(That is the question.)
Should you buy a building for your business? It’s a big step and can seem intimidating. And there are both pros and cons associated with owning a building. So, is it right for you?
I recently ran across an article that had some great tips for business owners about the process of buying a building – from selecting a property, asking the right questions, things to think about when making an offer, and more.
There are a lot of things to consider, but I’m just going to give you a quick overview of some details on the financing side. Hey, I’m a banker. It’s what I do.
If you’re like most business owners, you only have experience purchasing residential real estate. And while there are some similarities between the two processes, borrowing money to purchase a piece of commercial real estate can also be substantially different from buying a home.
Let’s take a look at some of the basics:
Loan-to-Value (LTV)
Loan-to-value is simply your loan amount compared to the appraised value of the property (LTV= loan divided by value). With traditional financing, the maximum loan-to-value on commercial real estate is usually about 75%-80%. With an SBA guarantee, this can sometimes go as high as 90%. What this means is that you would have to provide 20%-25% worth of equity (traditional financing) or 10% worth of equity (SBA financing) to purchase the building. This is typically done in the form of cash, or sometimes it can be in the form of a loan from the seller. In those cases, the seller may be willing to take 10-20% of the purchase in the form of a loan in addition to the cash that you will pay them.
Appraisals
An appraisal on the commercial side will often look at two perspectives to get an appropriate value – 1) a sales comparison approach and, 2) an income approach. In residential purchases, you only see the sales comparison approach – when you look at comps of what similar properties have sold for in the area. The income approach tries to determine the value of the property based on lease rates. In other words, how much income could an investor expect if they were to lease out the building? While I won’t go into details here, this is where cap rates come into play.
Rates
Interest rates are typically going to be a little higher on commercial loans than on residential mortgages. It is also much more common to see loans fixed for a shorter time frame (i.e. 5- or 10-year terms) compared to longer residential mortgage loans (i.e. 15- or 30-year terms). In fact, commercial loans usually max out at a 20-year term. Like most things, this can be negotiated, but it’s good to know what to expect before starting the conversation.
Professional Representation
While it may be tempting to save some money and represent yourself when purchasing a building, I wouldn’t recommend it. The commercial real estate process is complex, and it can be easy to overlook crucial details if you don’t know what you’re doing. Many of my clients have had great success using a broker and/or attorney to represent them as well. Even if you are buying a building that you’re currently leasing (and therefore dealing with a seller you are very familiar with), professional representation can prevent missteps that could end up costing you more than you saved by representing yourself.
If buying a building is something that might be in your future, I highly recommend taking a few minutes to check out the article I referenced.
Ultimately, every commercial real estate scenario will be different. But hopefully, this overview of the basics will help you better understand the financing aspects of purchasing your own building. This covered some of the most common questions I get about commercial lending. I could go on for pages and pages about nitty-gritty financing details, but I won’t. You don’t need ALL the specifics right now. (Plus, when I really start talking about commercial lending, that’s usually when my wife gives me the “you’re boring everyone to tears” look and goes to get our coats.)
If you would like to hear more details about commercial lending or discuss whether buying a building is right for you, just contact me. Better yet, stop by my office and we can talk face-to-face. My wife won’t be here, so we can talk as long as we want, and I can give you LOTS of great information…
And if it gets to be too much, you can just give me “the look.”
