Commercial Mortgages: “How to See the Deal”

When I first started working with Commercial Mortgages about 10 years ago, I had a hard time wrapping my head around what went into putting one of these deals together. Each deal is truly unique and I soon found can have many moving parts. In order to get a better understanding of what I was doing, I needed to put in place a process, or standardized approach that I could follow on all my deals. After a while, I found what works for me and wanted to share this approach. I found that there are several key factors that contribute to a typical deal and how addressing these factors can help you to “See the Deal”.

Since most, if not all commercial mortgages are paper-based and there really isn’t a web-based system like filogix that you can use to enter information into in order to produce a clear picture, the story or summary that is prepared for a commercial deal is very important. This summary gives me a good overview and allows me to “See the Deal” so that when I’m speaking to a prospective lender, colleague or drafting a quick email, I can highlight the critical points fairly quickly and concisely.

One way to “See the Deal” is to use the 3-legged stool or a 3-point triangle like the one at the beginning of this article. Basically, the main points or factors that I work with and focus on in my approach are:

1)     The Covenant

2)     The Income

3)     The Real Estate

The idea is to analyze each point and gather the necessary details for each in order to determine whether that point is weak or strong. What documentation do you need to assess each point? Also, what or where are the risks associated with each point and if necessary how can these risks be mitigated? How can you best sum up each point?

When looking at the ‘Covenant’, consider this;

  • What is the Borrower’s net worth? With commercial mortgage financing, the Borrower’s income is not that important since we don’t rely on their income to pay the mortgage – the property’s rent does. The Borrower’s net worth is more important.
  • Is the Borrower’s net worth all comprised of real estate or is it well diversified? How much in liquid assets do they have?
  • If they needed to inject funds into the property for emergency repairs (ie. Roof or HVAC  system needs a replacement immediately) or they need to cover the mortgage payment from their own resources due to unexpected or chronic vacancy, would they have the funds available?
  • How’s their personal credit? Are their taxes current? Do they have any other sources of income?
  • Etc

When looking at the ‘Income, we typically consider what determines and what can affect the property’s rent and this can include;

  • Cash flow. What does this look like? How much rent does the property generate? What is the likelihood that it will continue?
  • Net Operating Income (NOI), which is Income minus Expenses. The NOI is important since we use the NOI to calculate the two critical ratios used in commercial lending – the Loan To Value (LTV) and the Debt Coverage Ratio (DCR)
  • What are the leases like? Short term, long term? Do the tenants pay for any expenses such as taxes, utilities, insurance or maintenance? Ie. Are the leases Gross, Semi-Gross or Triple Net?
  • Do all the leases come due at the same time, in the same year or are they staggered over several years (this is known as Rollover Risk)?
  • Are the rents belowat or above market rents? How do they compare to similar properties? Are there yearly increases (step-ups)?
  • What type of tenants are they? Weak or strong? For example, Tim Horton’s is a great tenant; stand-alone restaurants, not so great. What’s the history of the tenancy?
  • What is the vacancy like and how has it been historically?
  • Does the client have a properly prepared Rent Roll?
  • Etc

Finally, when looking at the ‘Real Estate’ (which IS the lender’s main security) some of the points to consider are:

  • What type of property is it? Conventional, unconventional or special use? Can it be easily converted for other uses?
  • Where is it located? Is it urban or rural? Is it located in an area with other similar properties? Or does it stand out?
  • What is the property worth? How does the value compare to similar properties? Do we have an appraisal?
  • What is the property’s condition? Are there any major repairs or upgrades that are needed in the short or medium term?
  • How old is the property? Is the property too old to repair? Do we have a Building Condition Report (BCA)? Will we need one?
  • Are there any sources of environmental impact on or near the property? What is located acrossnext to or upgrade to the property? Do we have an Environmental Site Assessment (ESA)? Will we need one?
  • Etc

I’ve ended each section with Etc because by no means did I include all of the possible things to consider or questions to ask.

