With commercial mortgage rates at historic lows and good availability of funds, we don’t find occasion where alternative finance options are often used.
There are, however, times when a different finance plan is required for the buyer to fund the deal.
Flexibility
For instance, a buyer may not be able to meet the lender’s typical 75 per cent loan-to-value ratio. The buyer, for example, may be only able to come up with 21 per cent but the seller is motivated to make a deal.
In some cases, the cash flow from the property may not adequately cover the lender’s typical 1.1 to 1.4 debt-service ratio.
As an example, if the owner of an office building receives $200,000 per month net rent from tenants, a lender will typically not give a loan that requires monthly payments above $160,000, which represents a 1.25 debt coverage.
There are times when a seller may, for many reasons, desire to sell a property but does not immediately require the sale proceeds.
By offering attractive terms to a buyer, the seller may be able to negotiate a more favourable price prior to a binding agreement.
An agreement for sale involves the basic transfer of control of a property without transfer of title.
Both buyer and seller execute a binding agreement. The agreement provides remedies to a seller that would typically be available to a financial institution, in the event of default by the borrower.
Vendor take-back mortgages
Unlike an agreement for sale, title does transfer to the buyer upon closing.
The vendor registers an instrument against the title in the amount of the mortgage and both parties execute a mortgage document, such as what a financial institution would require.
Simply stated, this strategy is similar to a typical transaction except the vendor, rather than a bank, is holding the financing.
As a broker I have facilitated both agreements for sale and vendor take-back mortgages on several occasions.
Generally speaking, a buyer prefers a vendor take-back because he obtains title and a seller prefers an agreement for sale because it provides an extra measure of comfort due to the fact title remains in the owner’s name.
It’s best to obtain legal advice before entering into either agreement.
It’s important that both parties are fully aware of their contractual rights, obligations and responsibilities.
Make sure all the basic terms are identified within the initial sale agreement, such as loan amount, term, interest rate, amortization period, amount of payments (when they commence and whether monthly or bi-weekly) and whether there is a penalty for early prepayment.
A seller needs to complete a thorough review of the buyer’s financial status, which may include but not be limited to personal net worth statement, three to five years’ notice to render business financial statements, and a personal credit check.
If you’re investing there are a number of financing issues that you may want to consider.
Commercial mortgage brokers
This is where the expertise of a commercial mortgage broker comes into play. A good commercial real estate broker can help guide a client through the process and provide smart questions to ask the lender.
I have witnessed examples where a commercial mortgage broker was able to obtain a better “offer to finance” from the client’s own financial institution than the client had previously received themselves. A good broker knows the institutions that are best suited to the type of deal at hand. He or she will package all the necessary information together so it is properly presented and solicit proposals from those institutions. If a proper process has been followed, the client should receive a number of offers from lenders.
The commercial mortgage broker then reviews the offers thoroughly to present the pros and cons of each offer. Price is not always the most important consideration. We see clients committing to loans where they may not be fully aware of hidden terms within the contract.
Typically the mortgage broker will charge the client a fee based on the amount of the loan. It is best to deal with someone who does not accept incentives from the financial institution. A good broker will present options that more than compensate for the fee you’ve paid.
Barry Stuart is managing partner and senior sales associate with ICR Commercial Real Estate in Saskatoon. Email barry.stuart@icrcommercial.com
