# 1 The Definition of a Commercial Mortgage
A Commercial Mortgage is a loan securing real estate such as an office building, an industrial warehouse, commercial zoned land, farm land, apartment complex, or any single residential property that carries 4 units or greater. However,it is not limited to this. It can also be a mortgage on multiple residential properties such as a blanket mortgage. The due diligence process with a commercial mortgage is very detailed and thorough.
#2 Commercial Mortgage vs Residential Mortgage
When you take out a residential mortgage, your personal finances are a major part of the calculation by the lender. Personal income, employment history, credit history, and the down payment source (purchases) or the equity remaining (refinance). In the case of a commercial mortgage, The lender will look primarily at the income being generated by the property, property use, and location. In cases where the property isn’t generating income, the lender will also look at the property and income potential in addition to the guarantors of the loan.
# 3 Commercial Mortgage – Turnaround time
Processing times for commercial mortgages can run longer. With a residential mortgage, it is possible to move to an approval in a few days with a private lender, and within a week with a traditional lender. A commercial mortgage takes more time… four to six weeks is a good rule of thumb. The loan to value requirement is generally 65% – 75% of the property value, however higher can be considered on CMHC approved commercial mortgages or private cross collateralized mortgage where additional real estate is pledged.
Higher risk also means higher interest rates associated with commercial mortgages. After all, people will generally pay off their own mortgages before handling their business loans if they hit a financial crisis, and that simple change in position will bump the interest rate higher.
# 4 Commercial Mortgage – Debt Service Coverage Ratio
There are key calculations that lenders consider when analyzing commercial mortgage applications. The most important is debt service coverage ratio (DSCR). This figure determines the health of the application and the ability for the borrower to meet the payment obligations. To determine the DSCR; you must divide the total annual net cash income by the total annual debt. n.
- $1,000,000 net income / $750,000 annual debt service = 1.33 = Good Cash Flow
- $1,000,000 net income / $900,000 annual debt service = 1.11 = A Little Cash Flow
- $1,000,000 net income / $1,250,000 annual debt service = 0.80 = Negative Cash Flow
If you have a DSC of 1.25 or higher, there is a good chance that you will be approved for your loan with a traditional lender if everything else checks out. If your DSCR is hovering around 1.000 or less, you’ll likely need to obtain a non-traditional or private commercial mortgage.
#5 Credit & Commercial Mortgages
While your personal income will often not matter as much as it does with a residential loan, your credit history can be very important especially if the corporate entity is relatively new. With respect to your current business, you need to be able to show that your operations are steady and profitable. You will generally need to provide 2-3 years of history of the business; however if the commercial property is income producing, less weight can be placed on this and in some cases bypassed altogether.
# 6 Commercial Mortgage Alternatives
If you are having a difficult time qualifying for a mortgage with a traditional lender, another avenue is Owner Financing, or Seller Financing. In this case, the entity from which you want to buy the property would also serve as your bank, and it would turn into an ongoing investment for them.
This takes one of two forms: the “recourse” private loan and the “non-recourse” private loan. With a recourse loan, the lender can obtain ownership by selling the property by way of power of sale/foreclosure. If there is a deficiency in the sale of the property, the lender can also look to satisfy the shortfall from the sale by coming after your assets. A “recourse” loan is also known as a “personal guarantee.”
If obtaining a “non-recourse” private loan, the lender can only seize and sell the property. Most private loans extended to individuals are “recourse” loans, with “non-recourse” loans generally going to limited partnerships (LPs) or limited liability companies (LLCs), in order to shield the other assets of the borrower.
If you or your organization is looking to take out a commercial mortgage in Canada, take a minute and fill out our no-credit check pre-qualification application, and you’ll be contacted at our earliest convenience. Let us help you take that next step today!