A Comprehensive Guide to Commercial Auction Finance

Commercial Auction Finance is a specialized form of lending used by property investors and developers to finance the purchase of commercial properties at auction. Auctions are an attractive avenue for acquiring commercial real estate, often offering properties at below-market value or unique investment opportunities. However, securing the necessary auction finance can be a complicated process, especially if you have adverse credit, are a first-time landlord, or if the property you intend to purchase is considered high risk.

In this guide, we’ll explore how commercial auction finance works, the impact of adverse credit, being a first-time landlord, lender appetite for specific types of commercial properties, loan-to-value (LTV) ratios, and how these factors influence your chances of securing financing. We will also examine how tenant strength and tenancy agreements affect lenders’ willingness to offer favorable terms for auction purchases.

What is Commercial Auction Finance?

Commercial Auction Finance is a short-term financing solution designed for individuals or businesses seeking to purchase commercial properties at auction. Unlike standard commercial finance, auction finance must be arranged quickly to meet the often-tight payment deadlines following the auction’s conclusion (usually 28 days). This financing can take the form of bridging loans or short-term loans specifically tailored to support auction purchases.

When bidding at a commercial auction, it’s essential to have your financing pre-arranged or at least in principle to secure the property quickly once your bid is successful. Auction finance differs from traditional property finance in that it is generally provided on a short-term basis, often lasting between 12 to 18 months, and may have higher interest rates than long-term mortgages.

The Role of Adverse Credit in Commercial Auction Finance

Adverse credit, also known as a bad credit history, can significantly impact your ability to secure commercial auction finance. If you’ve experienced missed payments, bankruptcies, or CCJs (County Court Judgments), lenders may be more reluctant to provide you with financing. However, this does not mean it is impossible to secure funding. Understanding how adverse credit affects your auction finance prospects and how you can mitigate its impact is essential.

1. Higher Interest Rates and Fees: Lenders view borrowers with adverse credit as higher risk, which often translates into higher interest rates and additional fees. While commercial auction finance generally has higher rates than standard loans, those with poor credit histories may face even steeper costs due to the perceived risk.

2. Lower Loan-to-Value (LTV): For borrowers with adverse credit, lenders may offer a lower loan-to-value (LTV) ratio. LTV refers to the proportion of the loan against the property’s value. For example, if you are looking to purchase a commercial property at auction worth £500,000, and the lender offers an 80% LTV, you would receive £400,000 in funding. However, if you have poor credit, the LTV may be reduced to 60% or 70%, meaning you would need a larger deposit.

3. Need for a Strong Business Case: When applying for auction finance with adverse credit, a strong business case becomes even more crucial. Lenders want to see that you have a clear plan for managing the property, generating income, and addressing any potential risks associated with the purchase. Demonstrating a viable exit strategy—whether through the sale of the property or its income generation—is key to persuading the lender to take the risk.

4. Guarantors: If you have adverse credit, you may be asked to provide a guarantor—someone with a stronger credit history to back up the loan. The guarantor essentially assumes responsibility for the loan in case of a default, which reduces the lender’s risk and can help improve your chances of securing finance.

The Impact of Being a First-Time Landlord on Auction Finance

Being a first-time landlord presents another challenge when applying for commercial auction finance. While having experience in property management can make you appear less risky to lenders, first-time landlords can still secure financing, although it may require more work to convince the lender of their ability to handle the responsibilities involved.

1. Lack of Track Record: Lenders are more likely to offer favorable terms to borrowers who have a proven track record in property management. As a first-time landlord, you don’t have this history, which can make lenders cautious. To mitigate this, a solid business plan that demonstrates your understanding of property management, market conditions, and potential risks can increase your chances of securing finance.

2. Higher Deposits: First-time landlords are often required to contribute a larger deposit to the purchase, reducing the risk to the lender. A deposit of 30% to 40% is common, as lenders may offer lower LTV ratios to new landlords who lack experience in managing commercial properties.

3. Guarantor Support: If you lack experience, having a guarantor who has a proven history of property management may help improve your chances of securing financing. The guarantor is essentially vouching for your ability to manage the commercial property effectively, adding credibility to your application.

4. Clear Exit Strategy: Lenders want to see that you have a clear exit strategy in place. As a first-time landlord, you may need to offer more detailed plans regarding how you intend to make the property profitable, whether through renting out space, refurbishment and resale, or a long-term hold strategy. Without this, lenders might see your purchase as a risk.

Lender Appetite for Certain Types of Commercial Properties

Lenders’ appetite for different types of commercial properties can vary widely. Some properties are considered high risk, while others are seen as safe investments. Understanding which types of commercial properties lenders prefer and how their characteristics affect auction finance is essential when bidding at commercial auctions.

1. Retail Properties: With the rise of online shopping and the decline in foot traffic in physical stores, lenders may be cautious about financing retail properties. A high street store or a shopping center might be considered a higher-risk investment, and lenders may require higher deposits, offer lower LTV ratios, or impose higher interest rates on such loans. However, well-established locations or prime retail spaces with long-term tenants might still attract favorable terms, even in a challenging retail market.

2. Office Space: Office properties can be a tricky investment, especially with the trend toward remote working. Lenders are likely to be cautious about office spaces, particularly in areas where demand has dropped. However, properties in prime locations or those with strong long-term tenants might still attract more favorable financing terms.

3. Industrial and Warehousing Properties: Industrial properties like warehouses, logistics centers, or distribution hubs are often favored by lenders, especially given the rise in e-commerce and demand for storage and distribution space. These assets tend to generate stable rental income and are seen as lower-risk investments.

4. Mixed-Use Properties (MUFB): Mixed-use buildings that combine residential and commercial units are often seen as more attractive by lenders. This is because they offer diversified rental income and are less vulnerable to market fluctuations in a single sector. Commercial units in a residential area can provide a steady income, and lenders may offer better terms for this type of property.

5. Tenancy Type: Properties leased to strong, long-term tenants are more appealing to lenders. Lenders want to ensure that the property will generate stable, predictable rental income. For example, a commercial property leased to a government agency or large corporation will be seen as less risky than one leased to a small business with an uncertain financial future.

Loan-to-Value (LTV) in Commercial Auction Finance

The Loan-to-Value (LTV) ratio is an essential consideration when applying for commercial auction finance. The LTV ratio determines how much of the property’s value the lender is willing to finance. In general, the higher the LTV, the more the lender is exposed to risk, which may affect the terms of the loan, such as the interest rate or repayment schedule.

1. Higher LTV for Strong Tenants: Properties with long-term, strong tenants often attract higher LTVs. A stable and reliable income stream gives lenders confidence in the borrower’s ability to repay the loan, and the LTV may be as high as 70%-80%.

2. Lower LTV for High-Risk Properties: If the property is located in a high-risk area, has weak tenants, or is a type of property with lower demand (e.g., retail space), lenders may offer a lower LTV. This means the borrower will need to contribute a larger deposit to secure the loan, typically ranging from 30%-50%.

Conclusion

Securing commercial auction finance is a strategic and sometimes complex process, especially when factors like adverse credit, being a first-time landlord, lender appetite, and tenant strength come into play. Although challenges exist, careful planning, a strong business case, and understanding the nuances of commercial property financing can increase your chances of securing funding. By preparing for the auction and understanding the intricacies of LTV ratios, tenant strength, and lender preferences, you can confidently approach your next commercial property auction with a higher likelihood of success.