Benefits and Challenges of Owner-Occupied Commercial Property Loans

Securinga new loan to purchase or refinance owner-occupied commercial propertypresents unique benefits and challenges compared to investor commercial properties. An owner-occupied property is one where 50% of more the space is occupied by a business owned and operated by the owner of the building. Owner-occupied properties cover a range of business and property types, from office, retail, and warehouse properties to special use properties such as medical and dental offices, gas stations and auto repair shops, restaurants and hotels and motels.

The benefits of owner-occupied commercial loans include:

  • Lower Interest Rates – In general, rates on owner-occupied properties are lower. That is because the loan is backed not just by the leases and the creditworthiness of the owner, but also by the creditworthiness of the owner’s business. Also, occupancy is more predictable, as the owner-occupied business is less likely to move to secure lower rents or a more favorable location or facility.
  • Longer Fixed Rate Terms – Most investor loans are limited to rates fixed for 5, 7 or 10 year, with a 25 (occasionally 30) year amortization, due in 10 years. Owner-occupied commercial property loans are often available as 20 year fixed rates, with a 20 year amortization, due in 20 years, or 15 year fixed rates, with a 15 year amortization, due in 15 years. Locking in a low fixed rate of interest for 15 or 20 years with no need to refinance after 10 years provides borrowers with long-term certainty of monthly loan payment amounts and avoids transaction costs associated with refinancing.
  • Access to SBA 7(a) and 504 Financing – SBA financing is only available on owner-occupied property and is a mixed blessing. The additional paperwork and underwriting steps are a hassle and there are SBA fees that add to the cost of financing. However, SBA financing allows for a higher loan-to-value financing – up to 90% – and mitigates certain credit challenges (i.e. late payments, past due property taxes, defaults) and property risks that would rule out conventional financing. For example, most lenders will only extend conventional financing on special-use properties and those with environmental risks – such as gas stations and auto repair facilities – if there is a low loan-to-value and excellant credit. A recent change in rules now allow SBA 504 fixed rate financing to be used for refinance of existing owner-occupied properties where previously only typically variable rate 7(a) loans were possible.

Owner-occupied commercial property loans are not without their challenges. These include:

  • Business Must Guarantee the Loan – With an owner-occupied commercial property loan, the property owner’s business must guarantee the loan. The lender will underwrite not just the property and the owner, but also the owner’s business. This involves lender review of the operating results of the business including tax returns, interim financials (income statement and balance sheet) and business debt schedule. This means more paperwork and scrutiny which most borrowers would prefer to avoid. Issues may also arise if the ownership structure of the business is different from that of the property. For example, if the owner of the property has partners in the business who are not partners in the property.
  • Rates Tied to Banking Relationship – The interest rate offered by lenders on owner-occupied commercial property loans are generally set according to the overall relationship with the borrow and the borrower’s business including their business and personal checking and savings accounts and, when applicable, other business loans and/or payment processing relationships. Often, borrowers are not happy about changing an existing business banking relationship in order to secure the lowest rate on the commercial property loan.

In summary, greater flexibility in loan terms and lower rates are available when financing owner-occupied commercial properties. However, this comes with added complexity in the underwriting process and may involve changes in other banking relationships to secure the best rates and terms. Working with knowledgeable professional and comparing quotes from multiple lenders is key to closing with the most favorable financing solution.