Commercial Financing versus Residential Financing

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By Michael Lee

Financing for commercial property is completely different than financing for residential property. To a large degree, it is a different set of lenders and a different set of lending criteria.

Qualification

One of the main differences regarding qualification for commercial financing versus residential financing is that the borrower’s personal income is generally NOT a factor. From the lender’s point of view, the property should be generating enough net income to stand on its own merit.

This is not to say that lenders don’t need to see any income from the borrower. They will look at the whole picture, and consider all factors, in their assessment of a loan request (property location, its condition, personal net worth, credit, etc.). If the property’s income were to be reduced, the lender will want some assurance that the borrower has additional personal income to supplement potential cash flow shortfalls.

Interest Rates

Interest rates on commercial property tend to be higher than on residential property for the simple reason that, from the lender’s point of view, there is a greater risk of default on commercial property (i.e. a person doesn’t have to live in their commercial property). One exception is CMHC insured financing of multi-family property.

Loan to Value

In general, lenders require that borrowers provide a larger down payment when purchasing a commercial property. Lenders will generally finance 75% on multi-family, mixed use, and strata office/retail types of property. They will normally do 65% on industrial warehouse, flagged (part of a chain) hotels/motels, strip malls, gas stations, RV/mobile home parks, and 50% on raw land. If the land is to be developed within a year, and rezoning is in the latter stages, lenders will generally consider providing a higher loan to value or simply do it as part of a construction loan where they might do 70% of the overall costs (including all soft costs, hard construction costs, and land costs).

Other Considerations

The turnaround time on commercial financing is usually 4-6 weeks. In the case of more complicated transactions, such as construction/development projects, the timeframe can easily be 3-6 months or longer. As compared to the residential side, where a deal commonly is completed and funded within a few weeks, you must allow for the longer lead times when setting subject removal and completion dates. Unless it’s an all-cash deal, and financing is not required, do not let Realtors® suggest that you should write the purchase offer with less than 4 weeks for financing subject removal and 5-6 weeks for completion (citing that the seller won’t accept that long a lead time). It’s rarely going to happen any quicker and you’ll just end up in a more stressful situation, requiring the seller to extend dates.

Costs are much higher than on the residential side, as commercial lenders will usually require a commercial appraisal, and environmental Phase 1 report, and sometimes require a building condition report. Depending on the type of property and location, and how busy the consultant is, a commercial appraisal may cost upwards of $2500 and an environmental is usually around $2000. This is also part of the reason that the commercial financing turnaround time is so much longer, as it usually takes several weeks for these types of reports to be prepared.

Unlike the residential side, whereby the mortgage broker is compensated by the lender, on the commercial side brokers are not compensated and, therefore, charge a broker fee. Typically, there are lender and broker fees involved in putting the commercial financing in place, and the legal costs of both the lender and the borrower are to the account of the borrower.

If you have been investing primarily in residential real estate, and are looking to move into the realm of commercial real estate, you will definitely need some help navigating the new waters.

Even if you are a seasoned professional with commercial property, it is hugely beneficial to make use of a knowledgeable commercial mortgage broker. As the year progresses, a lender’s portfolio and tolerance for certain asset classes will change. For example, your bank/lender might have been able to finance your development project at the beginning of the year but later in the year their portfolio for that asset class might be full and they would have to turn you away.

A commercial mortgage broker can correctly structure the loan request for a particular lender, know which lenders to approach at any given time, and shop the market for a client. It is extremely time consuming work. It is far better to use the commercial mortgage broker as a resource and extension of your team and concentrate on what you do best.

Michael Lee, AMP, B Comm., has over 9 years of commercial financing experience in Western Canada. As the head of the Vancouver office for Mortgage Alliance Commercial, Michael has experienced all types of commercial financing and was a 2008 and 2013 finalist for the Commercial Mortgage Broker of the Year award.

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