Commercial Mortgage Overview

Introduction

• Commercial mortgage brokerage requires more education and experience than brokerage for residential mortgages
• Requires knowledge of lenders, financing options, and valuation methods for commercial properties.
• Commercial mortgage transactions rely on referrals rather than advertising

Key learning outcomes

• Understand differences between residential and commercial mortgages
• Recognize different types of commercial property
• Understand commercial qualification requirements and how leverage works
• Recognize the fees and documents needed for commercial mortgages.
• Understand the differences in applicant and lender relations.

What is a Commercial Mortgage

• A commercial mortgage is a mortgage loan for a business or income-generating property as loan security.
• Security includes properties such as retail complexes, apartment blocks, offices, industrial buildings, manufacturing facilities, or bare land for development.

Types of commercial mortgages

• Purchase transactions for new or existing properties.
• Refinance transactions, may involve paying out an existing loan.
• Expanding or renovating the property.
• Buying out a partner's share of a business or property.
• Leveraging a commercial property for tax and estate planning.
• Construction loans for funding development.

Types of Commercial Property

• Commercial property is defined by use: industrial, office, multi-family, and retail.

Industrial

• Properties for manufacturing, production, distribution, and logistics.
• Varies from small equipment repair operations to large distribution centres.

Office

• Properties intended to provide space and amenities to businesses.
• Differentiated by location, quality of finishes, and amenities.

Multi-family

• Residential properties with five or more separate dwellings.
• Examples include high-rise towers, townhome developments, mobile home parks, or student residences.
• Apartment and townhome developments are traditional multi-family, while mobile home parks and student residences are specialty multi-family.

Retail

• Properties intended to market and sell consumer goods and services.
• Examples include grocery-anchored centers, power centers, regional malls, neighborhood retail, small convenience retail, and fast food locations.

Other property types

• Vacant land zoned for commercial development (serviced or unserviced).
• Leisure properties such as hotels, motels, resorts, spas, sports and recreation centers, campgrounds and golf courses.
• Healthcare properties such as nursing homes, medical office buildings and medical research properties.
• Properties categorized as commercial under local land-use bylaws.

The Purpose of Commercial Mortgages

• Commercial mortgages offer different opportunities for consumers.

Portfolio diversification

• Commercial mortgages provide investors with portfolio diversification.
• An investor with $1 million could buy a single property or four properties using mortgage financing

Capital stack

• The capital stack is the financial structure used by debt lenders and equity investors acquiring a commercial property.
• The structure contains senior debt lenders, mezzanine or subordinate debt lenders, and equity investors.
• Senior debt lenders are paid first and generally earn the lowest rate of return.
• Mezzanine and subordinate debt lenders are second in line and earn a slightly higher rate of return.
• Equity investors receive excess proceeds and earn an unrestricted rate of return when the property performs well, and are the first to lose money if it performs poorly.

Leverage

• Leverage uses debt financing to increase return and access bigger deals.
• Rewards come with risk and potentially increases the volatility of the return.

Using 100% equity

• If property value decreases by 25%, they only lost 25% of the investment.

25% equity with 75% loan-to-value

• If the property value decreases by the same 25%, they lose 100% of the equity investment.

Positive and negative leverage

• Two types of leverage, positive and negative are determined by cost of capital and rate of return
• Positive leverage has a rate of return on the investment that is higher than the interest rate on the mortgage.
• Negative leverage has an interest rate higher than the rate of return, earning the investor a lower return on equity.

Owner-occupied property

• If a commercial real estate owner intends to occupy a unit of their commercial property for the use of their business, it is considered an owner-occupied property.
• Lenders require these applicants to lease remaining units to arms-length third parties at market-level rates.

Qualifying Applicants

• Residential mortgages require both the applicant and property to meet qualifying standards.
• Residential lenders prioritize the applicant’s ability to repay the loan from their income.
• Commercial mortgages similarly require the applicant and property to qualify.
• Commercial lenders prioritize the value of the property as the primary factor for qualification.
• The borrower's credit strength can be a more important factor than the property in certain situations or with some lenders
• Example: borrower looking for a mortgage secured by land to develop and would generate no income from the property

Underwriting guidelines

• Lenders structure underwriting guidelines around the applicant's income, equity, and credit behavior for residential mortgages.
• Commercial underwriting guidelines consider: property valuation and cash flow, property to generate income and ability for applicant to service loan payments

Qualifying ratios

• Residential qualifying ratios include gross debt service ratio (GDS), total debt service ratio (TDS), and loan-to-value ratio (LTV).
• Commercial qualifying ratios are loan-to-value ratio (LTV) and debt service coverage ratio (DSCR).
• Loan-to-value ratio (LTV) is the ratio of the commercial mortgage to the purchase price or appraised value of the property, as a percentage.
• Debt service coverage ratio (DSCR) is the ratio of revenue remaining after paying property operating expenses (Net Operating Income (NOI)), divided by the total relative debt service cost.

