The cost of deferred maintenance

Director of Commercial Lending , First National Financial Corporation
  • May. 6, 2015

Darryl BellwoodCapital work is expensive. When replacing or refurbishing the major components of a property, costs can rise and rise rapidly.

All the major aspects involving roofs, boilers, the exterior facade, brickwork, foundations, electrical, mechanical, etc. can be expensive, depending on the work and the severity of the deferred repairs. If you own a house, you may have experienced the cost of replacing these items in the past.

These items are no different on a commercial property, though generally larger in size and cost. Postponing necessary work can complicate existing problems and increase the cost of solutions, so being diligent and proactive will keep maintenance expenses under better control. 

As a lender, we see different scenarios and situations, but when an owner decides to avoid completing them, this can profoundly affect financing.

Lenders use the property as security for the mortgage and, as a result, we need to ensure the property will be maintained in satisfactory condition for the amortization period. When working on financing a property, we look for items that are deferred in order to ensure they are replaced or refurbished as part of the mortgage financing.  

Three levels of deferred maintenance

Lenders in general have three levels of deferred maintenance that we classify as Priority 1 items, Priority 2 items and safety items. Depending on the severity and classification, we will either require an undertaking to complete work on any of the deferred maintenance or we will hold back money from the advance of the mortgage in order to ensure the items are rectified.

Funds are released to the owner once the work has been completed. 

Safety items are considered anything likely to put the health and safety of property users in jeopardy and have to be dealt with immediately. They can range in severity from a tripping hazard to spalled brickwork falling off a chimney to a loosely secured railing on a building balcony. If sufficiently severe, we may halt the financing of the property until the items are rectified.

Priority 1 items immediate repairs

Priority 1 items usually affect the integrity of the property and are identified as being immediate repairs that should be completed within the next 12 months. Such items can include, but are not limited to, the roof being at or nearing the end of its useful life, an aging parking garage requiring a new waterproofing membrane or a boiler in need of upgrades.

They are usually components essential to the economic life and physical useful life of the property and, if not addressed, would lead to a drop in the integrity of the building and over time affect the lender’s security.  

Priority 2 items are the least severe. They are usually identified as items which need to be reviewed and potentially replaced or refurbished in the next two or more years. Most lenders look at a period of 10 years out from the set-up of the mortgage and will monitor the state and condition of Priority 2 items over the life of the loan.

These items are most likely to require an undertaking to complete at some point during the term of the mortgage.

Undertakings and holdbacks are the lender’s way to enforce completion. When refinancing existing mortgages, an owner should be aware of any of these types of deferred maintenance items and address them accordingly. As a lender, I attempt to visit each property I finance and look for any of these items if I can identify them. Require an engineering report

Requires an engineering report

But we are not experts in major building components, and therefore usually require a borrower to obtain an engineering report to address all the items referred to and have the engineer comment on their severity.  

In extreme cases, holdbacks to enforce completion can be large. It really depends on the severity and estimated cost of the repairs identified. If, for example, the cost to repair an item is 10 per cent or greater than the loan amount, an owner should expect a holdback to force completion of the item. 

The owner of the propert would then need to pay the cost of the repairs out of pocket and would be reimbursed from the holdback once they are completed.

The lender, while requiring a holdback, may also limit the leverage against the property by reducing the loan amount or, in an extreme case, decline the loan if the safety and priority one items are extensive. 

Other factors to be aware of in financing your property are a lender reducing the available leverage on the property, or the risk-associated interest rate being higher for financing. These factors are always considered during the underwriting of the mortgage.

Not being proactive can be expensive by forcing you to complete work or by paying interest on the funds held back. This can be avoided. Any time property owners decide to be proactive and start work prior to a lender forcing them, this will help in securing long-term trust with your lender.

Darryl Bellwood is the Assistant Vice President, Commercial Financing with First National Financial, Canada’s largest non-bank lender. He is active in most markets in the country with a focus on investment real estate. All feedback is welcome and he can be reached at darryl.bellwood@firstnational.ca.

 


Darryl Bellwood is the Assistant Vice President, Commercial Financing with First National Financial, Canada’s largest non-bank lender. Darryl provides commercial mortgage financing solutions for all types of commercial real estate…

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Darryl Bellwood is the Assistant Vice President, Commercial Financing with First National Financial, Canada’s largest non-bank lender. Darryl provides commercial mortgage financing solutions for all types of commercial real estate…

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