Commercial real estate investors look for the best financing arrangements before they construct new buildings. One option to consider closely is the leasehold mortgage. While similar to other mortgages in many ways, this approach to financing does involve a slightly different strategy. Here are some of the basics that you should know.
The Definition of a Leasehold Mortgage
Leasehold mortgages are part of a broader category of financing known as commercial mortgage lending. Instead of being aimed at landowners, this mortgage option is designed for use by tenants. The stated purpose of this type of mortgage is to construct buildings on leased land that is not developed.
How Does It Work?
Unlike other mortgage arrangements, a leasehold mortgage makes it possible for a business owner to secure the funding needed to construct buildings on property that is currently leased for a time frame that the lender considers acceptable. For the duration of the mortgage loan, the debtor must remit payments in accordance with the payment schedule. The debtor is also expected to maintain the lease on the property until the debt is retired in full.
This strategy makes it possible for a business owner to secure a tract of land at a reasonable price and not deal with many of the responsibilities associated with maintaining that land. For example, the debtor must make the mortgage payments, but is not responsible for paying the annual property taxes. That remains the responsibility of the landowner.
What About Collateral?
With most mortgage arrangements, the applicant must pledge some type of collateral. Often, the real estate owned by the applicant serves as the security. Since the business owner seeking a leasehold mortgage does not actually own the land, the security must be in some other form.
The land lease itself is sometimes considered enough for security. That’s why the duration of the lease is so important to the financing. If the lender looks at the lease and sees the applicant has entered into an agreement that will last for another three to four decades, that indicates a fair amount of stability. When the applicant can also provide evidence that the proposed building project is highly likely to generate a steady flow of revenue, the lender will often consider the risk reasonable.
Will the Credit Score Enter Into the Picture?
The lender will evaluate both the credit score and the credit history of the lender before approving the leasehold mortgage application. Doing so provides more information about the financial habits of the applicant, and indicates whether the business owner is known to pay debts on time. Assuming the applicant has a strong history of borrowing money and repaying it according to the lending terms and conditions, that will also improve the odds of securing the loan.
Why Not Use Existing Assets?
One question many people have is whey the business owner would seek financing in the first place. Arranging to use something other than company assets to finance the construction of an office building, apartment complex, or retail establishment ensures those assets are free for other uses.
In the best-case scenario, the new building will begin to generate revenue shortly after it’s finished. That revenue stream is used to cover the leasehold mortgage payments, the lease payments on the land, and still leave some net profit for the business owner to increase the company’s wealth.
Does the Landowner Figure into the Loan Evaluation?
The landowner is an integral part of the mortgage arrangement. Before approving the loan application, lenders typically want confirmation that the owner is aware of the proposed building project and has no objections. If the lender finds that the landowner was not aware of the tenant’s intentions and has not provided permission to build on the land, the application is either rejected or placed on hold until all parties agree to go ahead with the project.
Leasehold mortgages are often profitable for all parties concerned. The tenant gets to develop a business site that ultimately generates a lot of money. The landowner gets a developed property without the need to actually pay for that development. The mortgage lender enjoys returns from the financing for an extended number of years.