The Multi-Family financing market is in continual flux due to the so-called sub-prime crisis. The rules seem to change on a month by month basis.
The following is an article written by Peter Cook, Assistant Vice President of Commercial Lending at First National Financial Corporation. First National is one of Canada’s largest apartment lenders.
It provides insights into the market, choices that need to be made when considering the financing of your Canadian multi-family properties.
THE LOWEST RATE MAY NOT ALWAYS BE THE BEST DEAL
The emergence of the World Wide Web has had an amazing impact on our day to day lives, especially in the way we shop. The convenience and speed of the Internet has turned many industries into a commodity. Searching for the lowest airline tickets and car rental rates, purchasing shares of your favourite stock or finding the lending institution with the lowest home mortgage rates has become a simple process without leaving the comfort of your home computer. The days of obtaining sound advice and great service from your travel agent, stock broker or banker is becoming a thing of the past. The lowest price seems to be the only factor when consumers make major purchases or financial decisions.
When arranging new mortgage financing apartment owners should be careful not to convert the commercial lending industry into a commodity. Selecting a lender based solely on the lowest interest rate quotation may not always be the best deal.
Securitization has increased the number of lending institutions and commercial mortgage products available to the apartment industry. Borrowers have their choice of financial institutions including chartered banks, life insurance companies or a number of mortgaged-backed security lenders. Financing products available include CMHC insured, conduit and conventional mortgages. The method of determining the interest rate, the timing of when your rate may be set, borrowing costs and closing requirements will vary depending on the lender and product you choose. Signing a financing offer and providing a deposit to the lender with the lowest rate may be a costly mistake.
Interest rate quotes provided sixty days prior to the funding date may have little value if you’re not permitted to establish the interest rate until five days before closing. In a rising interest rate market this type of limitation by your lender may cost you several thousand dollars in additional interest. Several lenders will allow the option to set the rate early with or without additional cost. Borrowers should have their lender disclose details of when the interest rate may be established and any additional costs associated with an early rate set.
A clear understanding of how the lender determines the interest rate is also an important factor that varies among institutions. Most commercial mortgages are established based on a spread over Government of Canada bond yields. Bonds yields are published daily in major newspapers or may be found at the Bank of Canada website (bankofcanada.ca.). A number of institutions have moved to setting their rates on a spread over their internal cost of funds. Borrowers may be at a disadvantage as the lender’s cost of funds are not published and do not always fluctuate at the same time as bond yields. Request that your lender provide a quote based on a spread over Government of Canada bond yields only and define which bond they will be using to set the rate. Another convenient option of determining interest rates for smaller commercial mortgages is a spread above or below residential posted mortgage rates.
Borrowers often do not consider the lender’s closing costs when choosing a financial institution. The difference in costs between lenders may be equivalent to adding several basis points to your interest rate quotation.
Third party report costs will vary depending on the appraisal, engineering/structural or environmental companies that are approved by your lender. I’ve had appraisal quotations on the same apartment building range between $2,500 and $5,000. Environmental reports and engineering/structural reports will also vary depending on the engineering firm completing the investigation. The difference between firms may add $2,000 to $3,000 to your borrowing costs.
The lender’s legal fees may vary by several thousand dollars depending on the law firms approved by your lender. We recently had three quotes for legal fees on a $2,000,000 mortgage that ranged between $2,500 and $5,000.
Insurance requirements also differ between lenders. Increased liability coverage or other additions to your policy required by your lender may add several hundred dollars to your annual insurance premium.
Lender’s processing fees may range from 0.10% to 0.50% of the loan amount depending on the institution.
Hiring a mortgage broker to arrange your mortgage financing is often a great idea to help navigate through the lending process and shop for the best rate. However, a half point brokerage fee adds 0.12% (12 basis points) to a five year term and 0.075% (7.5 basis points) to a ten year term mortgage.
Although most lenders will not provide details of future renewal fees and requirements, having a basic idea of their current structure and fees may provide an estimate of costs at maturity.
The following is an example of two quotations on a $2,000,000 mortgage with different interest rates and closing costs. The example proves the lowest rate is not always the best deal.
Lender A Lender B
Loan Amount $2,000,000 $2,000,000
Interest Rate 5.15% 5.0%
Term 5 years 5 years
Amortization 25 years 25 years
Interest Costs – 5 years $482,498 $468,069
Lender’s Processing Fee 2,000 10,000
Appraisal Report 3,000 5,000
Structural Report 1,200 2,500
Environmental Report 1,200 2,000
Legal Fees 2,500 5,000 Additional Insurance Requirements nil 3,750 ($750/yr)
Total Cost of Borrowing $492,398 $496,319
Although the quote from Lender B was 0.15% (15 basis points) lower, the total cost of borrowing over the first five years was $3,921 higher than Lender A. If the borrowing costs were converted into the interest rates over the five year term, the equivalent rates would be 5.27% for Lender A and 5.35% for Lender B.
Also, having a great relationship with a commercial lender is a key to the success of any real estate investor. Borrowers should take into consideration the level of service provided by the lending institution, including location of where their mortgage will be administered, staff response time, industry knowledge and product availability. Saving a few basis points in rate on your mortgage may easily be off set by obtaining the wrong advice or receiving poor customer service.
Borrowers should take their time when arranging new mortgage financing and receive written quotations from more than one lending institution. The financing proposal should not only include the current interest rate but how and when the interest rate is to be determined. Also, request a detailed list of all costs associated with the transaction including estimates for legal fees, third party reports and insurance requirements.
Fortunately, the Internet has yet to turn the commercial lending industry into a commodity. Experienced real estate investors know the importance of a lender in their long-term success and do not always base their financing decisions solely on interest rate. Obtaining a competitive rate along with low costs, sound advice and great customer service is still a necessity and available in our industry.
Peter Cook is the Assistant Vice President of Commercial Lending at First National Financial Corporation. First National is one of Canada’s largest apartment lenders and has over $16,000,000 of mortgages under administration. Peter may be reached at 416-593-2913 or 1-800-465-0039.
This article first appeared in the FRPO’s Fair Exchange magazine and is published with permission from the author Peter Cook.