Loan size and repayment

• Commercial mortgage loans range in value from hundreds of thousands to hundreds of millions of dollars, much larger than residential loans.
• Commercial mortgage loans are usually repaid through blended monthly payments of principal and interest.

Knowing Your Commercial Applicant

• Commercial borrowers differ from residential applicants (individuals wanting to buy property as a home)
• Commercial applicants are typically experienced investors/businesses with an interest in investment or income-generating value of the property.

Commercial applicant business possibilities:

• Sole Proprietorship: One owner responsible for all assets and liabilities, where personal assets may be used to meet business debt obligations.
• Partnership: Similar to sole proprietorships, where owners are responsible for assets and liabilities; there is joint ownership between two or more individuals.
• Corporation: Legal entities recognized under law, where individuals running the corporation arent liable for its debts and personal assets are severed from the business portfolio.
• Limited Liability Company: Similar to corporations in protecting personal assets from debt obligations, but income flows through owners or investors like sole proprietorships/partnerships.
• Limited Partnerships: Investment partnerships in real estate development with a written agreement between general & limited partners, where limited partner's share is larger until a certain limit.

Lender Preferences

• Commercial lenders prefer lending to corporations and may require becoming incorporated.
• Commercial mortgage underwriting assesses managing income or sale projections of the commercial property over the ability to sustain income
• The applicant's financial capabilities, history in real estate property management, sales, and experience are important for lenders.

Personal Guarantees

• Lenders may request a personal guarantee to lend to corporations.
• A personal guarantee is a promise obligating a business owner to honor the debts incurred by the business.
• The potential amount may include the total value of the mortgage loan amount.

Applicant Relationship

• The relationship between is between commercial and residential mortgage brokerage is different
• Residential mortgages involve personal relationships given the emotional attachments. Commercial usually involves working with experienced applicants and a business portfolio.

Commercial Deals

• Commercial mortgage deals differ greatly with varied commercial property types and investment opportunities.
• More complicated than residential mortgages with significantly more paperwork

Closing Time

• Commercial mortgages have longer turnaround times than residential
• Commercial property appraisals are almost always required that take one month to complete.
• Environmental reports may take one month to complete; a Phase I Environmental involves a map review and site review, with a qualified engineer requesting further phases
• Commercial building inspections may be needed for buyer’s due diligence, required as a finance condition from the lender.
• Due diligence involves assessing the income-generating potential of the property, requiring detailed financials
• Cumulative effect of these conditions significantly increases the processing time

Interest Rates

• Residential rates based on posted rates, commercial not fixed, but banks offer an interest rate based on the risk for that particular transaction
• Expect 175 to 250 basis points over Canada Bond Yield, may be higher depending on term length and risk profile
• Commercial mortgage spreads correlate with BBB-rated corporate bonds.

Brokerage and other fees

• Most straightforward residential deals do not charge extra fees.
• Commercial deals almost always charge brokerage fee, larger amounts because significantly larger loan amounts in commercial mortgages
• Larger transactions/institutional lenders can collect portion of the fees from the lender and include in the interest rate
• For commercial transactions,closing costs are much higher especially where real property appraisals, environmental reports and brokerage fees are involved
• Need to keep client knowledgeable of costs, which can be incurred, even if deal does not work out

Summary - Residential vs Commercial Mortgage

• Qualifying residential mortgages require both applicant and property to meet standards. Lenders prioritize ability to repay from employment income.
• Qualifying commercial mortgages also need applicant and property to qualify but prioritize property value as the main qualification factor.

Qualifying Guidelines and Ratios

• Residential mortgages guidelines are structured around applicant’s employment income and credit behavior. Lenders use GDS, TDS, and LTV ratios.
• Commercial mortgages guidelines are property valuation and quality of cash flow from the applicant and the property. Lenders use LTV, DSCR, and cap rate ratios.

Loan Size

• Residential mortgages are smaller amounts; lenders may specify a maximum loan amount but rarely a minimum
• Commercial mortgages are larger amounts; lenders may require a minimum loan amount.

Borrowers

• Residential mortgage borrowers tend to be individual buying/refinancing a property to live in
• Commercial borrowers are usually experienced investors or an incorporated business buying, refinancing, or constructing a property for investment or income purposes.

Relationship with applicants

• Relationship is emotional connecting of trust in residential mortgage applications
• Relationship is very complex to build trusting rapport in order to succeed.

