I tried looking up the last time I did an article on commercial deals. I thought I had summarized somewhere as I seem to find I’m repeating myself lately in emails. 2008 seems to be a bit of a long stretch for an update or re-familiarization with commercial so here goes. I’m also finding I’m repeating myself lately (and forgetting certain items) and want a nearly complete reference for people.

I’m coming from the perspective of those who have purchased at least one investment property through a mortgage agent and are now thinking of stepping up to the commercial world.

Let me begin by saying that in the commercial world, the rules are just different enough that you should first consult with someone who has done a commercial deal (be that a fellow investor or a mortgage agent who has done a commercial deal).

The assumption in the commercial space is that the purchaser has access to funds, whether it is your own funds or OPM (other peoples money) doesn’t concern them much. The expectation is you will be paying upfront for most items and as it is commercial, most of these items wont be cheap (think double or triple most costs).

Why are things more expensive in the commercial realm? The thinking or philosophy is that any expense incurred in the commercial space will in turn be used as a tax deduction against your business. Expenses related to the acquisition of the property can be deducted (disclaimer, I’m not an accountant, seek professional advice) against the revenue of the property. If I understand this correctly, you can deduct up to 50% of the expense, thus the doubling effect?

Let’s start with the lender. On the commercial side they outline that they want to see 3% of the purchase price available in some liquid form in order to close. For those who have read a normal residential mortgage commitment recently, you’ll recall that typically they require 1.5% available to close.

The lenders themselves also want to see some kind of commitment upfront, which is non-refundable by the way, so that they know if they are going to put the work in there is at least some cash in the deal. What lenders charge varies, but typically it is between 1-2%. They don’t need the full amount upfront but typically 10% of the 1-2% is required for them to continue to work on your file. Some quick numbers $1M mortgage will require $10K fee at close (which can be added or capitalized into the mortgage) and they will want to see $1000 (non-refundable) at the time of the letter of intent.

Here is the first significant difference from the residential world. In residential, we start with a purchase and sale and provide income verification. The lender then looks at the deal and declines it or provides a commitment. We meet the conditions of the commitment and the deal closes. In commercial, we gather the income and expenses for the building for 2 years, purchase and sale agreement and your personal networth statement (PNW). We submit that to the lender and they review with a committee. The result, if they agree, is a letter of intent (LOI). Within the LOI there are several conditions that must be met, but this is in no way a commitment from the lender. That only comes when we get to the letter of offer stage.

In the residential world, when you get a commitment, your rate is locked in at that point. On the commercial side, your rate is not set until 2 days before the closing date. Why? The source of funds for commercial is completely different from that of “bulk” buying on the residential side. The lenders only source the funds 2 days before they know they have a done deal as they know anything can happen (and regularly does) in the commercial space to nix the deal.

Timelines. Assuming we have collected the documentation upfront, once submitted to the lender, it can take from 48 hours to 5 business days to get a letter of intent (LOI). The LOI will normally require an appraisal and these days more commonly a phase 1 environmental report. There will be a proviso that CMHC may require an inspection, but that is up to CMHCs discretion and you should allow time in your planning for that.
The appraisal. Here’s where the fun begins. First the price. This will vary depending upon the size/type/location of the building, but start at a base of $2500 and go up from there with a minimum charge per door. This type of appraisal typically takes longer to do, both on the inspection side and the research side finding comparables that have sold within a reasonable time frame. The reports are longer, contain more information, etc. etc. If you managed to schedule an appraisal in less than a week you are off to a good start. Once the appraiser has been to the site, expect at least 2 weeks before you’ll see the report (larger buildings 3-4 weeks or if it’s a busy season).
Environmental report. Similar timelines/cost to the appraisal. You hope the report shows nothing out of the ordinary otherwise you move onto phase 2 (the removal of underground oil tanks say) and hope that when they resample the soil nothing is found otherwise the current owner now has a rather large headache to fix.
The appraisal and enviro phase 1 can be done at the same time if you have confidence in both. If you think the value might not be there and may adversely affect the financing you may want to get the results of one before starting the other. Keep in mind the lenders will only lend based on the purchase price OR appraisal value, which ever is LOWER.

The appraisal comes back at or below the purchase price. Phase 1 finds nothing. You’ve provided the deposit. Your deal now goes for review. Again 2 to 5 business days later you get a letter of offer, which might quote a rate based upon today’s bond yields, but offer no guarantees. From there, the lenders are willing to close within 5 to 10 business days.

I’ve mentioned lender fees, let’s not forget broker fees. These deals are a heck of a lot of work for me as well. I can’t just simply submit the deal electronically as I do with residential deals. I have to contact various lenders and explain the situation and negotiate on my clients behalf. Then there’s the pile of documentation. I’ve only known one investor to purchase commercial as his first deal. Everyone else builds up to this level and has several rental properties and I have to collect the income/expense for the complete set. T1 generals, etc. etc. Keep in mind, I don’t get paid until the deal closes. So I have incentive to make the deal work as well.

Keep in mind that your closing date is going to be a moving target. Make sure that your vendor and the realtor are aware of this possibility. Why? If the appraisal comes in significantly lower, you may have to take a month to refinance something you already own or sell or find a partner with the extra cash.

If the environmental report doesn’t pass, how long will it take to remedy the problem (assuming it’s minor)? One month, two?

To give you some idea, I purchase a commercial deal many moons ago and it was the longest closing date I’ve ever had. It wasn’t a large building, but at every step of the way something came up. The appraiser got sick. The home inspector was delayed for some reason. The environmental guy took 3 weeks to get to the property and 6 weeks to write up the report. No contamination, but they did find a buried oil tank (empty). Lender didn’t like this, so I had to negotiate with the vendor to split the cost of removing. Got it removed and had to get the same environment guy to go back (another 3 week delay). They made an error in the number of samples collected and had to go back again.
We started with an August close date and ended up closing in February. I now try and avoid using the term “before the snow flies” when discussing commercial deals.