Commercial and residential mortgages: why it’s important to know the differenceNews
Before ever arriving on Homburg’s (digital) doorstep, many prospective learners have already engaged with the real estate industry - even those who have spent no time working in a professional real estate capacity. This is, of course, due to common participation in residential real estate as both buyer and seller.
On the topic of finance for investment in commercial real estate, knowing not only how to recognize the difference between commercial and residential mortgages, but how to then compare mortgage products, is an asset. Don’t be fooled - there’s a significant difference between the residential mortgages you might’ve seen in the past, and the commercial mortgages you’ll come to understand.
Qualifying yourself, and qualifying your property
At the outermost level, the key difference separating commercial and residential mortgages is how qualification for funding occurs. As you may or may not have experienced in the residential setting, the specifics of the borrower lend to whether or not one is qualified, by any given institution, for a mortgage.
Alternatively, commercial lenders qualify mortgages based on the prospective value of the property both now and in the future. Factors at play when these decisions are made include the tenure of leases and occupancy rates, the (net) operating income of the property, and how reliable a property’s net operating income is against interest payments, among others.
Being a landlord vs being a business
Perhaps the only contradiction to the distinct crater between commercial and residential real estate is a lender’s focus on the individual involved in either case. Where a borrower’s credentials lend insight into their likelihood to yield a return on investment, lenders are also predisposed to opt for owners leasing their properties as opposed to businesses seeking a mortgage. Understanding why is key in understanding that preference.
In short, a lender has to look at one of two things based on whether they’re presented with a business mortgaging a property, or an owner leasing theirs. The former calls for an evaluation of the business’ growth strategy, cash flow, and market viability. The latter bypasses those evaluations, because the business of being a landlord is home to stability not found in each and every business.
Prepare for commercial property variance
From there, things continue to stray further away from the routines and designations of commercial’s residential sibling. Because residential real estate is typically limited to specific structures and use case scenarios, commercial real estate winds up inherently more complex due to variance in the same categories. The reality is that there are probably as many intricacies (and institutions to enforce them) as there are commercial property types. Preparing for the ones relevant to your situation will require some additional homework.
In the end, preparation is both the reward and the call to action when you know the difference between commercial and residential mortgages. Understanding that difference empowers real estate professionals with insight on a lender’s expectations (both in general and based on the property), and how to prepare accordingly. For a deeper look at commercial and residential mortgages, and the factors behind their design, head to Homburg’s Advanced Real Estate Finance, with Roger Staiger page.