Commercial Property Loans: How banks put a price on debt

Ever thought about how to get the best deal on commercial real estate finance? Below, James Kelder, our very own Commercial Finance expert, explains the key considerations of banks and lenders:

When it comes to bank loans for property, people often think in terms of buying a home. Usually, the terms are quite rigid and there’s not much opportunity to negotiate.

For commercial property loans, it’s a different playing field. There are many variables that determine how lenders price commercial debt, which is largely assessed on a risk-adjusted basis. The riskier the loan, the higher the interest they’re going to charge. But as the loan gets bigger, there’s more room to move.

Experienced commercial property investors probably know the process but there are some lesser-known factors. Here are some of the bank’s key considerations:

Loan amount
The larger the loan, the higher the revenue for the bank. Larger loans often allow more room to negotiate better rates because banks are more likely to reduce their margin. Generally, there’s less scope to negotiate in the sub $1 million bracket. Between $1 million and $5 million there’s a reasonable chance and once you’re above $5 million, pricing gets more competitive. From $10 million to $50 million the scope widens further — banks are hungry for those big chunks. Once you get out of that $10 mill picture, you probably should have a three (%) in front of your commercial debt, which is very cheap.

How much you’re borrowing against the asset
Having a lower loan-to-value ratio (LVR) is less risky for a bank and thus provides for room to negotiate better pricing. If you’re borrowing less against the asset value, the risk for banks is lower and they’ll price the debt accordingly.

Type of asset
Commercial property assets can be split into categories of office, retail, industrial and specialised. A specialised asset that has been purpose built for a function may incur a premium on funding costs. Specialised assets can be a childcare centre, service station or even a bowling alley. The bank has to consider the consequences in the event that a business cannot operate in the configuration it was built for and the building has to be knocked down.

Banks view metropolitan areas as less risky. So if you’re in a rural location, that will certainly affect debt pricing.

Strength of asset
Strong lease terms, well-regarded tenants and higher rental income will help debt pricing. Banks want to see stability in cash flow and high-quality tenants. For example, blue-chip national tenants are considered stronger. And if a tenant has been there for a while, that can give you leverage to negotiate rates as well.

All the above considerations are pretty well known to most people who’ve had experience with commercial property investment and also make sense in terms of risk adjustment. Usually not as well known are the ways banks classify their exposures on the debt. This comes down to the source of the repayment. These are some of the lesser-known factors:

Loan term and type
Banks’ cost of funding is based on the bank bill swap rate (BBSY). Different costings apply to different loan terms depending on the market’s expectation of rate movements. Rate reduction can even be achieved by changing the roll on your debt. Generally, banks structure their commercial debt to roll on a 30, 60 or 90-day basis. Borrowers can specify how often debt rolls to match their cash flow or, if cash flow is less important, there are potentially savings to be made by extending the roll of the debt — for example, from 30 days to 90 days. What that really means is interest is charged on a 90-day basis instead of a 30-day basis. Consistently structuring your loans on a principle and interest (P&I) basis can also provide scope for rate reduction.

Source of cash flow
Banks classify their lending exposure against the source of cash that will repay the loan (that is, if a client owns a business and occupies the property – the risk will be related to that business industry). This can affect the rating systems they use to price debt. Consistently if they want to reduce their exposure to an industry they will price higher. Existing commercial property investors would know of the premiums in funding that the banks put in place via APRA to reduce exposure.

Volume of loans from a broker
If you are to use a broker who is a valued source of business for that bank, you can utilise their volume power in rate reduction. Professional commercial loan brokers who write a lot of volume can have better negotiating power with the banks. It makes sense that if a supplier or referral source is bringing in a lot of business, you look after them. The same applies for a commercial broker. Generally we can leverage our volumes on buyers’ behalf to help negotiate better rates. 

Strength of guarantors
If guarantors to the loan have strong income and asset position, it provides scope to strengthen a deal. A lot of the time the directors of your entities are going to be guaranteeing the debt. Their assets and liabilities as well as incomes they derive from other sources can have a strong influence on the way the banks will price debt.

Bank appetite
If a bank wants less exposure to an industry, it can price higher. Consistently banks and even individual bankers on a portfolio basis can go through periods where they may price debt cheaply for balance sheet growth or price it higher to increase their return on equity. This can be fairly dynamic so it’s good to have someone in place with a good understanding and contacts for all the banks to maximise your position.

Value of existing relationship to bank
Banks take a wholistic view of all revenue derived from client, both on personal and business basis. Overall revenue generated out of banking relationship can assist in negotiating rates. If you have a business, it could be the transactional accounts you hold with them; it could be foreign exchange, wealth and insurance or home loans — they take a view of all those things as a combined picture. If you’re worth more to them because you’ve got more services with them, that can help negotiate rates down because they’re making money from you.

Potential for further opportunity
Banks may price more cheaply if there’s opportunity for further business — and not just lending-related business. If you have a trading business or you have home loans, they would generally price competitively to get the opportunity to win your business later, down the track.

Ultimately, engaging a professional who understand how commercial debt is priced can help you negotiate a better rate and get a better finance deal. It’s good to have someone on your side who knows what the banks are looking for and can talk in their language.


NOTE: This article first appeared at Ray White Commercial