As an investor, there’s little doubt which type of property has been offering the lowest mortgage rates and greatest interest – residential. Meanwhile, commercial properties have been hit harder by the global financial crisis, and the rates have remained higher, often by a couple of percentage points or more.
Even those who work as commercial mortgage brokers have conceded that the residential mortgage rates are hard to pass up from an investment point of view.
“I’m paying a rate under two per cent on my own home,” says George Semine, vice-president of investment, lending and advisory services for Avison Young in Quebec. “That’s absolutely crazy.”
But the market started to shift in 2010 and commercial mortgage lenders have been increasingly offering competitive rates as their appetite has begun to increase again, says Dale Bilton of Mortgage Intelligence in Kitchener.
According to Semine, 2010 marked the beginning of a better commercial mortgage rate environment.
“There’s more capital available. Lenders are still conservative, but they’ve opened up their coffers a bit. There’s more money available with nearly every commercial mortgage lender.”
Unlike residential, a full recovery still seems distant in the commercial mortgage field.
The advantages of this market are still attractive to some investors, though. Commercial tenancies are often easier to manage and can last considerably longer than residential. Unlike a one-year apartment lease, retail commercial leases can be five years or more. Getting rid of unwanted tenants and raising rents is also simpler if it’s a retail property. And commercial mortgages on residential apartment complexes are offering competitive interest rates.
Investors from other markets have also been turning to buying commercial property.
“Lately there have been a fair number of situations where individuals have not been pleased with the return on the equity markets, and are looking for smaller to mid-size apartment buildings, as well as smaller plazas to purchase,” says Bilton. “They can see their actual investment and watch them appreciate over time.”
Types of commercial mortgages
Before understanding the rates, it’s necessary to understand some of the parameters and definitions of various commercial mortgages.
The value of these loans is often considerably higher than residential. A smaller commercial mortgage might range from $500,000 to $1 million, or even $2 million, says George.
Often these properties are sold by residential agents dabbling in the commercial field, such as Royal LePage or Re/Max, he says. An example of this smaller commercial property could be a mixed use building with a convenience store on bottom and four units above. While considered semi-commercial, it’s still analyzed as a commercial mortgage.
Another example could be a mechanic’s garage, or a small building with three separate retail tenants. Small office building with a floor or two and a few tenants also fall into the smaller commercial mortgage category.
“That (smaller commercial mortgage) market is a bit more conservative,” says George, estimating some LVRs can be as low as 60%, compared to 75% or more in larger commercial. The risk is still viewed as high.
Bilton says the net income the property produces is a key factor in obtaining the maximum mortgage amount. Along with the property, lenders will consider the borrower’s ability to service the debt on it considerably.
In terms of commercial mortgage rates for a smaller category commercial property, they might be as high as 6 or 6.5%. When you get into a larger commercial loan above $2 million, that rate is closer to five per cent, says George.
Some commercial mortgages for apartment buildings are as low as 4%.
“If you’re trying to finance a Class A building in centre ice in downtown Toronto or downtown Montreal, you’ll get a lot of bidders and players,” says Semine.
Many lenders will rank their loan amount categories from largest to smallest, starting with Class A, followed by smaller loans in Class B.
Commercial mortgage rates are influenced by the spreads of bond rates. The premium above the bonds is what is decided by the lender for the actual mortgage rate. Knowing the bond rate can help you understand the premium you are being charged.
Larger commercial properties can include a major highrise apartment complex in Toronto, shopping malls, shopping plazas with 12 to 15 stores, an industrial property or vacant land.
Vacant land is a challenging area to get finance for right now when buying commercial property, however.
“The hardest product to finance is vacant land,” Semine says. “And also, development projects are more risky.”
A construction loan, known as an interim finance loan, is used to help build a commercial property. “It’s quite complicated to manage and it really involves a lot of issues,” Semine says.
Commercial Mortgages – a longer process
One of the major differences between commercial mortgages and residential mortgages is the timeline. Unlike a residential loan, which might take five days for approval, a commercial mortgage will take a couple of weeks or even months.
