Just like the real estate securing them, residential and commercial property lending in Australia differs vastly.
In part one of this post, we run through a few of the fundamental differences between residential and commercial property loans, which are made up of different features, pricing, and structuring.
While some second-tier lenders will provide concessions on their loan products (such as higher LVRs, longer terms), we are primarily interested in the policies and offerings of Australia’s Big Four banks (ANZ, CBA, Westpac, NAB).
Deposit & Loan-to-Value Ratio (LVR)
The maximum LVR a bank will typically allow over a residential property on a first mortgage basis is 80 per cent.
Banks will sometimes consider debt levels as high as 90 and even 95 per cent of the property value, however, this will incorporate Lenders Mortgage Insurance – a pesky insurance premium to protect the bank’s interest in the asset should the borrower breach their loan terms.
The maximum LVR for commercial real estate is normally 65 per cent. This lower ratio is due to the more complex nature of a commercial property investment, which is reliant on more factors than borrower’s income and the property market cycle.
Naturally, this obligates commercial property owners to have a greater equity stake in the project – and provides greater security to the bank.
Generally the maximum term of a residential property loan is 30 years. The duration reflects the long-term nature of a residential investment (which typically sees significantly lower yields) or home purchase, where an emotional attachment may see its owners staying put for some time.
Thirty years seems like an incredibly long period. However, loans can be transferred to different properties or, which is mostly the case, paid off or cleared by the property’s sale well before the loan matures.
Commercial loan terms are heavily dependent on the property’s Weighted Average Lease Expiry (WALE) . The WALE takes the average of all tenant’s lease terms, and is then weighted against both the percentage of the building each tenant occupies and/or the percentage of income they contribute to the overall net rent.
For example, a property with a WALE of four years almost certainly won’t allow a seven or eight-year loan term – unless there are considerable factors influencing the loan application. Typically the bank will provide an interest-only loan for a term of 75 per cent of the property’s WALE. We will discuss the WALE and the importance of a commercial property’s tenants in part two of this post.
In short, banks will set the term of commercial loans between six months and 15 years.
Different Loan Products
Banks offer two types of loan products when purchasing residential property, being investment and owner-occupied loans (a home loan). They will incorporate either interest-only or principal & interest repayments, with either a fixed or variable rate (generally repaid monthly).
Currently, in APRA’s response to what they consider an environment of high housing prices and high household debt, banks have been coerced to bump up rates on investment loans. This means investment loans are typically 10 to 12 basis points higher than the same bank’s home loan rate.
The standard commercial property loan works much the same as a mortgage; repayments are made on either a variable or fixed rate, and either a principal & interest or interest-only basis.
Another option is a commercial bill facility. This type of loan works a little more complicatedly but is designed to provide a more flexible facility.
Interest Rate Pricing
Generally speaking, residential interest rates will move up or down, in line with the Reserve Bank’s cash rate. For example, an RBA decision to bump up the cash rate by 25 basis points will see all – or hopefully only some – of the interest rate rise passed onto the borrower. Therefore, this will also be influenced by whether or not the applicant wants to fix their interest rate, as additional premiums would apply in today’s market.
The bank applies a consistent margin to the fluctuating cash rate. This is applied for the bank’s profit (and their obligation to repay any wholesale funding used to finance your loan).
On the contrary, a commercial loan’s pricing will be heavily dependent on the market rate , the borrower, their relationship and track record at the time of application, as well as the bank’s appetite for the transaction. . This is enormously important as the banks are far more likely to provide competitive wholesale rates if you’re a proven borrower, with a demand for a large quantum of well-risked debt.
The latter is important, because if it is a deal the bank wants to win, they can reduce their interest margin (i.e. reduce their expected profit) to appeal to the customer. On the other hand, if the deal is perhaps a risky one, or there is less of an appetite for that particular application, the bank may fatten up their margin.
For these reasons, it is hard to say which is cheaper or better – a residential or commercial property loan. It all comes down to the market, the quality of your investment and most importantly, your relationship with your banker.
Look out for part two of this post where we look into how applications are assessed for both residential and commercial property loans.
If you’re interested in investing alongside an experienced commercial property syndicator, get in touch with Properties & Pathways. We don’t set the trends, but we like to ride the cycles.