external tenant staying in place. Lenders typically want at least two years of financial statements from the operating business to support this assessment.
Some business owners set up a lease between their operating entity and the property-owning entity, often for asset protection or superannuation reasons. Where this is the case, a lender will usually still ask for that internal lease to be on commercial terms, at a market rent, rather than an arrangement that looks designed purely to boost the numbers on paper.
What to have ready before you apply
A lease-backed commercial application moves faster when the full lease document is ready from day one, not just a summary of the rent. Lenders also usually want a schedule of any outgoings the tenant pays directly, details of any bank guarantee or security deposit held, and confirmation of whether the tenant has an option to renew and on what terms.
Where the purchase involves a business acquiring its own premises, add two years of financial statements and the most recent tax return to that list. Having these ready before an offer is made, rather than scrambling once a contract is signed, is often what separates a smooth commercial settlement from a stressful one.
Key Takeaways
- Lenders assess a commercial property’s existing lease before they look closely at the borrower’s own finances.
- Remaining lease term, tenant covenant strength, rent review clauses and outgoings arrangements all affect the loan offer.
- A short remaining lease term can reduce the rental income a lender will count, or shorten the loan term on offer.
- Vacant commercial property is assessed on hypothetical market rent and usually attracts a lower LVR than a leased property.
- Owner-occupied purchases are assessed on the operating business’s own financials rather than an external lease.