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Commercial strata units + commercial properties, why such a high down payment?


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#1 Mike K.

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Posted 23 July 2012 - 09:18 AM

When buying a commercial property or a property for profit/investment purposes, why is the down payment so much higher (50%) compared to buying a residential property?

Are there instances where a property purchased as an investment, say a condo, doesn't require such a hefty down payment?

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#2 Bob Fugger

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Posted 23 July 2012 - 09:44 AM

When buying a commercial property or a property for profit/investment purposes, why is the down payment so much higher (50%) compared to buying a residential property?

Are there instances where a property purchased as an investment, say a condo, doesn't require such a hefty down payment?


Risk.

#3 Mike K.

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Posted 23 July 2012 - 09:55 AM

...and there's absolutely no risk when a 20-something buys a $500,000 condo with 5% down payment and a 40 year amortization?

A first-time homebuyer can put down at little as $25,000 to secure a $500,000 mortgage at the lowest interest rates. An investor or company has to put down about $250,000, or 10x as much, to secure a mortgage for $250,000 plus a higher interest rate. Meanwhile the commercial property generates higher taxes and is considered a larger cog in the wheel of the economy.

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#4 Bob Fugger

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Posted 23 July 2012 - 10:03 AM

...and there's absolutely no risk when a 20-something buys a $500,000 condo with 5% down payment and a 40 year amortization?


Not what I'm saying, at all - different (and far less) risk, though. When you buy a condo for investment, you have to factor in that you won't be living there - which from an underwriting perspective, is much riskier than an owner-occupied. In an owner-occupied, you're not paying living expenses elsewhere and there is very little risk (relatively speaking) that you won't be paying living expenses to live there (via the mortgage). You are the landlord and tenant, in a sense - and that represents a lower actuarial risk than if you were at the whim of the tenancy market. Plus, it's theoretically harder to walk away from an owner-occupied than an investment mortgage.

#5 Mike K.

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Posted 23 July 2012 - 10:13 AM

Ok, fair enough in regards to residential properties purchased for investment purposes.

But what about commercial units, i.e. a warehouse or strata commercial space? Why does such a property require a 50% down payment if it's fully leased and earning a certain amount of monthly income? You'd think the bank would look at the earning potential of the property and adjust the minimum down payment appropriately, no?

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#6 Matt R.

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Posted 23 July 2012 - 10:16 AM

From a layman's POV, I think the point is that that warehouse could become vacant as early as tomorrow or even tonight, leaving you without a revenue stream to pay your mortgage, while you are not likely to walk away from your house - because you need somewhere to live.

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#7 Mike K.

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Posted 23 July 2012 - 10:22 AM

I don't think an owner of a commercial property would walk away from their property after losing a tenant, either.

Is there actually a difference between someone who can't pay the mortgage on their home and someone who can't pay the mortgage on their commercial property as far as a bank is concerned? In either case the bank isn't getting it's money and if anything it's easier for a bank to reclaim a commercial property than a residential property.

That's why I think government intervention has more to do with the low deposits required for primary residences despite them being equally risky for the banks (but that risk is shared with CMHC), but I'm simply curious why 50% is the standard (and if some banks or situations call for a lower deposit) and if there are any government programs or economic incentives for certain buyers of certain commercial properties.

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#8 Bob Fugger

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Posted 23 July 2012 - 11:02 AM

I don't think an owner of a commercial property would walk away from their property after losing a tenant, either.

Is there actually a difference between someone who can't pay the mortgage on their home and someone who can't pay the mortgage on their commercial property as far as a bank is concerned? In either case the bank isn't getting it's money and if anything it's easier for a bank to reclaim a commercial property than a residential property.

That's why I think government intervention has more to do with the low deposits required for primary residences despite them being equally risky for the banks (but that risk is shared with CMHC), but I'm simply curious why 50% is the standard (and if some banks or situations call for a lower deposit) and if there are any government programs or economic incentives for certain buyers of certain commercial properties.


But they're not equally risky - that's the point. They may seem to have the same risk outcome (non-payment of mortgage), but when you're setting up the mortgages, based on history, economy and whatever forward looking risk factors that banks use, commercial mortgages are riskier than residential ones. Businesses go under and you're left without a tenant. That is far, far more likely than an individual going under.

#9 Mike K.

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Posted 23 July 2012 - 11:20 AM

I dunno, I'd have to say that there are far more deadbeat homeowners than there are failing businesses, at least in my experience.

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#10 Baro

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Posted 23 July 2012 - 11:33 AM

Insurers entire business is assessing risk and they actually come up with their policies with data beyond anecdotes and gut feelings.
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#11 sebberry

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Posted 23 July 2012 - 11:43 AM

Are the mortgage restrictions different for those purchasing rental properties vs. those purchasing their primary residence?

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#12 Mike K.

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Posted 23 July 2012 - 11:49 AM

Insurers entire business is assessing risk and they actually come up with their policies with data beyond anecdotes and gut feelings.


Yes, because we all know the insurance industry (in particular!) is fair and equitable in the way it conducts its business.