Time to closing

• Residential average one to two weeks to close
• Commercial time to close average two months or longer with larger and more complex deals

Commercial Land Use and Zoning

• Commercial brokers identify if the proposed use of the property conforms with its designated land use.
• Land is divided into zones that define the property type and permissible uses
• Land use zones and bylaws regulate the development of land by outlining rules relating to: the permissible use of a site, the approval of new development and placement of buildings

Land use bylaw maps

• Typically found on municipal websites and municipal resource centers.

Municipal Land Use Zoning code

• City districts usually given land code series starting with “I” for industrial, R for residential, and C for commercial.
• In Calgary, C-N1 Land Use code for commercial property zoned to offer small scale retail services in urban community

Commercial Development Permits

• Land Use bylaws are just one part of legal permits that affect the development of commercial site.
• Most projects need a series of Permits before starting construction or development or other development components on Projects
• Can take significant time because cumulative effect of permits causes great delays
• General contactor Project manager Lawyer or project architect usually pull permits on project

Development Permits

• Under Land use bylaw to authorize or refuse Development, development authority May place development conditions or Obligated provide reasons

Building Permits

• Most projects need building permits ensuring construction follows Municipal Bylaws in agreement with approved plans

Lender Considerations

• When determining whether to fund mortgage request lenders consider other factors with commercial property

Physical Condition

• How commercial property is greatly impacts revenue and resale - Building and inspection is great for not only recommending but doing financing

Location

• Appears Curb appeal, access, egress-exits parking/ factors to considering

Commercial Tenants

• When assessing least property to one or many lenders the strength and ability to pay tenant greatly effects lender side

Commercial LTV (Loan to Value)Ratios

• Commercial lenders have their on LTV they want to accept for commercial mortgage
• However it type of business and commerical property effects how acceptable the LTV
• Commercial - Lenders usually will give up to 40 % land that not good zoning, if want finance up 85 percent apartment

An LTV ratio of 75%

• A standard to consider as standard for Most Stabilized Income-Producing Properties

Mortgage Default Insurance

• Generally lower for cm compared to RES
• Commercial Lenders have the security to Mortgage Insurance but for Mult-family rental Commercial Lender can do for mortgage insurance

Risk Factors and Multi-unit RES lending

• open to mult-unit because low Risk; high Rental housing
• residential parts easy rental in diverse parts
• Some can may seem hard
• where linked to Industry and can also see turn down because insurance premiums cost plus non refundable application

Office Property

• Single Multi buildings for business for use
• Properties are under for different categories; class AA, A B downtown suburban offices medical

Risk and Lender

• Most are going want financial depending lending, less leasing Risk
• Major Affect or office vacancy may effect lenders - Class -Property can great effect level and attractive ——

Anchored Versus Unanchored

• Well know retailers Such like (department Store large Super market draw Customer inside shopping centers

Anchors and Interested Rates

• Have largest retailer = more stable = better Mortgage

Also decreased interested rates increase in shopping consist only local-

• may have hired and some possible lowered LTV

RiSk factor

• Most receptive and some lenders are reject especially bars and recreation
• To maintain more rent and value =replacement tenant same industry

Industrial property

—includes warehouses Distribution Center storage facilities manufacturer plants research Facility

Rick factors

• Is potential lender concerning include industrial property -limited use even foreclosure
• Environment always affect liability/ must lend in environmental contamination

Chartered banks (prime or institutional lenders)

• typically accept LTVs up to 75% LTV or industrial
• Considering the applicants financial strength might enhance capital

To retail properties

• Same properties can look highly after - example a warehouse is less out or not desireable example

Insurance and Mortgages

Great significance when comes to financing some property such as-Multi residential(4 untits) - Senior/ long term —student low/ community -such program may purchase etc

Introduction to commercial lenders

• Commercial mortgage can gives more business to both but borrower more to acquire property but launched new venture -Lenders into good solid and great return rates invest In the part look at -different lender and investment market

Commercial vs Residential Lenders

that deal residential property also deal Commercial

• some large is chartering bank usually do -Seperating different is usually like chartered bank division - Residential lender/ MICs also can Finance deals for commercial -also significance different between residentials and commercial in lenders But there offerings

Do to commercial Mortgage product

• Commercial Mort product different those product like new canada program Self employment —under write product general but

Commercial institutional lenders groups:

Credit Unions-life insurance come companies —(as prime Lenders in context / Mortgage primaryMarket)— Conduit lenders

• (for secondary Mortgage )/ Pension funds also in (secondary mortgage)
• Business of bank Development of Canada -program from government. Soucre the source affect —include Primary ,secondary , Mortgage market also the Government.

Commecial transaction has most to institutional lender . Significance - -Equity( down payment) experience/ low market high demand borrower

Priority for borrower

To minimized costs borrow-

In ability or high need flexibility or zoning -Subject property is considered a low risks stable income to have a marketable