Commercial Property Loans —
What you need to know

How commercial differs from residential investment

On the surface, a commercial property loan looks like a residential investment loan: borrow against an asset, charge rent, service the debt. In practice, lenders treat the two very differently. Commercial property is considered a different risk category because tenants behave differently, vacancies are typically longer, and values are driven by income rather than comparable sales.

The headline differences you can expect:

• Lower loan-to-value ratios — typically 65 to 70 per cent for standard commercial, sometimes lower for specialised assets
• Higher interest rates than equivalent residential investment loans
• Shorter loan terms — commonly 15 to 25 years, sometimes with shorter fixed periods or review points
• Larger deposit and cash buffers, plus higher establishment and valuation costs
• Greater scrutiny of the lease, the tenant and the property's location and use

For a primer on residential investment lending and how it sits in the wider tax and finance system, our negative gearing article is a useful starting point.

Why lease covenant strength matters

In residential lending, the rent is helpful but the borrower's personal income usually carries the loan. In commercial, the lease itself is part of the security. The lender wants to see:

• A strong tenant — ideally a national, listed or government-backed business, although smaller tenants are routinely accepted with the right structure
• A long remaining lease term, often three years or more, ideally with options to extend
• Clear rent review mechanisms — fixed annual increases, CPI, or market reviews
• A net lease structure where the tenant pays outgoings (rates, insurance, maintenance) is generally preferred
• Personal or director's guarantees from smaller tenants where appropriate

An asset with a weak tenant on a short lease will be valued and lent against very differently to the same building with a five-year lease to an investment-grade tenant. The same property can support quite different loan amounts depending on who is in it.

Valuations based on yield

Residential property is usually valued by direct comparison with similar properties that have recently sold. Commercial property is valued primarily by capitalisation rate (cap rate) — that is, by dividing the property's net income by an appropriate yield for the asset class and location.

If a small Perth retail unit produces $80,000 of net income a year and the market is valuing similar properties at a 6 per cent cap rate, the indicative value is $80,000 ÷ 0.06 = approximately $1.33 million. Move the cap rate to 7 per cent and the same income produces a value of around $1.14 million. Small movements in yield drive large movements in value, which is why commercial values can shift more sharply than residential during interest rate cycles.

Practically, this means:

• Anything that strengthens net income (longer lease, stronger tenant, fixed reviews) supports value
• Anything that weakens income (vacancy, short lease, weak tenant) compresses value
• Lenders use independent commercial valuations, which are more detailed and more expensive than residential ones

Rates, structure and terms

Commercial loans come in a wider variety than residential loans. You may see:

• Variable, fixed or partially fixed rates
• Interest-only periods, sometimes for the whole loan term in lower-LVR deals
• Shorter review periods — for example, a 15-year loan with a review every 3 to 5 years, where the bank reassesses the deal
• Optional line-of-credit structures for active investors

The Reserve Bank of Australia's cash rate decisions influence commercial pricing, although margins tend to be wider and more lender-specific than in the residential market.

The SMSF angle (briefly)

Commercial property is one of the more common assets purchased through a self-managed super fund using a Limited Recourse Borrowing Arrangement (LRBA), in part because business real property can be leased to a related party (such as your own business) at market rent, where residential generally cannot. That makes it attractive to small business owners who would otherwise pay rent to an external landlord.

However, SMSF commercial lending is its own category — fewer lenders, higher deposits (often 30 to 35 per cent), and significant compliance overhead. We have a separate piece on SMSF property loans (LRBA) with the full picture, and we strongly recommend involving a financial adviser and SMSF accountant before going down that path.

Commercial vs residential investment — the trade-offs

It is worth being honest about the trade-off. Commercial typically offers:

• Higher yields — net rental returns of 5 to 7 per cent are common, compared with much lower net yields on most residential
• Longer leases with the right tenant, providing more income stability
• Tenants who often pay outgoings, reducing your ongoing costs

The other side:

• Vacancies are typically longer — months rather than weeks
• Values are more yield-sensitive and can move sharply
• Capital growth has historically been more variable than residential in many segments
• Specialised assets (hospitality, service stations, childcare) carry higher risk and tighter lending
• Less liquid; selling can take longer and cost more in agent fees and legal

Commercial lending suits some investors very well, particularly those with business cash flow, an existing residential portfolio, and a reasonable tolerance for vacancy risk. It is not a like-for-like substitute for residential investment.

This article is general information only. Whether commercial property suits your circumstances depends on your goals, cash flow, tax position and risk tolerance. Speak to a qualified mortgage broker, accountant and financial adviser before committing.

Frequently asked questions