Preface
If you are reading this, you may be considering acquiring a commercial property, for example, a commercial or industrial condo, an office building, a manufacturing/warehouse facility, apartment building, shopping centre, strip mall etc., and this generally involves the negotiation of a commercial mortgage. While most of you may have had experience with residential mortgages, commercial mortgages come with their own set of rules and headaches. This paper explores a few of the considerations inherent in the procurement of commercial mortgage financing.
Case-by-case basis
The principal challenge in securing a commercial mortgage is meeting the requirements of the commercial lender at a given point in time. Commercial mortgage applications are typically more involved than residential ones and are open to considerable subjective analysis on the part of lenders. This is because the assessed value of the underlying security – the real estate – is given mainly by market forces occurring where the property is situated. Hence, location, timing of the current economic cycle, use, rental income and expenses or owner occupancy are key factors considered by lending institutions before advancing a loan.
Loan-to-value ratio
As you can guess, commercial investment properties are viewed conservatively by lenders and require significantly more equity than may be required in the residential scenario.
Loan-to-value (LTV) is the percentage calculation of the loan amount divided by the purchase price. If you know the LTV requirements of a particular lender, you can calculate the loan amount by multiplying the purchase price by the LTV percentage. Note, however, that the purchase price must be buttressed by an independent property appraisal. If the appraisal amount shows a value less than the purchase price, lenders will typically use the lower number determining the loan value.
Homework before approaching a lender
Approaching a commercial lender is not simply a matter of just showing up. There is a long list of things you should know and have prepared prior to making a commercial mortgage application.
They include:
- An appreciation of the typically lengthy commercial mortgage application process,
- An understanding of cash flow generated by the property relative to debt servicing the mortgage;
- Ensuring the appropriate ‘conditions’ are set in the Agreement of Purchase and Sale;
- The documents the lender will require so it can intelligently assess the risk involved;
- The third-party reports that will be required as well as the approximate costs and time required to complete them;
- A knowledge of the financial criteria the lender will use to assess the application and;
- An understanding that the lender may request collateral security in addition to the property;
- A survey and all pertinent zoning information.
The above list is by no means exhaustive. As such, it is prudent to meet with a lawyer experienced in the area of commercial real estate acquisitions at the beginning of the process in order to make sure you are covered going into the deal.
Timelines
Given the higher degree of lender risk inherent in commercial financings, lenders typically require anywhere from 30 to 90 days to carry out their due diligence on commercial mortgage applications. It typically takes as long to procure various necessary documentation – Environmental Assessments, Property Appraisal(s), Financial Statements, Operating Statement, etc. – because doing so takes time. Given this, purchasers must ensure that the financing condition in the Purchase and Sale affords sufficient time for said diligence to be carried out.
Collateral Security
Prospective purchasers should also be aware of the possibility that other collateral security may be requested by the lender to secure the commercial mortgage. In many cases personal guarantee will be required. The quantum of the guarantee will depend on the transaction. Purchaser guarantees of 50 per cent of the mortgage amount in such deals are common. In addition, lenders typically require property insurance be in place for a sum covering the full quantum of the mortgage.
Conclusion
Commercial mortgages are more complex financing vehicles than the residential variety to which most people are accustomed. There are numerous elements to be aware of and a considerable number of things to come up to speed on when thinking about purchasing and financing a commercial property. This paper only scratches the surface and it is recommended that you consult directly with a commercial lender or lawyer experienced in commercial real estate should you be in the market to purchase a commercial property.
Author: Jayson Schwarz LL.M. is a Toronto business lawyer and partner in the firm Schwarz Law LLP.