Are the mortgage restrictions different for those purchasing rental properties vs. those purchasing their primary residence?


Absolutely. Primary residences are eligible for better rates, lower down payments and higher amortization periods.

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#13 Mike K.

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Posted 23 July 2012 - 11:59 AM

But they're not equally risky - that's the point. They may seem to have the same risk outcome (non-payment of mortgage), but when you're setting up the mortgages, based on history, economy and whatever forward looking risk factors that banks use, commercial mortgages are riskier than residential ones. Businesses go under and you're left without a tenant. That is far, far more likely than an individual going under.


Ok, now that I've thought about this I can see how things can get out of hand quickly for an investment property without a tenant. Taxes, municipal fees, strata and mortgage can add up quickly while a new tenant is signed and actually starts paying rent.

So if 50% down payments for commercial properties are the norm, what other restrictions do buyers face? Like in terms of interest rates, would they be significantly above prime compared to primary residences? Would there be an average amortization period for a commercial property?

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#14 LJ

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Posted 23 July 2012 - 07:09 PM

I think also the easier rules for home buyers are in place so that more people can afford to shelter themselves.

Commercial property owners are usually a company who can write off losses and depreciation of an asset if that happens, while a homeowner can't.
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#15 Bob Fugger

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Posted 23 July 2012 - 09:36 PM

Ok, now that I've thought about this I can see how things can get out of hand quickly for an investment property without a tenant. Taxes, municipal fees, strata and mortgage can add up quickly while a new tenant is signed and actually starts paying rent.

So if 50% down payments for commercial properties are the norm, what other restrictions do buyers face? Like in terms of interest rates, would they be significantly above prime compared to primary residences? Would there be an average amortization period for a commercial property?


Rates are definitely higher. Where you could a 5 year fixed residential in the 3% range, you're in the high 4s and into the 5s for a comparable commercial mortgage. Plus, you pay an absolute **** tonne of fees on a commercial mortgage, like a mortgage preparation fee, enviro assessment, engineering report, etc.

#16 pherthyl

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Posted 23 July 2012 - 09:54 PM

When buying a commercial property or a property for profit/investment purposes, why is the down payment so much higher (50%) compared to buying a residential property?

Are there instances where a property purchased as an investment, say a condo, doesn't require such a hefty down payment?


Pretty sure you only need 20% down for investment condos.

#17 Bob Fugger

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Posted 24 July 2012 - 05:52 AM

Pretty sure you only need 20% down for investment condos.


Actually, I think that the number is 35% - at least for your first three (which are the hardest). After that, bankers tend to use something called "The Rule of 1.1." After three rentals, they figure that you are a true real estate investor. So rather than the traditional TDS/GDS ratios for mortgage suitability, they use this 1.1 formula, which is pretty simple: for every $1 in total expenses, you need to demonstrate $1.10 in gross revenues.

It really opens up the floodgates, because TDS/GDS is finite and cumulative: that is, once you own a couple of places, you need to demonstrate proportionally more income to offset your expenses. It doesn't help that most banks only consider 50% rents (again, there's that risk aversion), or that your place will be vacant about 1/2 of the time. Reasonable for Fredericton, maybe - not so much for Victoria.

#18 pherthyl

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Posted 24 July 2012 - 07:09 AM

Actually, I think that the number is 35% - at least for your first three (which are the hardest). After that, bankers tend to use something called "The Rule of 1.1." After three rentals, they figure that you are a true real estate investor. So rather than the traditional TDS/GDS ratios for mortgage suitability, they use this 1.1 formula, which is pretty simple: for every $1 in total expenses, you need to demonstrate $1.10 in gross revenues.

It really opens up the floodgates, because TDS/GDS is finite and cumulative: that is, once you own a couple of places, you need to demonstrate proportionally more income to offset your expenses. It doesn't help that most banks only consider 50% rents (again, there's that risk aversion), or that your place will be vacant about 1/2 of the time. Reasonable for Fredericton, maybe - not so much for Victoria.


Did it change again? In 2010 the rules were tightened to require 20% for investment condos (used to be just 5%):

"Effective April 19, CMHC will:

Require 20% down on non-owner occupied rental properties (instead of 5% today)
Change its rental qualification formula from an “80% offset” to a “50% add-back.” (More on this below)"


http://www.canadianm...ntal-rules.html

#19 Bob Fugger

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Posted 24 July 2012 - 07:33 AM

Did it change again? In 2010 the rules were tightened to require 20% for investment condos (used to be just 5%):

"Effective April 19, CMHC will:

Require 20% down on non-owner occupied rental properties (instead of 5% today)
Change its rental qualification formula from an “80% offset” to a “50% add-back.” (More on this below)"

http://www.canadianm...ntal-rules.html


Yeah, I'm not entirely certain, to be honest - it changes based on who you talk to at what bank. I know that when I was in a position to put down multiple 5% down payments, I was told that for investment properties it needed to be 35%, unless I already owned three.

#20 Mike K.

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Posted 24 July 2012 - 10:41 AM

Wow, 20% is much more palatable than 35%.

Bob, are those additional assessments you mentioned required for investment condo purchases as well?

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