Commercial mortgages are broken down into two categories:
- Owner occupied
- Investment property
The lending guidelines are going to be quite different for each type of mortgage but there are some similarities. An appraisal will be required in each case to establish the value of the property. Plan on spending a minimum of $2,000 for a commercial appraisal. It is also possible that an engineer’s report will be required, particularly if there are any concerns about the soundness of the structure of the building. An environmental assessment will have to be conducted by the bank. If this assessment finds any areas of concern, a full Phase 1 environmental report will be required. Phase 2 and Phase 3 reports could be required, depending the results of the preceding reports. The bank takes environmental liability very seriously (you should as well) because the cost to clean up a contaminated site could be devastating.
Unlike a residential mortgage, you’ll have to pay the cost of the above reports along with the legal fees for registering a mortgage. As a result, closing costs can be quite significant and they need to be planned for.
An owner occupied mortgage has a lower approval standard that must be met. Cash flow from the business must be sufficient to make the mortgage payment each month. The bank will look at your financial statements for the past few years to determine how stable you cash flow is. This gives them a degree of certainty that the mortgage will be paid. Lending value for a mortgage of this type will be in the 50% to 75% range. This means that the down payment will need to be in the range of 25% to 50%. This will depend on the marketability of the property. For example, a single use property in a rural area may be given a lending value of less than 50%. This is because if the bank foreclosed on the property, it would be very difficult to sell for a good price. The maximum amortization for this type of mortgage is usually 25 years.
Investment property mortgages have a higher standard of approval. The property must pass a cash flow test that shows that the rents from the building can cover the mortgage payments plus costs associated with maintaining the building. The bank will want to see historical rent rolls so that an average rent and a vacancy rate can be established for the cash flow test. With these types of mortgages, the amortization will have to be 75% or less of the remaining economic life of the property as determined by the appraiser. This can often result shortened amortization times. Lending values and down payments are generally the same as for owner occupied property. It is possible to get CMHC insurance on some types of properties such as apartment buildings, but the cost of the premium usually makes the insurance too costly.
It’s best to talk to your bank or credit union before shopping for commercial property. Lending guidelines can vary widely between institutions. It’s important to make sure that your Commercial Account Manager has expertise in these types of deals. They can be complex and therefore difficult to get approved. You’ll want an experienced person working with you.