By being able to “See the Deal” a commercial broker will be able to discuss the file clearly. Discuss the strengths and weaknesses. Discuss the risk factors and what can be done to mitigate those factors. This will also help in gathering the necessary documentation and identify what will be required in order to proceed, quickly and efficiently.

The benefits to developing an approach similar to this are many. This allows for a more streamlined and standardized process which will also make a broker’s life easier when putting the deal together and making the process as painless as possible for the client.

It also instills confidence in the lenders you will be marketing the deal to since it shows some thought and insight into your underwriting. Also, one factor I know is critical with most lenders, is to have some conviction and to believe in the deal; when submitting a file for review I find that really standing behind the deal, “…I recommend the deal based on…..” and list your thoughts goes along way versus saying, “….I have a deal….what do you think……?”. “Seeing the Deal”, makes it easier to stand behind the deal and express why. This will only strengthen your relationship with your lenders.

In the end, this will result in a quicker turn around and the ability to get a better deal for your client.

 

Ermanno Tasciotti  | January 2018

Commercial Mortgages: How Much Down Payment Do I Need?

“It Depends”. These are the two words I frequently use when discussing a commercial mortgage. Whether it’s how much of a downpayment is needed, what the rate is, amortization, etc. It depends.

Let’s consider the first one; downpayment. How much does a client need to put down for a commercial property purchase? When determining this amount, the process isn’t as simple as it is for a residential deal but in some ways is very similar.

Please note that the following discussion pertains to when underwriting a deal based on the property’s cash flow and when dealing with a lender that will look to the rental income as the primary source of repayment.

With residential, the clients can get a preapproved mortgage by calculating how much they qualify for using their income and existing debts. They can then make a Purchase based on their Pre-Approved Mortgage plus their Downpayment.

Simply put,

Preapproved Mortgage + Downpayment = Purchase Price

With commercial, you really can’t get a preapproval since the mortgage is generally based on the income of the property and not the borrower – having said that, I can take the income and expenses on a commercial property and approximate how much of a mortgage it can carry, while not a preapproval, it can give you some guidance – contact me for details!

So you start with a Purchase Price and then work backward similar to a residential preapproval and end up with the Qualifying Mortgage amount and subsequent Downpayment. The process looks like this,

Purchase Price – Qualifying Mortgage = Downpayment

The best way to illustrate this is with a couple of examples. To make things simple I will be looking at conventional and not high ratio financing.

Please note the following terms:

  1. Net Operating Income or NOI
  2. Debt Coverage Ratio or DCR, DSC or DSCR
  3. Loan To Value or LTV
  4. NOI. This is the net income once all expenses pertaining to the property are deducted from the rent collected. Typical expenses can include, property taxes, property insurance, utilities, snow removal, routine maintenance, etc. There will also be allowances made for Vacancy & Bad Debt, Structural Expense and Management. Every deal is different and it depends on the specifics of a particular deal which expenses will be included. Note that these expenses do not include mortgage principal and interest.
  5. DCR. This is the ratio of the NOI to the mortgage principal & interest payments. Depending on the deal, an acceptable DCR would be as low as 1.10 (or 110%) to 1.30 (or 130%). This should always be greater than 1.00 or 100%. The ‘extra’ or excess over 100% is a cushion that gives the lender comfort to account for any interruptions in rent due to high or chronic vacancy, unexpected costs, etc that could reduce the income for a period of time.
  6. LTV. The ratio of the loan or mortgage amount to the lesser of Purchase Price or Appraised Value. ‘Rule of Thumb’ LTVs can range from 60% to 70% for most commercial deals and 75% for multi-family (m/f) properties. (Note this 75% for the example below). Each lender is different.

Residential Example

Clients are looking at purchasing a single-family dwelling. They are preapproved for a $562,500 mortgage (GDS/TDS are in line) and have $187,500 for the downpayment. Using the formula above,

$562,500 + $187,500 = $750,000

Pre-Approved Mortgage + Downpayment = Purchase Price

They can purchase a home valued at $750,000. This works out to an LTV of 75% ($562,500/$750,000). Assuming that the credit is good and the property is acceptable – the deal could be fairly straightforward.

