Whether you are Buying or *Selling it is critical to understand how Financing can and will affect the transaction. As a Buyer, you and your Sales Representative/Broker should understand the financing aspect of multi-residential purchases. The same applies in everyday life when you see your doctor or accountant; you must be driving the relationship and have a solid understanding of the process.
It is best if you are working with a Real Estate Sales Representative or Broker who understands the processes & procedures to achieve the predetermined and desired amount of financing. Your real estate representative should have relationships with the lenders who lend on these types of properties. Putting it in the hands of a Mortgage Broker who has never dealt directly with the lenders for these property types never seems to work.
Financing is a simple set of numbers and criteria so if you understand the criteria, it is simple to determine if there is a chance or a good opportunity for achieving the desired financing within the parameters of your desired goal.
Too many times you hear people say the deal fell apart because of financing; well, I argue other than a few circumstances beyond anyone’s control something other than financing caused the deal to fall apart. When deals fall apart due to financing it is because some factors that should have been known were not and wrong data or not enough data was applied to the template.
The lending institutions that specialize in these types of transactions are always willing to work with you and give you a solid understanding of the likelihood of achieving your desired outcome on an individual building and Buyer’s basis. I can’t stress the importance of having a relationship with a lending institution or working with a Real Estate Sales Representative/Broker who understands the process enough to lead the transaction.
It is far too late, 4 weeks into Due Diligence, to find out that you as the Buyer or the Building can’t achieve the desired amount of financing. You as the Buyer must know in advance how much you need as a down payment including financing costs and any building Repair/Upgrading that may be required. This is when knowing the lending criteria will save you time, disappointment, and money.
Remember that you as the Buyer can’t be prequalified the same as for a residential mortgage because so many variables of the building change the dynamics, and potential loan-to-value. The lower the loan-to-value based on income & expenses; the more down payment will be required. This combined with potential mandatory repairs makes it impossible to be prequalified. You will need a certain amount of net worth; however identical buildings side by side can and will have different cash flows and the building with the greater cash flow will achieve a higher ratio of loan-to-value.
If you miss calculating what the lending institutions are willing to lend for a loan to-value-ratio by 5 to 10% on a one million dollar building the difference in value is between $50,000.00 and $100,000.00 and not a lot of buyers purchasing a $1,000,000.00 building will have an extra $100,000.00 available and even if they do this can drastically change the dynamics of the transaction in the Buyers mind and trigger a panic leading to a cancellation of the transaction. Usually, a Buyer will have a vision for improvements they would like to complete upon closing and these funds may be required to complete those leasehold improvements, the bank may be expecting the Buyer to do mandatory repairs on closing as part of their conditions to advance funds leaving the Buyer short.
As the buyer you may not want to lock any mortgage in until a predetermined set of renovations and or energy retrofits are completed. On poorly managed buildings that haven’t had a lot of upgrades over a couple of decades (deferred repairs), it may be beneficial to complete these as poor-performing buildings can use up to five times more energy per square meter compared to high-performance buildings. In today’s market for every dollar gained in NOI, you gain twenty dollars in increased value at a 5 cap. This starts to add up when you start increasing the NOI by tens of thousands of dollars or even just $1,000.00 increments and financing can be a critical tool for unlocking the potential for new retrofits and performance standards. CMHC has a product to assist with these types of loans.
CMHC Insured Multi-Unit Residential Housing
Product Type: Multi-unit residential properties with a minimum of five self-contained rental units.
Borrower Type: Borrower should be experienced with the management of multi-unit properties. If not, third party management may be required.
Geographic: Location is discretionary by lender.
Loan Amount: Discretionary by lender and CMHC
Interest Rates: The interest rate is based on the Canada Mortgage Bond rate plus the lenders spread rate.
Lower Interest Rates: CMHC insured financing provides access to competitive interest rates for the life of the mortgage and renewals.
CMHC Fees & Loan-to-Value Ratio: See the CMHC tab.
Lenders Fee: Negotiable
Payment: Equal, blended monthly payments including monthly taxes
Maintenance: Capital deferred maintenance deemed required in year one will be subject to a holdback by CMHC. Holdback will be advanced when proof of work satisfactory to CMHC is provided.
Prepayment: Subject to penalty
Eligibility: Borrower must have a net worth equal to at least 25% of the loan amount with a minimum of $100,000
Buyers may debate whether it is best to assume existing financing or arrange new financing. For years, the concept of mortgage averaging has been advanced to answer this question. Consider the following situation.
Buyer Jones needs $80,000 in financing. He has two alternatives:
- Arranging new financing at 11% or
- Assuming an existing $50,000 mortgage at 10% and arranging a new second mortgage for $30,000 at 14%.
Mortgage Averaging Formula:
The mortgage averaging formula reveals that an assumption of the first combined with a new second mortgage indicates an overall interest rate of 11.5%. Arranging new financing at 11% is less expensive.
Extreme caution is necessary when using this formula even as a general guideline for the following reasons:
- The formula assumes constant interest rates for one year only; interest rate changes beyond that point can seriously impact findings.
- Differing payment schedules and amortization periods are not taken into consideration.
- Upfront costs concerning the arranging of new financing are not considered.
Keep in mind that mortgage averaging only weighs the pros and cons of the final interest rate on a given day and no other potential benefits of arranging new financing. The terms and conditions and associated cost of releasing obligations from the existing financing will have a variance on your final decision. Mortgage Pooling is quite common today and if this is the case with a mortgage on a building you are contemplating you will have to assume the existing mortgage. Mortgage Pooling is when lenders pool their funds behind the scenes into a pool of bulk funds. If this is the case the mortgage can’t be broken because of the multiple lenders in the pool of funds.
Financing Package
When you are ready to move forward from the letter of intent you need to comprise a lending package for CMHC (when using) and the lending institution you will be using, it is best if you prepare as complete a package as possible. This will save you time and fewer changes being made by CMHC and or the chosen lending institution.
Sample Lending Package based on CMHC requirements
- Location Map and Description
- Front and Rear Pictures of the Subject Property
- Loan Summary
- General Information
- Application/Borrowers Financials
- Personal Net Worth Statement
- Property Income & Expenses
- Sale & Financing Synopsis
- Rent Roll & Summary
- Phase I Environmental Report
- Utilities Summary & Bills
- Agreement of Purchase & Sale