Commercial mortgage

Owning your place of business can give you more freedom to shape and control your operations and let you build wealth. But commercial mortgages are not without risk, so it’s important to evaluate the pros and cons of owning your property.

You’re likely familiar with the concept of a residential mortgage, but there are some important differences between residential and commercial mortgages.

Kevin Kelley, a Senior Account Manager with BDC, says many of these differences come down to the fact that commercial mortgages are riskier for both lenders and borrowers. As a result, these loans tend to come with higher interest rates and other fees.

One thing that makes commercial mortgages riskier is that the property can be harder to liquidate. “A commercial building can be very specific to a business and what it needs,” says Kelley.

Commercial mortgages generally have lower loan-to-value ratios than residential mortgages, as well as shorter amortization periods. That means a bank will likely expect your down payment to make up a higher proportion of the property value. They will also expect you to pay off the loan balance in less time than would a homeowner.

Why consider a commercial mortgage?

Buying commercial real estate can make sense for the following reasons.

• You’re facing landlord-imposed restrictions or steep rent increases
  When commercial real estate costs are high, buying can free up working capital by reducing your monthly rent costs.
• You want to use your business property to grow your personal wealth
  Owning commercial real estate can help you build equity as the property’s value rises.
• You need to equip your property for a highly specialized purpose
  The average landlord won’t pay for the specialized construction needed for scientific research or manufacturing. In addition, they would expect you to undo those changes at your own expense once you leave.
• You’ve found the perfect location for another business
  It could be attractive to various companies because of such things as size, amenities, foot traffic, equipment and proximity to key suppliers. Buying the location and developing it could offer an additional revenue stream.

Kelley notes that if you’re a buyer, another motivating factor can be pride of ownership: You may prefer to invest in, maintain and improve your property in ways that would not make sense if you were leasing.

How much down payment is needed on a commercial property?

The more you put down, the less you need to borrow—and the less interest you will pay over the life of the loan. It’s a good idea to put down as much as you can afford, especially during times of rising interest rates.

However, if you’re intending to put down the minimum (to free up working capital), you’re likely looking at a down payment representing 20% or more of the purchase price, although it can be higher or lower depending on the lender, the financial health of your business and the building you are trying to purchase.

The size of a down payment required is closely related to the loan-to-value ratio, which determines the maximum amount of a secured loan based on the market value of the asset pledged as collateral.

How long is a commercial mortgage?

Commercial mortgages are usually amortized over a period of 20 years or less and repaid in regular instalments. A longer amortization period can be obtained from lenders, such as BDC, to help businesses protect their cash flow.

What interest rates should you expect for a commercial mortgage in Canada?

As with residential mortgages, the interest rates on commercial mortgages will trend up or down as the economy shifts. But that’s not the only factor influencing the rate you will receive; there’s also the financial strength of your company, since banks use higher rates when giving loans to borrowers they deem riskier.

As with residential mortgages, rates are also connected to mortgage terms. The mortgage term is the length of time your mortgage is in effect.

“All of the banks will offer fixed rates, usually from one to 10 years,” says Kelley.

Interest rates typically rise when the Bank of Canada tries to tame inflation.

“When rates go up, many will say, ‘Let’s see what happens. For now, we’ll do a two-year fixed rate.’”

How to calculate commercial mortgage payment

As with a residential mortgage, your monthly payments will consist of both principal and interest. The principal is the total amount of the loan divided by the number of months in your amortization period. For the interest portion, says Kelley, divide the annual interest rate by 12 to get the monthly interest rate for your calculation. Add the principal and interest to arrive at the monthly amount.

Most people use online mortgage calculators. These can also help you to figure out what size mortgage your business can afford and evaluate various scenarios.

Commercial mortgage calculator

Use this tool to calculate the costs of a commercial mortgage and get a monthly amortization schedule.

Simply enter the amount you’re borrowing, the interest rate you negotiated (or anticipate), and the length of the term you chose (in months). The calculator will tell you how much your monthly payments would be, what your payments would add up to, and how much total interest you’ll pay.

Commercial loan scenario

Can you get a residential mortgage on a commercial property—and vice versa?

Banks will not let you use a residential mortgage to buy a commercial property. That said, if you’ve made a sizeable down payment (40% to 50% of the purchase price) on your commercial property and have a home-equity line of credit, you may be able to use that to finance your commercial property.

While theoretically you can use a commercial mortgage to buy a residential property, it wouldn’t be advantageous. You would face needlessly higher interest rates and fees, and would likely need to come up with a larger down payment.

What are the risks of taking out a commercial mortgage?

Commercial real estate loans can come with fees and terms that you may not be familiar with.

For example, along with an initial application fee, there are ongoing annual costs that can be significant. They usually make up a percentage of the loaned amount and can range from 0.5% to 1%.

There may also be fees related to appraisal, legal work or surveys. Commercial mortgages may also have restrictions on (or penalties for) prepayment, or the settling of a debt before its due date.

Kelley says it’s important to read the fine print on your contract “word for word.” For example, many commercial mortgages are call loans, meaning that the lender can demand to be repaid at any time. Although banks rarely call in their loans, it has happened before, most notably during the 2008–2009 financial crisis. To be prepared for such an event, you would need to know that you can line up alternative financing on short notice.

Preparations you’ll need to qualify for a commercial mortgage

If you’ve decided to pursue a commercial mortgage, have your financial statements prepared by a chartered professional accountant (CPA) every year and keep them as well organized as possible. They’re generally what an underwriter will focus on when evaluating larger business loans.

“The underwriter needs to build a case for the loan,” says Kelley. “What they want to know is: How are you going to pay this back? Your financial statements can hold the answer to that.”

“Until you have two years’ worth of recorded financial statements—even if you’ve been running the business for longer—you’ll still be considered a start-up. That means you’ll have a harder time getting credit, and you’ll have access to less funds while the interest rate may be higher,” says Kelley, adding that if you’re not incorporated already, do so as soon as possible so you can get those Year 2 financials.

And finally, says Kelley, don’t fall behind on your business taxes.

Find out more about commercial mortgages

Check out our Guide to Buying Commercial Real Estate to learn about whether and how to buy a property for your business, including how to set up financing. If you’ve found a property and are ready to get started, read about how to negotiate effectively when buying commercial real estate.

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