Commercial Example

Now let’s look at a commercial property selling for the same amount of $750,000 and again, the client has $187,500 to put down.

We’ll assume the subject is an 8-plex m/f. The subject is fully occupied with a rental income of $7,200/mo or $86,400/yr. Applicable expenses come to roughly $46,400/yr.

The NOI in this case is $86,400 – $46,400 = $40,000.

I’ll assume that the property is appraised at $750,000. As you will see below, the property value won’t be a factor in determining the mortgage amount. The driver will be the DCR.

Now here’s where they differ. In order to get an acceptable mortgage amount, we will use a trial rate (let’s go with 3.5%) and generate a P&I payment based on a 5 yr term & 25 yr amortization. Working backwards we make sure to stay within an LTV of 75% and a DCR of 130% (In this case – some lenders may go with 120%).

Trial and error yields a mortgage of $515,000, a DCR of 130% and an LTV of 68.7%. Using the formula above,

$750,000 – $515,000 = $235,000

Purchase Price – Qualifying Mortgage = Downpayment

So if they are buying the subject for $750,000 and the property qualifies for and can only support a mortgage of $515,000, the client will have to come up with a downpayment of $235,000 or $47,500 more than they have. As you can see, you just can’t take the purchase price and calculate an amount based on either 60, 65 or even 75% LTV. Furthermore, if the same property sold for $800,000, the mortgage amount is the same since the NOI doesn’t change and the client would now have to put $285,000 down (64.4% LTV).

In this case the client now has three options if they wish to proceed:

1)      Come up with the difference from their own resources.

2)      Secure a second mortgage. This will likely be at a higher rate & fees and note that the lender providing the first may have to approve allowing the second due to serviceability.

3)      Look at an alternative lender (private, etc) that will do the full amount requested ($562,500) or even higher but at a higher rate & fees.

In summary, when calculating downpayment for commercial, treat it like a residential preapproval and work backwards.

  • The ‘client’ would be the property and the ‘client’s income’ would be the NOI.
  • The DCR would be the qualifying ratio much like the GDS/TDS.
  • Once you have a ‘Qualifying Mortgage’ (ie. Pre-Approved Mortgage), then you look at the purchase price/appraised value for the difference.

Now I must stress that the numbers alone DO NOT determine whether or not you have a deal; they’re just a guide or an estimate to get the analysis going. As per the Mortgage Triangle I will discuss in a future post, the Income is one point that must be fully analyzed; there’s also the Real Estate and the Covenant.

I hope this helps give a clearer picture as to how the downpayment needed for a commercial mortgage is determined. As you can see, it depends.

If you have any questions or comments, please feel free to call me at 647.302.8065.

Now is the time to think commercial!

 

By: Ermanno Tasciotti |  January 2018

Commercial Real Estate Loan (CRE)

Commercial Real Estate Loan (CRE) is income-producing real estate that is used solely for business purposes, such as retail centers, office complexes, hotels, and apartments. Financing – including the acquisition, development, and construction of these properties – is typically accomplished through commercial real estate loans: mortgage loans secured by liens on commercial, rather than residential, property.

Just as with residential loans, banks and independent lenders are actively involved in making loans on the commercial real estate. Also, insurance companies, pension funds, private investors and other capital sources, make loans for the commercial real estate.

Let’s take a look at commercial real estate loans: how they differ from residential loans, their characteristics and what lenders look for.

Individuals vs. Entities

While residential mortgages are typically made to individual borrowers, commercial real estate loans are often made to business entities (e.g., corporations, developers, partnerships, funds, and trusts). These entities are often formed for the specific purpose of owning commercial real estate.

An entity may not have a financial track record or any credit history, in which case the lender may require the principals or owners of the entity to guarantee the loan. This provides the lender with an individual (or group of individuals) with a credit history and/or financial track record – and from whom they can recover in the event of loan default. If this type of guaranty is not required by the lender, and the property is the only means of recovery in the event of loan default, the loan is called a non-recourse loan, meaning that the lender has no recourse against anyone or anything other than the property.

