Commercial Mortgage Basics
I’ve always taken the position that Commercial Mortgage lending is a fairly simple undertaking. It’s when we try to complicate things that we get ourselves into trouble. The same can be said for borrowing. Borrowers occasionally turn themselves inside out negotiating aspects of a deal. Aspects which may not be particularly critical to them at the end of the day.
Let’s have a brief refresher on the 4 main components of any commercial mortgage financing Offer. What is critical for you?
Loan Amount is often the critical component to your financing Offer. This is particular true in the case of a property purchase. The loan amount will drive your other considerations. Will you need to source secondary financing? Seek partners or co-investors? Or perhaps provide additional equity?
A critical, but often overlooked component is the term of your financing. In our post entitled Mortgage Term Preferences, we outlined borrower preferences for length of mortgage terms selected. An important consideration is your investment strategy. Are you a buy and flip investor, or are you interested in a long term hold? How long are your primary Lease terms? What is your property exit strategy? All of these considerations will inform your decision regarding length of Term.
From personal experience, little attention is paid by Borrowers to amortization periods. Again, your preferences will be guided by your investment strategy. Your need to manage cash flow, and the specific income generating characteristics of your property will be important.
Do you wish to be debt free by a particular point in time? Do you want to grow your project or portfolio equity so that you can leverage the asset(s) for future acquisitions?
Rate is the component which garners the most interest (pun unintended). But it may be less critical to your financing plans than you’ve previously thought.
If you are conventionally financing a well leased commercial asset in a major centre, chances are that a number of lenders will be interested in your investment opportunity. Lenders will be competing for business like yours. They will have a budget for annual loan approvals. As such, available market rates from major “A” lenders will likely not differ greatly. Rates may differ significantly when you are seeking to finance a specialty use property. There may be a difference in perceived risk between lenders. Choose your lender wisely!
Your Investment Strategy will be Key
Understand which of these 4 factors or combination of factors is most important to you. All are negotiable to a greater or lesser extent.
Perhaps you need a full loan for an acquisition, so loan amount will be the critical piece. Paying a slightly higher rate, in exchange for the “right” loan amount, may be a wise decision.
Possibly debt service coverage and sufficiency of cash flow is key to your strategy. You may anticipate a softening of rental rates, or possible anticipate a vacancy increase. Focus on securing a comfortable amortization period.
Perhaps a number of your Leases are structured to mature in 36 months. Arrange the term of your loan to coincide. Taking a a 5 year term may lock you into waiting an additional 24 months before you can secure an increased loan (without going the secondary financing route).
Understand what is important to you, to implement your commercial real estate investment strategy.