What is a Commercial Mortgage?
A commercial mortgage is a loan taken out by a company or a business to buy (or refinance) a commercial real estate with the property as collateral. A commercial mortgage is similar to a residential mortgage.
The differences lie in the type of the borrower (an individual vs a business) and in what is used as collateral (residential vs a commercial property).
The business applying for the mortgage will be assessed together with the property itself, but the owner’s own credit history may be considered as well.
Evaluating creditworthiness of a business is more complex than for individuals and the lender needs to assess the risk associated with the individual property as well. For these reasons, assessing credit standing is more complicated with commercial mortgage, so loan amounts are usually larger and rates are higher due to higher risks involved compared to residential mortgage.
What Can You Finance with Commercial Mortgage?
A number of properties fall under a commercial mortgage like an office, retail or industrial property. Also, several other types of properties can be classified as commercial properties and as such can be financed under a commercial mortgage. For example, a residential real estate is treated as a commercial property if it is purchased as an investment property. For this reason, it is important to identify exactly what type of property you are looking to finance.
Why a commercial mortgage loan?
A commercial mortgage loan is a usual financing option if you want to acquire new office or location, renovate your existing commercial property, develop a property, etc.
There are many steps in the purchase of commercial real estate:
- evaluating the investment opportunity,
- selecting a location,
- hiring experts to help with the purchase,
- financing the purchase.
There is a variety of options to finance the purchase of a commercial property in Canada.
Traditional financial institutions
Commercial mortgage terms in this case range from 1 to 10-year, with either a fixed or variable interest rate. Some institutions only offer a first mortgage, and many require a current appraisal, a passing environmental report, and potentially a report on the building condition.
The bank may also be willing to roll a part or all of the costs of renovations into the mortgage loan, particularly if they add value to the property. Depending on their own policy, traditional banks may not offer commercial mortgages for some building and/or usage types.
Specialized lending options
a. Business Development Bank of Canada (BDC)
The Business Development Bank of Canada is founded by the federal government to support Canadian entrepreneurship by providing financial and management services to small and medium-sized enterprises
As such BDC is a good option for businesses that may find traditional funding to be either beyond their reach or to be too demanding in terms of due diligence and ongoing reporting requirements.
b.The Canada Small Business Financing Program
CSBFP loans (the link here to the CSBFP page) can be used to finance the following costs:
- purchase or improvement of land or buildings used for commercial purposes
- purchase or improvement of new or used equipment
- purchase of new or existing leasehold improvements, that is, renovations to a leased property by a tenant
Private lenders are different from traditional lenders because they are accepting to finance commercial real estate by focusing more on the borrower’s wealth or the property itself, rather than the business when conducting credit assessment.
These financing options may involve more complex debt structures like mezzanine financing. You should get expert advice if you are considering exploring this option.
Loan-to-value ratio indicates the portion of the property’s value that the lender will finance.
Amortization period is the period over which the loan will be repaid; It is generally shorter than in the case of residential mortgages.
Interest rate – the commercial mortgage rate is generally higher than on a residential mortgage. However, it tends to be better than on a regular business loans because commercial mortgages require property as collateral. The interest repayments on the commercial mortgage are tax-deductible.
Term of loan repayment – you need to consider a tradeoff between shorter term with higher payments and longer term with larger total interest paid over the life of the loan.
Points to Consider
Commercial mortgages in Canada involve a number of steps and variety of documents in order for lenders to assess whether the loan is likely to be paid back.
Particularly, you will need the following:
- A business plan and financial records covering previous years
- Real estate legal documents and the appraisal value
- Property survey that marks out the boundaries of the property, the location, and any other physical feature that might be important
- A property condition assessment that checks compliance with the building code
- A passing environmental report
These steps involve paying a variety of fees and charges which you should factor in your estimate of the total costs of commercial real estate acquisition: legal fees, mortgage broker fees, application fees survey charges, evaluation charges, etc.
When buying a property or a land, you might need additional money as costs are usually higher than expected. For this reason, you may want to consider additional financing options such as working capital loan, leasehold improvement loan, equipment loan, line of credit, vendor financing, etc.