Loan Repayment Schedules

A residential mortgage is a type of amortized loan in which the debt is repaid in regular installments over a period of time. The most popular residential mortgage product is the 30-year fixed-rate mortgage.

Residential buyers have other options, as well, including 25-year and 15-year mortgages. Longer amortization periods typically involve smaller monthly payments and higher total interest costs over the life of the loan, while shorter amortization periods generally entail larger monthly payments and lower total interest costs. Residential loans are amortized over the life of the loan so that the loan is fully repaid at the end of the loan term. A borrower with a $200,000 30-year fixed-rate mortgage at 5%, for example, would make 360 monthly payments of $1,073.64, after which the loan would be fully repaid.

Unlike residential loans, the terms of commercial loans typically range from five years (or less) to 20 years, and the amortization period is often longer than the term of the loan. A lender, for example, might make a commercial loan for a term of seven years with an amortization period of 30 years. In this situation, the investor would make payments for seven years of an amount based on the loan being paid off over 30 years, followed by one final “balloon” payment of the entire remaining balance on the loan. For example, an investor with a $1 million commercial loan at 7% would make monthly payments of $6,653.02 for seven years, followed by a final balloon payment of $918,127.64 that would pay off the loan in full.

The length of the loan term and the amortization period will affect the rate the lender charges. Depending on the investor’s credit strength, these terms may be negotiable. In general, the longer the loan repayment schedule, the higher the interest rate.

Loan-to-Value Ratios

Another way that commercial and residential loans differ is in the loan-to-value ratio (LTV): a figure that measures the value of a loan against the value of the property. A lender calculates LTV by dividing the amount of the loan by the lesser of the property’s appraised value or purchase price. For example, the LTV for a $90,000 loan on a $100,000 property would be 90% ($90,000 ÷ $100,000 = 0.9, or 90%).

For both commercial and residential loans, borrowers with lower LTVs will qualify for more favorable financing rates than those with higher LTVs. The reason: They have more equity (or stake) in the property, which equals less risk in the eyes of the lender.

Commercial loan LTVs, in contrast, generally fall into the 65% to 80% range. While some loans may be made at higher LTVs, they are less common. The specific LTV often depends on the loan category. For example, a maximum LTV of 65% may be allowed for raw land, while an LTV of up to 80% might be acceptable for a multifamily construction. There are also private mortgages available for commercial lending.

Debt-Service Coverage Ratio

Commercial lenders also look at the debt-service coverage ratio (DSCR), which compares a property’s annual net operating income (NOI) to its annual mortgage debt service (including principal and interest), measuring the property’s ability to service its debt. It is calculated by dividing the NOI by the annual debt service. For example, a property with $140,000 in NOI and $100,000 in annual mortgage debt service would have a DSCR of 1.40 ($140,000 ÷ $100,000 = 1.4). The ratio helps lenders determine the maximum loan size based on the cash flow generated by the property.

A DSCR of less than 1 indicates a negative cash flow. For example, a DSCR of .92 means that there is only enough NOI to cover 92% of annual debt service. In general, commercial lenders look for DSCRs of at least 1.25 to ensure adequate cash flow. A lower DSCR may be acceptable for loans with shorter amortization periods and/or properties with stable cash flows. Higher ratios may be required for properties with volatile cash flows – for example, hotels, which lack the long-term (and therefore, more predictable) tenant leases commonly to other types of the commercial real estate.

Interest Rates and Fees

Interest rates on commercial loans are generally higher than on residential loans. Also, commercial real estate loans usually involve fees that add to the overall cost of the loan, including appraisal, environmental report, legal, loan application, loan origination and/or survey fees. Some costs must be paid up front before the loan is approved (or rejected), while others apply annually. For example, a loan may have a one-time loan origination fee of 1%, due at the time of closing, and an annual fee of one-quarter of one percent (0.25%) until the loan is fully paid. A $1 million loan, for example, might require a 1% loan origination fee equal to $10,000 to be paid up front, with a 0.25% fee of $2,500 paid annually (in addition to interest).

