By: Jayson Schwarz and Konstantine Chatzidimos

Introduction

If you are reading this article you may just be considering acquiring a commercial property, i.e., an office building, manufacturing/warehouse facility, apartment building, strip mall etc. and this generally  involves the negotiation of a commercial mortgage.  While most of you may have had experience with residential mortgages, commercial mortgages come with their own set of rules and headaches.  This article explores a few of the considerations inherent in the procurement of commercial mortgage financing.

Case by Case Basis

The principal challenge in securing a commercial mortgage is meeting the requirements of the commercial lender at a given point in time.  Commercial mortgage applications are typically more involved than residential ones and are open to considerable subjective analysis on the part of lenders.  This is because the assessed value of the underlying security, i.e., the real estate, is driven mainly by market forces occurring where the property is situated.  Hence, location, timing of the current economic cycle, use, rental income and expenses or owner occupancy are key factors considered by lending institutions before advancing a loan.

Loan to Value Ratio

As you can guess, commercial investment properties are viewed conservatively by lenders and require significantly more equity than may be required in the residential scenario.

Loan to value (“LTV”) is the percentage calculation of the loan amount divided by the purchase price.  If you know the LTV requirements of a particular lender, you can calculate the loan amount by multiplying the purchase price by the LTV percentage. Note, however, that the purchase price must be buttressed by an independent property appraisal. If the appraisal shows a value less than the purchase price, lenders will typically use the lower number in determining the loan value.

Homework before Approaching a Lender

Approaching a commercial lender is not simply a matter of just showing up.  There is a long list of things you should know and have prepared prior to making a commercial mortgage application; they include:

1. an appreciation of the typically lengthy commercial mortgage application process;
2. an understanding of cash flow generated by the property relative to debt servicing the mortgage;
3. ensuring appropriate ‘conditions’ are set in the Agreement of Purchase and Sale;
   1. the documents the lender will require so it can intelligently assess the risk involved;
4. the third party reports that will be required as well as the approximate costs and time required to complete them;
5. a knowledge of the financial criteria the lender will use to assess the application; and,
6. an understanding that the lender may request collateral security in addition to the property;
7. A survey and all pertinent zoning information.

The above list is by no means exclusive. As such, it is prudent to meet with a lawyer experienced in the area of commercial real estate acquisitions at the beginning of the process in order to make sure you are covered going into the deal.

Timelines

Given the higher degree of lender risk inherent in commercial financings, lenders typically require anywhere from 30 to 90 days to carry out their due diligence on commercial mortgage applications.  It typically takes this long as procuring various necessary documentation, i.e., Environmental Assessments, Property Appraisal(s), Financial Statements, Operating Statement etc.., takes time.  Given this, purchasers must ensure that the financing condition in the Agreement of Purchase and Sale affords sufficient time for said diligence to be carried out.

Collateral Security

Prospective purchasers should also be aware of the possibility that other collateral security may be requested by the lender to secure the commercial mortgage. In many cases a personal guarantee will  be required. The quantum of the guarantee will depend on lender’s assessment of the overall risk of the transaction.  Purchaser guarantees of 50% of the mortgage amount in such deals are common.  In addition, lenders typically require property insurance be in place for a sum covering the full quantum of the mortgage.

Conclusion

Commercial mortgages are more complex financing vehicles than the residential variety to which most people are accustomed.  There are numerous elements to be aware of and a considerable number of things to come up to speed on when considering the purchase and financing of a commercial property.  This article only scratches the surface and it is recommended that you consult directly with a commercial lender or lawyer experienced in the trials of commercial real estate should you be in the market to purchaser a commercial property.