While most people invest in residential properties and know how to avail loan, the procedure is quite different for Commercial Real Estate (CRE). The application process and eligibility criteria vary. To understand how to avail loan for buying commercial property, here is a detailed guide with all nitty-gritty that investors should keep in mind.
It is common for people to get overwhelmed when it comes to applying for loans to purchase commercial properties. Even if they know the intricate details of home loan application procedures, they may find financing for an office space or commercial unit complex. Commercial Real Estate (CRE) transactions may be for office spaces or retail outlets such as stores or shops. These may either be under construction or ready to occupy. As the home loan procedure is relatively simpler, Asset Hub has collated this comprehensive guide to help potential investors with the process of availing a loan for buying commercial property.
Eligibility guidelines and important information
Fees and charges
Residential transactions usually carry processing fees of up to Rs 10,000, whereas the rate for any commercial property loan is up to 1.5 percent of the entire loan amount. Some banks may offer a minimum charge of 0.5 percent as well.
LTV (Loan to Value)
The Loan to Value (LTV ) ratio stands for the percentage of the loan amount released against the total value of the property. For example, it may be 75-90 percent for residential units, while it may be just 50-55 percent for commercial properties. This means that you can only avail half the value of the commercial asset as your loan amount. In such cases, buyers have to make a substantially higher down payment.
Banks and Non-Banking Financial Companies (NBFC) are highly concerned about the profile and reputation of the developer, especially if the commercial property is still under construction. Commercial properties are developed faster than residential units; however, the number of occupants is lower. Financial institutions scrutinise the delivery schedule of the builder before approving the loan amount.
Rate of interest
For commercial properties, loan interest rates are 4-5 percent higher than interest rates on residential properties, depending upon the borrower’s credit history.
The commercial building should comply with all official regulations, including fire safety measures, civic amenities, elevators, shafts, and escalators. It should also have sufficient staircases and emergency exits. Banks have technical analysis teams to verify every aspect before processing the loan application.
Further, commercial property developers need to acquire clearance from all departments of the government and municipal bodies besides presenting legally approved development plans.
Average tenures for home loans can go up to 30 years, though they are usually 10-15 years for commercial property loans. This means a higher Equated Monthly Instalment (EMI) have to be paid every month.
Banks may decide to fund the commercial property purchase only partially if it assesses a possible loan default in the future. Banks can also take the step if they anticipate any structural risks due to non-compliance with standards.
Valuation of the property
The cost for purchasing the commercial property determines the final loan amount. The lowest valuation, as reported by independent agents to the bank, is considered.
Old buildings find it difficult to secure funding, not only due to risks but also the lack of sanctioned development plans or other mandatory aspects like fire exits.
Financial institutions tend to sanction the loan for a minimum area in sq ft. Retail stores often come up in smaller spaces for ATMs and other such kiosks. They may be smaller than even 100 sq ft at times. Lenders may have minimum rules, which means they may only provide funding for spaces above 300 sq ft or 500 sq ft.
How to qualify for a commercial real estate loan?
Eligible applicants for commercial real estate loans include both salaried and self-employed professionals. The latter category includes doctors, engineers, architects, lawyers, and chartered accountants. Entrepreneurs, traders, and contractors may also apply for loans in the category.
Here is a checklist to help you qualify for a commercial property loan-
- Ensure that the builder has a reputed background and profile with a soundtrack record of delivery
- Verify the title deed of the commercial property. Check if it meets all official regulations and civic approvals
- Have a fair valuation of the commercial property in mind while applying for the loan
- Have a healthy financial record with a good credit score, sufficient monthly income, and other credentials
- The age of the property should comply with the criteria of the bank
- Your commercial property should meet the minimum space criteria of the bank
- All technical specifications of the commercial property must be in order, with full approval from the government and other authorities
Once you meet these criteria, you can expect to get your loan approved at a reasonable interest rate.
Can you get a mortgage on a commercial property?
Several banks offer Loans against Property (LAP) to customers available against both residential and commercial properties. You can avail a mortgage on your commercial property and receive a certain amount for meeting your business or personal needs. However, tenures for these loans are usually up to 10 years while the interest rates are lower.
Commercial investors can expect to get up to 60 percent of the value of your commercial property as your loan amount, while a rented commercial property will get you up to 50 percent of the property value. Amounts usually hover between Rs 10 lakh and Rs 10 crore on average. Since it is a secured loan, it is processed faster than many other types of loans. Make sure that you meet the age and income criteria of the bank. Your commercial property can be an asset if you need money for diverse reasons.
Should you buy a commercial property on loan?
To understand the viability of buying a commercial property on loan, let us take four scenarios where you are in four different stages of your professional and financial lifecycles-
Millennial investor (Mid/High-level professional / Entrepreneur)
You just received a lump sum as a bonus or have been saving your bonuses. You may also have received a lump sum on account of stock/share sales, blockbuster IPOs, or even via inheritance.
You can readily invest in commercial, agricultural or industrial land, retail, or office spaces. You can build an income-generating asset through steady monthly rentals and recover your investment swiftly, besides gaining through capital appreciation. In such cases, it is better to avoid availing a loan, unless you are sure that your monthly income (after deducting maintenance and other costs) is enough to cover your EMI (based on the loan amount for 50 percent of the property value).
Older, professionally and personally settled investor
Now you are at your peak professionally, earning substantially, with good savings, and fulfilled your basic goals. If you are looking to avail a loan, you can consider the same if it helps you build a rewarding commercial asset for the future and your salary increase has enough leverage to cover the loan amount.
Remember that you will also be putting in 40-50 percent of the property value as the down payment. Hence, if you are sure about the investment type and can repay the loan over the 10-15 remaining years of your professional career, then you can go ahead. Make sure it does not impact your savings, investments, and basic financial goals.
Investor with high income but lower savings
In this case, it is best to avoid a loan for commercial property. You should rather start saving up through smart investments that will enable you to purchase a commercial property in the future.
Saving up for the 40-50 percent down payment is crucial, particularly if you have been eyeing commercial, agricultural land or any other investment in a retail outlet or shop. If you have lower savings, you can start by investing a lesser amount in a smaller but efficient commercial asset. Start earning income from it and then build up your savings without taking a loan at all.
You can then sell it off, gaining from appreciation and the savings you have built up over time. Later, you can invest it into another income-earning asset with a bigger ticket size and cover the loan with your salary increase. You can also start earning income from the asset and use that to offset the loan EMI, if possible.
Those selling off ancestral property
You need not take a loan and hinder your monthly cash flow. You can simply invest the proceeds into buying commercial property and check out the tax benefits carefully. You can invest in agricultural or farmland for higher benefits as you do not have to pay capital gains tax on selling the same in the future, while land prices do not depreciate in most cases. Else, you can invest in pre-leased properties or office spaces to earn an assured monthly income. Many invest in retail shops and showrooms, which they let out to sellers and brands, for regular income.
Availing a commercial property loan is only advisable if you have enough to cover the high down payment and a sufficient salary or income, which helps you pay EMIs for a comparatively shorter tenure. At the same time, your goal should be to invest strategically to generate income and gain through capital appreciation.