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Posts Tagged ‘commercial mortgage canada’

Commercial Mortgages versus Residential Mortgages – Rates and Rules

Sunday, December 21st, 2008

Not a day goes by that I don’t get a call from someone from my website or blog asking about my rates and then when I meet with them, they drop the bomb on me that they are talking about commercial real estate. I have to hit the brakes hard in this situation as commercial real estate financing and residential real estate financing are two totally different animals.

First off, why? The rules regarding the protection for homeowners are very different than the laws that protect business owners. Also, the lender’s rights are substantially different in a commercial transaction that in a residential transaction. If the commercial property happens to be a farm, that makes it ever MORE difficult for the lenders.

Secondly, when lenders “securitize” or sell their mortgage “paper” it means they are offering the mortgages to investors and turning a profit in the process while also getting back their money for the next mortgage. This is the way all banks operate, despite the fact that the original issuing bank happens to service the mortgage. Commercial paper, in this credit crisis, is very difficult to sell, and many lenders are tightening their guidelines to ensure that they are able to sell paper (and thus stay in business) throughout the crisis (which, by the way, is far from over).

So what exactly are the differences between a commercial and residential mortgage? The most prominent are:

1. Rate
2. Amount of down payment required
3. Pre-payment terms
4. Amortization
5. Timeline for Approval and Conditions of the Approval

RATE

IF YOU ARE FINANCING COMMERCIAL PROPERTY YOU WILL PAY A HIGHER RATE.

This isn’t something you can avoid. The BEST 5 year rate I have seen on commercial money in the past week was 5.42% on a 5 year term, but in the residential world I can get 4.70%. In most cases, I am getting quotes of 6.25% – 6.45% on 5 year terms from other commercial lenders. I always have people call me wanting to buy a property that has a commercial unit in the basement with residential upstairs. They intend to live in it (irrelevant as it is a commercial property), and are upset when the best rate I can find is 6.00% when they see my blog advertising 4.70%. The mortgage behind the scenes is different and clients need to expect this.

Rate is the lender’s return for the RISK they are taking with your mortgage. You may think the risk is small, but commercial properties are often very hard to sell, and if the lender has to foreclose (always something they consider) they want to know how long it will take them to offload and sell the property. So, the rate is higher. This is a fundamental fact that must be accepted.

DOWN PAYMENT

Secondly, commercial mortgages generally require a substantial amount more down payment. Typically, you will need 35% down payment when purchasing (or need to leave 35% equity in the property in the case of  a refinance) commercial property. This is not a totally hard and fast rule as we can often get an additional 10% financing from private lenders – but rarely more – unless the property has amazing cashflow. The normal commercial lenders want 35% down, but they will allow us to get a 2nd mortgage for an additional 10% (or whatever we can arrange). The max I have seen through conventional bank commercial financing is 80% and that was on a strata unit for a 30 year existing client of the credit union who had millions of dollars on deposit with the credit union. Normally, you only get 65% financing. You cannot get 5% down commercial mortgages (in 99.99% of cases – there are exceptions but it isn’t through banks – it is usually through the Business Development Bank of Canada who also takes an equity stake in the company in these cases).

PRE-PAYMENT TERMS

In most cases, in a residential mortgage, you are able to make lump sum pre-payments (without a penalty OR with a penalty) as well as increasing your monthly mortgage payments. Also, the banks are not allowed to prevent you refinancing (or getting 2nd mortgages). The terms in the law is that a lender cannot “clog the equity of redemption” for a RESIDENTIAL borrower. Lastly, if a borrower sells the property, the lender MUST let the mortgage be paid out.

In a commercial mortgage, this might not be the case (depending on your lender). Some lenders do not allow ANY pre-payment at all. Nevermind a penalty. That doesn’t matter. To them the mortgage is an investment with FIXED cashflow. They may not allow ANY extra payments, or ANY accelerated payments. In fact, there are a couple lenders out there who do not allow ANY payout of the mortgage (even if the property is sold!!!). This situation requires the mortgage to stay with the sold property, and is often a sticky point that buyers are unaware of if they are used to residential mortgages.

AMORTIZATION

In a residential mortgage, you can often get a 35 year (or even 40 year in some cases) amortization. In a commercial transaction, the norm is 25 years or “remaining useful life of the building.” If the building is, say, 25 years old, needs some repair, and really is only usable for another 15 years, then the mortgage will be NO MORE than 15 years – but usually only 10 (remaining economic life minus five years – for standard commercial properties – exceptions apply). This results in often FAR higher payments than clients expect if they are used to residential transactions. The higher payments can often be a deal breaker if the lender thinks the commercial property’s cashflow doesn’t support the payments (even if the client thinks they can “afford” the payments they may not “qualify” for the payments)

TIMELINE OF THE APPROVAL AND CONDITIONS OF THE APPROVAL

Most times residential mortgages can be “buttoned up” and fully approved within 48 hours if your mortgage broker is really pushing hard, but normally within 5 business days for a standard transaction. In a commerical transaction, from application to funding is normally around 60 days. The reason is that a commercial transaction has numerous additional requirement. For starters, you will need a commerical appraisal (generally takes 3 to 4 weeks) as well as a phase 1 environmental (also takes 3-4 weeks). Yes, you can get it faster, but expect the prices to double. There may be additional geotechnical studies, other more in-depth environmental studies, and even when you get it all approved, you face a much more lengthy legal process to have the mortgage registered and the documents prepared. Generally, expect 45-60 days for a NORMAL commercial deal. If it is a complicated deal with multiple properties, development potential, and/or construction and building, it may take far, far longer.

SUMMARY

So there are the differences. They are many, varied, and depending on the property or lender there can be even many more differences that this article does not cover as the number of situations and permutations are vast. If you are considering buying commercial property, PLEASE CALL ME FIRST even if just to get a layout of how the deal will look. It costs nothing for my advice and info, and it could save you a lot of time, hassle, and money.