Private Mortgages - When/From Who/Negotiating Terms

Private mortgage lenders can be companies or individuals who provide necessary financing when normal institutional options are not available. They hold security on the property, as would a typical bank type mortgage, as an asset backed loan.  They can prove to be an excellent alternative to conventional financing in many circumstances.

When

Examples of where taking mortgages out from private sources can be a preferred option:

·        Buying a specialty property (ie.gas station), that banks will not consider

·        Buying a property with physical impairments (ie.environmental issues)

·        Loan to value considerations (needing 80% vs. institutional @ 65%)

·        Poor  credit rating or previous bankruptcy

·        Needing a short term (stop gap) loan for a short period of time (ie. 1 yr.)

·        Small business owner with unverifiable income

·        Needing quick financing approval in order to firm up a sale

·        Seller financing often can include more favourable terms given the

their motivation in selling the property

Who

Private mortgages are best sourced through Mortgage Brokers (MB), who would have a list of companies or individuals who wish to invest their cash into private mortgages. The mortgage brokerage industry has grown exponentially in the last 20 years in Canada, so there are a plenty of MB’s to consider. The key is to ensure they are qualified to deliver a private lender, who can meet your objectives and timelines.

Things to look for include:

·        Will a detailed Letter of Commitment be provided

·        What other costs and fees are involved

·        Time to process the approval

·        Can you meet the private lender to review your situation

·        Costs to Payout Early (prior to expiry of the term)

Terms

Keep in mind that if your intentions and commitment are sound and your mortgage ends up being paid as agreed – it proves to be a good investment for the lender.  The key then is to take this position upfront, in order to help you negotiate the most favourable terms. As with everything in real estate – ‘you don’t get what you deserve..you get what you negotiate’. Even when dealing in the private mortgage market, don’t sell yourself short! 

As always, enlist the assistance of an experienced commercial realtor in locating the best private financing sources available in your area.

Private Mortgages - Need a Written Mortgage Commitment?

If you look to finance a purchase through a Private Mortgage – that is a lender who is not a financial institution – is the process any different with respect to obtaining a formal (written) Mortgage Commitment (MC)?  It should not be and there are a number of reasons to insist on receiving one, before moving forward.

As with any of the specifics involved with the transaction, you want to be informed in advance of all costs and obligations which pertain to the mortgage. All of the same details which we outlined with institutional lenders, may infact apply to the private mortgage. There could also be some additional ones – ie. upfront administration fees, punitive penalties for early payout, mortgage brokerage fees and the list goes on.  Best practice, is to insist on a detailed MC so that there are “no surprises” at closing.

Private lending plays an important role in the commercial property market. It is often a good option and sometimes the only option, in being able to fund a purchase. With that said, the industry is littered with closings (and non-closings), on transactions which involved private mortgages which were significantly misunderstood until the day of closing. The ramifications of this are not only costly, but painful to experience for all concerned.

As a final note and with respect to a Vendor Held Mortgage (with the Seller), a major benefit is that you are able to incorporate the terms of the MC within the body of the offer. You can not only outline mortgage amount/rate/term/amortization (the basics), but also cover prepayment options, specifics on guarantors, any details on secondary financing etc. Some of it may need to be negotiated, but you at least get it on the table

and they become terms within your Agreement of Purchase and Sale.  The Seller is often your best source of Private Financing, so make sure that is your first stop!

It’s worth repeating - the “DEVIL IS IN THE DETAILS”. Again, it’s always a good idea to review a MC with your lawyer and your Experienced Commercial Realtors upon receipt, and especially given the fact that much of it affects their task in closing the transaction.

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.