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Buyer beware of often onerous commercial mortgage process

As a commercial real estate broker, it’s my job to prepare my clients. Typically, there is a proc...

As a commercial real estate broker, it’s my job to prepare my clients. Typically, there is a process they will need to go through to complete a lease or purchase.

The purpose of my focus here is to provide an overview of the steps necessary to mortgage commercial real estate.

Time management

Establishing a period for due diligence and financing is part of the purchase negotiation process.

Typically, the buyer ends up with 30 to 45 days from acceptance of offer by both parties.

The process of obtaining the mortgage will consume most of that time.

Organized investigation

The initial priorities for due diligence upon acceptance of offer would be to immediately engage building inspectors, the surveyor and an environmental engineer.

If the property is in a major centre, we also request a “Property Information Disclosure” from the building standards department.

The report typically indicates building and plumbing permit history and deficiencies, outstanding fire orders, heritage and zoning designations, outstanding landscaping and parking requirements and the presence of additional zoning requirements.

Then more reporting…

In addition to the above-mentioned reports, the financial institution is likely to ask for the following items in the process of application:

– application Fee;

– copy of the offer to purchase and related documents;

– current rent roll and copies of existing leases if applicable;

– personal net worth statement;

– certificate of incorporation;

– three years of financial statements from your corporation;

– verification of equity or downpayment;

– estimate for cost of insurance;

– if the property is outside of the province in which you are incorporated, it will be necessary to extra-provincial register the corporation;

– may require a personal guarantee (amount and duration to be negotiated);

– establish an account with the subject financial institution (you’ll be encouraged to bring all your banking needs to the financial institution that provides the commercial mortgage);

– if new construction, a detailed construction budget and contractor information;

– may be asked for a business pro forma.

Do the math

Your commercial real estate broker can help you understand the loan-to-value options commercial lenders are likely to offer.

It’s important to understand the debt service coverage ratio (DSCR). A bank requires that there is sufficient net operating income to provide a surplus after paying the mortgage principal and interest.

Here’s an example, using a $5 million purchase price:

– A $3.75 million mortgage (at 75 per cent loan to value) at 3.5 per cent amortized over 15 years requires debt servicing principle and interest payments of $321,139 per year.

– If the bank has a 1.25 debt servicing ratio requirement, it will be necessary for the property to provide a total net annual income of $401,424, or a surplus of $80,285, to qualify for the mortgage.

These calculations are important to play with before even touring a property.

If the cap rate is too low, it can be very difficult to achieve the required DSCR. One logical solution is to provide a larger down payment.

Preparation is key

If buyers enter the purchase process unprepared, they may not be able to put together everything asked of them in time. This can often result in requesting an extension to their conditions.

If there is a back-up offer in place or the seller is not willing to extend, this could result in a frustrated contract and no deal.

Any time and money spent during the due diligence period is lost.

Although the process may sound onerous, if you’ve done your homework, are prepared with the required paperwork, and have selected a good, experienced mortgage broker or commercial lender to work with, the entire transaction should be painless!

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