Monday, July 29, 2013

Mortgage Terms/Conditions - "Not As Simple As Financing Your Home" (For Canadians Only)

In earlier posts, we talked in general terms about Mortgage Financing, and now would like to expand the discussion, as it relates to financing of commercial properties. This is a big topic and we will break it down into smaller parts over the next few posts.

In considering financing - the first decision is whether to work with a Qualified Mortgage Broker or to approach Institutional Lenders directly. In going the Mortgage Broker route, you’ll likely have a better opportunity to source multiple lending sources, since they will shop the market for you. If you approach Institutional Lenders yourself, the obvious benefit is that you are dealing directly with the mortgage originator (decision maker) and the one on one may simplify the process. Either approach can work, depending on not only your own expertise, but the type of property being financed.

Qualifying for commercial mortgages is a fairly rigorous process, and unlike residential mortgages (which often are insured through CMHC), there is no such backstop (protection) for the lender.  As a result, you should assume the following:

·        Designed to protect the institutions against default/losses
·        Generally tougher to qualify for
·        Involve shorter amortizations
·        Structured to guarantee the interest component
·        Involve considerably more upfront soft costs
(ie. appraisal, environmental, structural reports etc.)

Turnaround times on commercial mortgages are often 45-60 days - that is from the time of initial application to receipt of a detailed/written mortgage commitment.  This also assumes that all of the parties conducting all of the reports noted above, are on-time and not delayed for any reason. Certain lenders may also require the posting of a set-up fee at the time of application, to cover their costs to process the mortgage.

Lots more to follow on financing.... as always, seek out the advice of experienced commercial realtors within your market, as you consider mortgaging alternatives on any real estate acquisition.

Thursday, July 11, 2013

Purchase Price Allocation - How/When/Importance... (For Canadians Only)

Purchase price allocation of a commercial property, is necessary at the time of sale.  In the case of the the Buyer, they need to allocate the  purchase price to establish their original cost amounts, for the purpose of computing amortization and depreciation. With the Seller, they need to allocate the price to determine their taxable income – primarily with respect to capital gains and recaptured depreciation.  Best practice is that it be negotiated within the Offer to Purchase Agreement itself.

In terms of what’s being allocated in a typical commercial property sale, it should include valuations on the following at a minimum:

·        Building
·        Land
·        Equipment/Chattels

In addition, items such as major property improvements (ie. surfaced parking lots, out-buildings), can be categorized and valued separately. Valuations should be realistic and supportable, as they can certainly be called into question by the TAX MAN at some point later. Clearly this is also an area that requires the involvement of your accountant, to review the future tax consequences of the proposed allocation.

It should also be noted, that the Buyer and Seller will often have opposite positions on the respective valuations – the Buyer wanting to allocate as much as possible to the hard asset side (building/equipment) & the Seller wanting to minimize this portion to reduce capital gains/recapture costs . All the more to reason to ensure it is a term negotiated upfront.

As always seek out the advice of experienced commercial realtors within your market, as you consider the implications of Purchase Price Allocation on any Purchase/Sale.

Wednesday, July 3, 2013

Repairs and Replacement of Major Capital Items - Who Pays?

Who pays and is responsible, for repairs to major capital items, when they arise?  As the acquirer of any investment property, you should closely review all existing lease agreements to ensure you understand what the financial implications are to you, as the prospective landlord.

Full net leases typically allow the Landlord to assess the entire obligation for the repair, on to the Tenant. So in the event of a $1000 repair bill on a rooftop HVAC unit, it can be added to the Operating Cost Recovery for the property and results in a flow through charge back to the Tenant. Assuming it’s annualized, it effectively changes the Tenant’s regular operating cost by about $83 per month.

But in the event of a major replacement (ie. $10,000 to replace an HVAC unit), how does the “LEASE READ”?  More importantly how is this cost recovered from the Tenant and over what time frame?  Due at the time of replacement, within 12 months, or amortized over 5 -10 years...all may be possible, depending on how the ‘Repair & Maintenance Provisions’ are written in the lease.

As a prospective owner, funding major repairs and outright replacements of ‘big ticket’ capital items is an area you need to seriously account for.  Parking lots, roofs, and mechanical equipment are all significant cost items. Most often if they are 100% recoverable, it is likely only on an amortized basis and over a period of years.

In order to have a complete understanding of the maintenance and repair obligations, AND THE FINANCIAL BURDENS THEY POTENTIALLY INVOLVE, the maintenance and repair sections of the lease must be carefully reviewed in conjunction with the lease provisions dealing with operating cost recoveries.

This is again a case of completing sound DUE DILIGENCE with respect to the leases in place on the property. As always seek out the advice of experienced commercial realtors within your market and as you review the implications of ‘Repairs & Replacement' on investment properties being considered.