Mortgage Commitement Letters - For Buyers Only

Many versions of Mortgage Commitment Letters exist within the commercial mortgage market. This document provides written proof that the lender is willing to loan a specific sum, by way of a set mortgage amount, which allows the Buyer to complete the purchase of the property. They can be ‘conditional’ or ‘non-conditional’, but in most instances they are conditional - meaning the Buyer (or mortgagor) must meet certain conditions in order to qualify for the advance of funds.

Typically it should contain much of the following:

·        Mortgagor Details – Name, address, postal, email coordinates

·        Collateral – Description of the property type and location

·        Interest Rate – Fixed or Variable

·        Term – Set for a specific period

·        Amortization – Time period for 100% payback

·        Title Insurance – possible requirement

·        Survey – possible requirement

·        Guarantor Requirements – corporate/personal

·        Prepayment Options – if any (NB: if not included, mortgage is closed)

·        Expenses – All costs to lender, including legal,registration, and admin.

·        Secondary Financing – may not be permitted and excluded specifically

·        Expiration Date – time period by which MCL is executed & mortgage finalized

Specifically in the case of a conditional MCL, it  may include the following:

·        Satisfactory Environmental Report(s)

·        Full Appraisal Report (supportive of the value)

·        Structural/Physical Building Report (indicating no deficiencies)

·        Financial Reports – either corporate or personal as necessary

·        Credit Reports – to the satisfaction of the lender

Again, be aware that any conditions contained in the MCL must be met before the commitment is set and binding. As always, the DEVIL IS IN THE DETAILS, so make sure you understand the requirements as they are contained within the letter to ensure your funding is in place come closing date.

As a final note, it is always a good idea to review a MCL with your lawyer upon receipt, and especially given the fact that much of it affects their task in closing the transaction.   

Mortgage Discharge Penalties - Cost of Early Payout (Attention: Sellers)

One of the more controversial aspects relating to commercial mortgages, are the discharge costs to pay off a mortgage prior to its maturity date. There is realistically no common method of determining an early payout cost, as most typical commercial mortgages are deemed “closed” – meaning they run until maturity, without allowing for an early payout provision.

If a lender is to agree to an early payout of an existing mortgage, some of the more common discharge penalties may include:

·        Three months interest cost (based on the current balance)

·        Interest rate differential (actual interest rate vs. the re-lending/current rate)

·        Greater of either of the above 2 methods

·        100% interest recovery for the balance of the term (ouch!)

·        Any variation of the above (AKA – negotiating a better discharge fee)

It is important to note, that the lending institution has an obligation to outline the penalty that they could charge within the actual mortgage document. But this assumes, that you review (read) this detail within the mortgage terms, and that you understand what the financial consequences may be at some point within the mortgage term. This is a clear planning matter at the time of closing a deal and advancing a mortgage – your plans should account for such contingencies, so that there are no major financial surprises later on.

Other suggestions may include – negotiating with the Buyer to return to your lender for financing, paying down the rate for a prospective buyer to remain with the lender, or perhaps financing other properties with the lender. Lender’s are often more negotiable, if they can gain new business as an offset to the loss of the mortgage being discharged.

As always, SELLERS seek out the advice of experienced commercial realtors within your market, ensuring you account for discharge penalties on all existing financing prior to marketing the property. There may be more negotiating to do, than just with the Buyer!   

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.

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.

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.

Investment Property Insurance - How Important?

As is the case for insurance on your own personal residence, properly insuring your investment property is extremely important.  Protecting this asset with proper coverage is essential and helps ensure your overall investment strategy, doesn’t evaporate through an unforeseen event.

Building insurance generally covers total or partial building loss as to an agreed upon policy amount. Coverage should be sufficient to cover any damage based on relevant estimates of current replacement costs – ie. if $125/ ft. is the current figure to replace a commercial building in the event of a total loss, then that’s the level of coverage you need to have in place.  If you choose to ‘under insure’ by taking out insufficient coverage, you are in reality ‘co-insuring’ the property. In this case, you will be responsible to pay any amounts above and beyond what the insurance coverage provides for.

Landlord’s insurance generally covers loss of income and tenant damage.  Loss of income would be coverage if a property was unfit for rental purposes for a period of time. With respect to Tenant damage issues, it could cover default by the tenant due to vandalism, theft or malicious acts.

There are certainly other specific coverages that you may need for your specific purposes – ie. accidental plate glass breakage, power failures/surges, sewage back-up, to name a few.

Best practice here, is to review your requirements with your commercial insurance broker, making sure you have a comprehensive analysis done on your specific property.  As always, seek out the advice of experienced commercial realtors within your market, as you review your property insurance options.

Property Taxes - About Assessments & Tax Rates (Ontario, Canada Only)

Municipal tax costs on any commercial property are generally significant and a major annual expense.  The tax bill is basically a bi-product of 2 factors:

1. The Current Value Assessment (CVA) of the property

2. The Municipal Tax Rate

Assessments are provided by the Province of Ontario (thru MPAC) and the tax rates are then levied by the local municipality. The Net Tax owing is then determined through a process of straight multiplication. Since the Tax Rate is set by the municipality, it is a part of the formula which for these purposes, I would suggest you have little/or no influence on.  However, you do need to keep an eye on the CVA side, to ensure it is realistic and relevant to the property’s Current Market Value.

With that in mind, there are three specific methods of valuation

1. Income Approach 

2. Comparative Sales Analysis 

3. Cost Approach 

The first 2 are most often used, with the Cost Approach used primarily in cases where there is a lack of data available, for purposes of a proper evaluation/comparison.

In considering the above, it is always a worthwhile exercise to determine how realistic a property’s CVA is, ensuring you are not paying more than your fair share on property taxes. If your analysis determines that the assessment is overstated by 10-20-30%, by all means file an appeal through MPAC. Bear in mind, there are rules and regulations to follow in filing an appeal, and it can be arduously slow - but you can successfully reduce your assessment if the facts clearly support your position (meaning the CVA is overstated).

Just a final note, there are full time tax assessment consultants throughout the province, who specialize in reviewing property assessments and handling appeals.  Absolutely worth at least a discussion, to see how they might be of service.  Also, MPAC is very approachable on matters regarding assessments and their website is an excellent starting point.

As always, seek out the advice of experienced commercial realtors within your market, as you review tax assessment matters on specific investment properties.