Not all franchisees need commercial property. But, if yours does, it’ll be the largest single transaction you’re likely to ever undertake whether you plan to buy land and construct your own buildings or purchase existing, freestanding property. In either case, there are 3 major issues that you need to consider when buying property and ultimately getting a commercial business loan to do so.
Affordability
For any commercial or business loan, you’ll only be approved for what you can afford. All lenders look at your anticipated operating profits (revenue left over after all other business expenses are covered) to determine how much your business has to service loan payments. And, it’s from this amount how they determine what you can afford.
Example: Let’s say your franchise expects operating profits of $5,000 per month after salaries, marketing costs, inventory expenses, etc. This means that your business has this $5,000 per month to service or make payments on your real estate loan. Now, let’s say that you want to purchase property (or are searching for a property) that will cost $750,000. If you expect a loan at 10% for 20 years, your monthly payment (both principal and interest) will calculate out to approximately $7,238. But, if you only have $5,000 to make loan payments, you cannot afford property in the $750,000 range. If you drop your price range to say $500,000, your anticipated payment would be about $4,825 – within your range. But, this still might not get your loan approved given that most lenders want to see some cushion in your cash flow in case you have a bad month or two. They still want to ensure they get their payment should your revenue dip say 10% or more from time to time. If you assume a 10% cushion in your monthly cash flow, your monthly payment ability would be around $4,500 and would result in a maximum loan amount of about $466,000.
Keep in mind that you can do some things to increase your loan amount by negotiating your interest rate down, increasing your down payment and/or extending your loan term.
Down Payment
All commercial lenders will require some form of down payment. This down payment goes towards your purchase price but, in the eyes of the lender, ties you more closely with their loan. Thus, they feel that if the going gets tough, you’ll be less likely to walk away from the loan given your personal stake in it.
At a minimum, all lenders will require at least 15% to 20% down and, in this economy given weak consumer spending and low property values, many lenders may require more – from 30% to 60% down – depending on what else you bring to the deal.
That’s the bad news.
The good news is that the more you can put down, the more your business can afford – more it can afford in the property that it plans to purchase as well as more in the loan amount that it can be approved for. Also, know that for larger loan amounts and longer loan terms, the more risk the lender will be perceived to have and as a result will require more in a down payment.
Other Costs
Paying principal and interest and coming up with a down payment is not the only cost that your franchise will face. All lenders will require that you cover all the closing costs – costs associated with commercial appraisals, title searches and policy costs, origination fees, points and so on – costs that will have to be paid at closing out of your pocket (on top of everything else). On average, you can expect these closing costs to be in the range of 3% to 5% of your loan amount.
Conclusion
Know that buying commercial real estate is not easy or inexpensive. But, if you go into the transaction knowing both the requirements and the costs, you can better determine what type of property your franchise can afford, where that property can be located and ultimately your chances of getting your commercial loan approved. Then, from that point on, it’s up to you how far your franchise can go.