“Commercial mortgages usually take a minimum of three to four weeks to get all the conditions met, and sometimes this could take up to six months, depending on the environmental reports,” says Bilton.
Those environmental reports often cost as much as $2,000 in major cities. It’s part of a lengthy process that can be frustrating to investors.
“Some lenders take a long time, it’s a really painful process, whereas others are not,” says Semine.
He notes that in regards to commercial loans, private lenders that are not banks or institutions have a significantly shorter approval process. That’s the advantage. The disadvantage is this usually comes with a higher rate.
“(Private lenders) will probably gauge you with the rate, but you’ll get a quicker turnaround and answer,” Semine says.
Getting a quicker approval and just overall improving your chances all comes down to being prepared. A mortgage broker will help with that process. Those willing to take the task on themselves can try it solo as well, but it takes a serious time commitment and some research.
The key there is to do some research ahead and expand your search to beyond just a bank or two. Either way you do it, coming in prepared should be your end result.
“A good file that’s well prepared will help the lender make a quick and hopefully good decision for you,” says Semine. “Unfortunately, private borrowers that don’t use brokers usually go in there unprepared.”
He says going to a bank without much of a plan and asking them what you’ll need to finance a project will only hurt your negotiation power later.
Instead, come in with personal financial statements on the borrower as you may be asked for personal guarantees. You’ll also benefit with an income statement on the property, says Semine, which he says is preferably in the form of an appraisal report.
“If you come in with an appraisal done by a recognized company, you’re ahead of the game and can call the shots,” he says.
Bilton says that some preparations should wait until meeting with the lender, however. He says he wouldn’t want a client to order an appraisal or environmental report until it is confirmed the companies doing the reports are on their approval list.
That process is something a mortgage broker can take care of later, says Bilton, to avoid any issues.
The value of experience
Lenders will look at your past experience of investing in commercial property more depending on the type of property. If it’s a highrise multi-unit property, hiring a superintendent to manage it should suffice.
If you’re trying to manage a retail property with tenants, a lack of experience will likely be a cause for concern with lenders.
“The first thing they’ll ask you is, ‘Who will manage this property, Sir,’” says Mr Semine. “You’ll answer ‘I’ll manage it.’ ‘We’ll, what’s your experience?’ ‘I have no experience.’ So, how does that look?”
Thus matching the type of commercial investment with your personal experience level in that type of market is crucial.
Where the money is going
Within commercial lending, there are certainly areas where rates are better than others, and thus where lenders are sensing lower risk.
Bilton says some of the best rates are on CMHC (Canada Mortgage and Housing Corporation) insured mortgages for apartment buildings.
“With the CMHC insurance, they are able to offer up to 85% of the value, assuming there’s the income that supports this,” he says. “Rates are coming in under a 4% interest rate for a five-year term for deals in excess of $1 million presently.”
Office buildings and residential and industrial plazas are also getting good commercial mortgage rates, says Bilton.
Overall, it’s hard to generalize with the Canadian market. However, Semine says office produce in Alberta is “pretty risqué,” for example, whereas it is “doing pretty well” in Montreal. In Quebec, industrial properties are struggling, though.
“The general answer is the best type of properties that are getting the best financing are the ones that have good location, good tenants and good cash flow with long-term leases,” he says. “Any property that has those characteristics usually qualifies for a competitive bid.”
What to consider before applying for a commercial loan
State of the commercial market – Find out what state the commercial market is in right now, as the supply and demand of capital always affects your loan rates.
Size of commercial loan matters – Some of the larger loans can get some of the best rates, especially if they are in a prime commercial area. Understanding this and other factors can help you prepare for the rates you’ll likely get. Use a commercial mortgage calculator to work out exactly what figures you’re looking at.
Know what’s expected of you – You should determine from lenders what guarantees of you will be asked. Will there be any extra collateral?
Match your schedule – Ask your lender about their commercial loan process. Most commercial loans involve a longer process than residential loans, but that difference can significantly vary. Private lenders offer quicker approval, but at the cost of higher rates, usually.