Prepayment

A commercial real estate loan may have restrictions on prepayment, designed to preserve the lender’s anticipated yield on a loan. If the investors settle a debt before the loan’s maturity date, they will likely have to pay prepayment penalties. There are four primary types of “exit” penalties for paying off a loan early:

  • Prepayment Penalty. This is the most basic prepayment penalty, calculated by multiplying the current outstanding balance by a specified prepayment penalty.
  • Interest Guarantee. The lender is entitled to a specified amount of interest, even if the loan is paid off early. For example, a loan may have a 10% interest rate guaranteed for 60 months, with a 5% exit fee after that.
  • Lockout. The borrower cannot pay off the loan before a specified period, such as a 5-year lockout.
  • Defeasance. A substitution of collateral. Instead of paying cash to the lender, the borrower exchanges new collateral (usually Treasury securities) for the original loan collateral. High penalties can be attached to this method of paying off a loan.

Prepayment terms are identified in the loan documents and can be negotiated along with other loan terms in commercial real estate loans. Options should be understood ahead of time and evaluated before paying off a loan early.

The Bottom Line

With commercial real estate, it is usually an investor (often a business entity) that purchases the property, leases out space and collects rent from the businesses that operate within the property: The investment is intended to be an income-producing property.

When evaluating commercial real estate loans, lenders consider the loan’s collateral; the creditworthiness of the entity (or principals/owners), including three to five years of financial statements and income tax returns; and financial ratios, such as the loan-to-value ratio and the debt-service coverage ratio.

By: Daniela Peeva |  June 26, 2017

Top 5 Reasons to Use Mortgage Alliance Commercial Canada (MACC)

At Mortgage Alliance Commercial Canada (MACC) we pride ourselves in providing the best service possible. Our number one source of referral is via word of mouth, hence we make sure to conduct business professionally and diligently so all parties are satisfied. Here are 5 reasons we think you should use MACC on your next commercial transaction:

 

Top 5 Reasons to Use Mortgage Alliance Commercial Canada (MACC)

 

  1. Mortgage Alliance Commercial Canada was voted Canada’s Best Commercial Mortgage Broker for 5 years in a row by Canadian Mortgage Professionals Magazine
  2. MACC is Licensed across Canada with offices in Quebec, Ontario, Alberta, and BC
  3. MACC has maintained privileged relationships with all major lenders across the country to allow our clients to access better terms and conditions for their financing needs
  4. MACC will simplify and manage the entire process of the transaction from loan underwriting to lender negotiations, through to the disbursement requirements to ensure that successful completion and funding of the project
  5. MACC has 30 dedicated and experienced commercial mortgage professional at your service

 

If you have a current project you are working on and would like our assistance or have any questions on the best route to take, don’t hesitate to contact us.

MACC, Your commercial financing solution!

416-499-5454 ext 102

info@macommercial.ca

 

7 Steps to a Hot Commercial Real Estate Deal

Ask any real estate professional about the benefits of investing in commercial property, and you’ll likely trigger a monologue on how such properties are a better deal than residential real estate. Commercial property owners love the additional cash flow, the beneficial economies of scale, the relatively open playing field, the abundant market for good, affordable property managers and the bigger payoff from commercial real estate.

But how do you evaluate the best properties? And what separates the great deals from the duds?

Like most real estate properties, success starts with a good blueprint. Here’s one to help you evaluate a good commercial property deal.

1. Learn What the Insiders Know

To be a player in the commercial real estate, learn to think like a professional. For example, know that commercial property is valued differently than residential property. Income on commercial real estate is directly related to its usable square footage. That’s not the case with individual homes. You’ll also see a bigger cash flow with commercial property. The math is simple: you’ll earn more income on multifamily dwellings, for instance, than on a single-family home. Know also that commercial property leases are longer than on single-family residences. That paves the way for greater cash flow. Lastly, if you’re in a tighter credit environment, make sure to come knocking with cash in hand. Commercial property lenders like to see at least 30% down before they’ll give a loan the green light.

