The Risks of Commercial Building Financing

The risks of commercial building financing must be understood before any type of investment is made or a loan request for financing is granted. Every type of loan has certain risks, but the degree of risk involved in financing commercial buildings or investments is often greater because of the amount of property and money involved. The key to minimizing the risks involved with financing a commercial building is to arm yourself with knowledge so that you can be prepared for the ups and downs that will come with the financing of the commercial building.

The First Risk: Construction Risk

The construction can involve a simple remodeling or a new building, and can involve significant sums of money. The failure to follow a budget can be fatally detrimental to the financing of a project. The lender has to follow the project closely. Funds should only be advanced in stages and only  based on an evaluation on how the project is progressing and how closely the project is adhering to a planned budget. Always check the numbers involved and make sure the figures add up. Emotion should not be a deciding factor to finance, because remaining objective to see the reality behind the numbers is a critical skill.

Second Risk: The Risk to Capital

The second risk involved is that any type of commercial building requires capital. One point to remember is that when financing a commercial building, the lender is usually dealing with professionals who understand the expectations of a lender and have some resources to put towards the initial capital costs of the project. Proof of capital is an essential component before any deal can proceed to the next stage.  A related risk is that the capital used to finance the commercial building may be tied up for awhile, which means the ability to carry costs over a long period of time and having ample reserves to cover the ongoing expenses are critical because some commercial buildings may be difficult to sell.  Also keep in mind that buildings age over time and may become less valuable than the amount that was financed.

Third Risk: Market Risk

Market risk involves of the possibility of an economic downturn, which could mean that the commercial building financed may be producing little or no income for a while.  Having a capital reserve is critical if the project does not produce the expected results. A sensible and realistic business plan must be presented that can be backed up by hard data that justifies why the loan should be given. The potential profitability of any project must be fully analyzed before any loan should be made.

There are greater rewards involved in financing commercial buildings, but there are  greater risks too. Understanding those parameters can help mitigate the risks involved, and help the institution or person financing the loan prepare for as many situations possible.  Remaining objective, following sound financial principles, analyzing the business plans and overall project goals will help minimize the risks, although the risks will never entirely disappear.