Commercial mortgages made simple

A commercial building is likely the largest purchase the your small business will ever make small business.  Commercial mortgages are a little bit different than the typical residential mortgage that you might be used to.  Typically you will want to get this process started as soon as you decide that you are looking for a new location for your business.  I would suggest that you meet with your local bank and have a quick conversation so they can give you an idea of what they will be comfortable approving.  When it comes time for finalizing your small business mortgage, typically your bank will not commit to anything unless they know the property you are purchasing and have the financial statements that they are going to require.  You might not know what the purchase price of this property would be so you can provide them of the price range you are going to be looking at.  You can give them a copy of few years financial statements and ask them to give you a ballpark figure on what they would be able to approve this will give you at least an idea of how much you will be able to finance, what the terms, and would be what the rate would be.  It would also give the confidence that your bank is interested in approving the loan should you decide to purchase a building.

Once you found the property that you are interested in purchasing and entered into a purchase contract, you would then present that information to your bank along with three years of business financial statements and likely two years of personal tax returns.  Typically most banks will lend 80% of the purchase price of a commercial property assuming that your small business will operate more than 51% of the total square footage.  This is typically subject to the commercial building appraising at an amount equal or higher to the purchase price.  What the bank will be looking for is ability to repay the commercial mortgage from cash flow from the small business. 

A lot of people ask me how the bank determines if a small business can pay the loan and whether or not to approve the small business.  Banks will typically use something called EBITDA.  EBITDA is simply earnings before taxes, interest, depreciation, and amortization.  So simply, they will take your profit before taxes and add back interest, depreciation and amortization.  This will give the bank that total amount of cash flow available.  Then the bank simply adds up all debt that your are required to pay.  They  take the EBITDA/Debt Payments and they arrive at a ratio.  If the ratio is above 1.0x then you are on the right track.  If the ratio is above 1.25x then you should have an easy time getting approved.  If you're ratio falls below 1.0 that you will need to show the bank what expenses can be reduced by moving into this new facility and how that will affect your per financial statements.  This typically requires you to prepare projections for probably three years out so that they can see that you've done some planning to be able to service us the new commercial mortgage.

After you've been approved for the loan.  The bank will typically require an appraisal to be completed, as well as some environmental testing.  This will notify the bank of any environmental concerns that may have happened on the property.  It is also something that you as the owner will want to anyway to protect yourself.

Lastly, most small business owners choose to keep their building and their operating company in separate entities.  The most common approach is to simply have the ownership of the property in the owners personal name and have the owner as the borrower on the loan.  The bank will most likely require a small business to guarantee that loan, since that's where most of the cash flow will be coming from.  Another thing that small business loans will do is to form a separate entity, typically an LLC, and have the property in the LLC.   The small business then pays rent to the LLC.  This is just another way of protecting the owners interests in keeping their largest asset separate from the assets of their operating company.  You should talk to your loyal lawyer for additional advice.

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