- September 17, 2016
- Advisor Insights
- 0 Comments
When buying and selling apartments, the number one reason why deals fall apart is because of a problem with financing.
In this heated marketplace, a seller may think that they don’t have to worry about how a buyer will finance the purchase of their building, since they think there are so many buyers out there willing to make offers, but sellers will save themselves time and money if they do a little financing homework before putting their building on a market.
Sellers need to look at their own buildings from the viewpoint of a potential lender. Large buyers may have financing strategies and relationships with lots of lenders, but most mid-market properties are going to be bought by smaller buyers, many of whom will be investing in their first building. They aren’t familiar with financing, and banks are not familiar with them. They can use a helping hand.
Remember that it’s the building that lenders will qualify first, before even getting to the buyer. Sellers should go to financiers and ask how they would go about financing a building like theirs. Remember that some lenders love different types of loans, so don’t be afraid to shop around.
Then, when the time comes and you put your building on the marketplace, and you get an offer, you should counsel your buyer. Get to know them. Know their goals and objectives, and know what they can provide as a down payment. Do they have the expertise to run a building such as yours? Do they need a little help getting over the financing hump? Are they a good buyer, but do they have a small incident from years ago that’s complicating their financing? There are ways that you, as the seller, can help.
For instance, let’s take a simple example of a $1 million building placed on the market. Let’s say that a buyer can only gather up enough for a $300,000 downpayment, and the bank is only willing to offer a $600,000 mortgage. A seller can help the buyer by holding a mortgage for $100,000, which gets the buyer to the million and allows the deal to go through. The seller benefits by writing off the mortgage interest on their taxes, and he or she ends up getting $900,000 out of the million from closing.
Why should sellers do this? The most frustrating thing about selling an apartment building is tying it up in a deal that ends up falling through. Banks are underwriting buildings quite conservatively, so financing is a challenge for most buyers in the marketplace. When a seller puts a building up for sale, they only have three to six months to effectively market it. If a seller wastes sixty days on a potential deal that falls apart because the building wasn’t properly underwritten in the first place, the seller has lost two months of marketing time.
It’s a lot harder for a broker to take a building out into the market a second time because potential buyers then ask “what’s wrong with the building”, even when nothing was wrong with the building, only with the buyer the seller chose to deal with.
So, sellers need to get to know their buyers and they need to know how their building can be financed. What can their building achieve for the loan-to-value? What criteria are financial institutions considering, and how can sellers help potential buyers meet that criteria?
Sellers should also familiarize themselves with Canada Mortgage and Housing Corporation’s loan programs. Today, 90% of apartment sales are financed by CMHC. CMHC offers many attractive advantages that can buy-down the interest rate by as many as 100 points. Even with the insurance fee, the payback is less than five years, so it makes sense, especially if the buyer is in the investment for the long haul.
In today’s hot market, many buildings are bought with cash, but that’s not for everyone. At SVN Rock Advisors we’ve helped a number of buyers and sellers creatively arrange financing in order to secure deals. Sellers should never just assume that the right buyer will come along. Nothing is more disappointing than spending time and effort securing a deal, only to have it fall apart due to problems with financing.
Sellers can save themselves from this disappointment by underwriting their own building like a lender, and being prepared to think creatively in setting up transactions that ensure that the deal goes through.