Understanding the Commercial Mortgage Process
Buying or leasing a property – whether residential or commercial – requires a series of steps that can take time, preparation of documents and some understanding of the process so you are aware of the steps needed to secure the right approvals.
I believe firmly in keeping my clients informed ahead of the process so there are no surprises along the way and because I want my clients to feel well-taken care of.
The process for securing commercial real estate is onerous, as I alluded to above, but worth it in the end when you are all set up. Here is a summary of the steps to help you get that lease or commercial mortgage.
Expect the process to take time
You know how long it can take to find a home, well, finding the right commercial property can take longer as there are usually fewer properties on the market at any one given time. Give yourself ample time to conduct the necessary due diligence when locating the right property for your needs, and it’s very important that financing is part of any negotiation discussions and processes.
It can take anywhere from 30 to 45 days from acceptance of the offer by both parties to secure the right funding and get the paperwork in order.
Upon Acceptance of your Offer
The initial priorities for due diligence upon acceptance of the offer would be to immediately engage building inspectors, the surveyor, and an environmental engineer.
If the property is in a major city centre, we also request a “Property Information Disclosure” from the building standards department. This report typically indicates building and plumbing permit history and deficiencies, outstanding fire orders, heritage and zoning designations, outstanding landscaping, parking requirements and the presence of additional zoning requirements.
Documentation you’ll be asked for
In addition to the above-mentioned reports that will be sought out on your behalf, the lender or financial institution will require the following documentation for your commercial funding application:
- Application Fee
- Copy of the offer to purchase/lease 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 down payment
- 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 registration of the corporation
- May require a personal guarantee (amount and duration to be negotiated)
- Establish an account with the funding financial institution
- If new construction, a detailed construction budget and contractor information will be required
- You may be asked for a business pro forma
And while this may seem to be a long list of required documentation, it may not be representative of every unique situation, as your funding institution may require additional documents to satisfy your unique needs.
Understanding the Math
Work with your commercial real estate broker to understand the loan-to-value options likely to be offered by commercial lenders during the process as understanding this is based on the commercial properties you are looking at.
Our team highly recommends that you spend time understanding the debt service coverage ratio (DSCR), as well as the financial institution your mortgage is placed with, will require 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 on commercial property:
- A $3.75 million mortgage (at 75 per cent loan to value) at 3.5 per cent amortized over 15 years requires debt servicing principal 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.
- If the capital rate is too low, it can be difficult to achieve the required DSCR. One logical solution is to provide a larger down payment.
These calculations are important to understand and work with before looking at a property to ensure it aligns with your financial needs, not just your business’ operational needs.
Being Prepared is Important
Understanding the process is important because it will help you prepare in advance for the time required, documentation needed, and it will provide you with an understanding of the steps needed to secure the right approvals.
Specific reasons to be prepared…
If you enter the commercial purchase process unprepared, you may not be able to put together all the documents and requirements in time, which often results in requesting an extension to their conditions.
If there is a backup offer in place or the seller is not willing to extend, this could result in your offer falling through.
Any time and money spent during the due diligence period is lost.
If you have prepared and understand the details, the commercial real estate and mortgage process, you will save yourself a lot of time and potentially money – so it’s wise to invest the time upfront to be prepared.
And if you have questions, lean on your commercial real estate and mortgage brokers – we are here to simplify the process and help you get your company into the right property so you can focus on building your business!
-AJ
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