2. Map Out a Plan of Action

Setting parameters is a top priority in a commercial real estate deal. For example, ask yourself how much can you afford to pay and then shop around for mortgages to get a sense of how much you will pay over the life of the mortgage. Using tools like mortgage calculators can help you develop good estimates of the total cost of your home.

Other key questions to ask yourself include: How much do you expect to make on the deal? Who are the key players? How many tenants are already on board and paying rent? How much rental space do you need to fill?

3. Learn to Recognize a Good Deal

The top real estate pros know a good deal when they see one. What’s their secret? First, they have an exit strategy – the best deals are the ones where you know you can walk away from. It helps to have a sharp, landowner’s eye – always be looking for damage that requires repairs, knows how to assess risk and make sure to break out the calculator to ensure that the property meets your financial goals.

4. Get Familiar With Key Commercial Real Estate Metrics

The common key metrics to use for when assessing real estate include:

Net Operating Income (NOI)

The NOI of a commercial real estate property is calculated by evaluating the property’s first year gross operating income and then subtracting the operating expenses for the first year. You want to have positive NOI.

Cap Rate

A real estate property’s “cap” – or capitalization – rate, is used to calculate the value of income-producing properties. For example, an apartment complex of five units or more, commercial office buildings, and smaller strip malls are all good candidates for a cap rate determination. Cap rates are used to estimate the net present value of future profits or cash flow; the process is also called capitalization of earnings.

Cash on Cash

Commercial real estate investors who rely on financing to purchase their properties often adhere to the cash-on-cash formula to compare the first-year performance of competing properties. Cash-on-cash takes the fact that the investor in question doesn’t require 100% cash to buy the property into account, but also accounts for the fact that the investor will not keep all of the NOI because he or she must use some of it to make mortgage payments. To uncover cash on cash, real estate investors must determine the amount required to invest to purchase the property or their initial investment.

5. Look for Motivated Sellers

Like any business, customers drive real estate. Your job is to find them – specifically those who are ready and eager to sell below market value. The fact is that nothing happens – or even matters – in real estate until you find a deal, which is usually accompanied by a motivated seller. This is someone with a pressing reason to sell below market value. If your seller isn’t motivated, he or she won’t be as willing to negotiate.

6. Discover the Fine Art of Neighborhood “Farming”

An excellent way to evaluate a commercial property is to study the neighborhood it’s located in by going to open houses, talking to other neighborhood owners, and looking for vacancies.

7. Use a “Three-Pronged” Approach to Evaluate Properties

Be adaptable when searching for great deals. Use the internet, read the classified ads and hire bird dogs to find you the best properties. Real estate bird dogs can help you find valuable investment leads in exchange for a referral fee.

The Bottom Line

By and large, finding and evaluating commercial properties is not just about farming neighborhoods, getting a great price, or sending out smoke signals to bring sellers to you. At the heart of taking action is basic human communication. It’s about building relationships and rapport with property owners, so they feel comfortable talking about the good deals —and doing business with you.

 

By: Daniela Peeva | June 14, 2017

Proud to announce we are nominated as the Best Commercial Broker for a 4th year in a row

For the last 15 years, M. Durand has built and led a firm that has become the largest, most active pan-Canadian firm dedicated to the Commercial Mortgage Brokerage Industry. M Durand’s efforts have been recognized by his industry peers’ who have nominated him in each of the last 4 years as the best commercial mortgage broker in Canada. No other professional in the industry has seen such recognition.

Congratulations Michel!

$ 143,850,000 secured in construction financing !

post-november

Mortgage Alliance Commercial is pleased to announce that it has secured $143,850,000 in construction & project financing to support the development of Unionville Gardens Condo & Townhomes Project. Multiple lenders participated in this financing masterpiece.

Unionville Gardens has 379 condo units and 72 townhouses. This project is spearheaded by a visionary real estate developer, Wyview Group who brings to Canada a reputation for delivering quality and craftsmanship to all his endeavors.

The project is a resounding success and is currently 95% sold out with a delivery anticipated to begin as of spring of 2019.
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Contact us today!
416-499-5454 ext 259 / info@macommercial.ca