Is an Owner-Occupied Commercial Mortgage Different Than an Investment Mortgage?

In September 5, 2017

Owner-Occupied Commercial Mortgage versus Investor

Yes! Let me explain if you’re new to the whole business of commercial real estate…

Walking into a bank to seek a commercial mortgage loan, the first question any borrower can expect is related to use of the property. “Will this be an owner-occupied or investment property?”

The reason for the question is simple: each type of loan has very different criteria and terms, and a lender may prefer one over the other. In fact, some banks won’t even consider real estate investment loans, which can be quite complex to underwrite and are considered a higher level of risk.

Investment property mortgages are financed using the property itself as primary collateral to secure the loan, dependent on lease payments from non-related third parties as the only source of revenue.

Loan-to-value (LTV) is a ratio commonly used by banks to measure risk for both investor and owner-occupied mortgage loans. It compares the total financed amount to the market value of the property, so lenders can determine equity (the difference between the two numbers) in case of foreclosure.

Generally the higher the LTV—meaning the amount of the loan is close to what it is worth, so less equity is available to cover the loan—the higher the risk is for the lender.

Maximum LTVs are typically set by the lender based on the type of loan. 

In contrast, an owner-occupied property loan is financed based on the revenue of the business and its collective assets as collateral, not solely the value of the building. Cash flow from the business pays the mortgage, rather than the often-unpredictable tenant occupancy that investment properties rely on.

If you intend to house your business in the property you’d like to buy, that’s good news to the bank.

What is considered owner-occupied?

If an owner-occupied mortgage is more attractive to the lender, what actually determines if a building is considered owner-occupied? Generally 51 percent of the property must be directly used for the borrower’s business – especially when it comes to Small Business Administration (SBA) loans. The specific percentage may change based on the type of loan or at the discretion of the lender.

Owner-occupied mortgages are easier to finance. 

Because a borrower has more “skin” invested in their business than an investor does in a rental property, a loan backed by revenue from that business is attractive. It’s harder for the borrower to walk away. Plus, since the bank isn’t investing in the stability and creditworthiness of tenants renting space in the building who pay for the mortgage, the risk is far less complex. They’re able to zero in on the company and its financial strengths.

Businesses who use the property themselves are also more likely to invest in the infrastructure of a property, intending to keep it long-term.

Horizon Community Bank’s senior commercial lending manager of the Mesa branch, Jim Nelson, shares an example. “We have a water bottling company as a customer who’d outgrown its facility, and was looking to move. It had unique requirements, due to its sizable conveyor lines and water purification equipment, and the need for a larger-than-usual water pipelines to rapidly fill a high volume of plastic bottles. ”

“They found an ideal new location in a former soda bottling plant. Because they’d still be required to invest heavily to configure the building to suit their needs, they’re likely to remain in the location for a long time.”

Owner-occupied loans also tend to offer more flexibility, with lower interest rates and down payment requirements than the higher-risk investor mortgage demands.

Owner-occupied mortgages have a wider range of financing options.

As a more attractive loan, owner-occupied mortgages offer a wider selection of financing options, including SBA 7a or SBA 504 loans, USDA loans (for those in rural areas only) and conventional financing.

Conventional loans are often simpler, requiring less paperwork, fewer fees and a shorter approval period than government-backed loans, but the trade-off can be a larger down payment and possibly higher interest rates.

For more information on commercial mortgages, Jim Nelson can be reached at JimN@HorizonCommunityBank.com or by calling 480-558-1220.

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