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Market value versus lending value
Category :- Credit and Debt

Author :- Peter Cook and Robert Flee 
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Posted on October 18, 2014, 6:56 am
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We often are asked to explain why there is a difference between market value, the price a willing buyer and seller negotiate and the lending value - the value a lender and CMHC use to determine your maximum mortgage amount. The obvious question being: “Shouldn’t they be the same?” The lending value is typically less due to a number of reasons. The easiest way to clarify this is to break down the standard underwriting criteria used by most lending institutions and CMHC.



Lenders will take the existing rent roll at the time of application and multiply the total monthly rental revenue by 12 to determine the gross annual rental income. They will sometimes include future guideline and above guideline increases if proper notice has been given to the tenants and the increases take place prior to the funding of the mortgage. Borrowers often expect to use projected income, however lenders and CMHC will not typically consider potential increases that may or may not occur after the funding of a mortgage.

Laundry income is usually based on the amount disclosed on the owner’s financial statement. If an owner cannot support the amount of laundry income, the rule of thumb is $15 per unit per month. A landlord who wants to maximize his or her valuation for lending purposes should make sure they properly disclose laundry revenue on financial statements.

Parking income used in underwriting is the amount recorded on the current rent roll or on the owner’s financial statement. Similar to apartment income, parking revenue is based on actual income received and lenders will not project potential future income. Separate parking income on financial statements and rent rolls and exclude it from apartment revenue.

Ancillary income such as furnished suites, vending machines, ATMs and antenna revenue are typically not used for underwriting purposes. Occasionally, lenders and CMHC may consider some portion of ancillary income. It would be helpful to separate these items on financial statements to allow the lender to identify all income sources to maximize the loan amount.

Additional revenue will be considered if one has a lease with a commercial tenant. However, CMHC has a requirement that commercial space and revenue cannot exceed 20 per cent of the overall square footage of the building or total revenue. All commercial tenants should have leases for the longest term they are willing to negotiate. Also, separate all revenue and expenses on financial statements allocated to commercial tenants.



“Why do lenders use a vacancy rate when my building is full all of the time?” Borrowers must remember lenders are providing mortgage funds and CMHC is insuring those funds for a 25 year amortization period. During this period, vacancy rates may fluctuate considerably. For underwriting purposes, lenders use the higher of the current vacancy data provided by CMHC in their market surveys or the actual current building vacancy. When there is a significant discrepancy between actual and market vacancy the borrower may be asked to provide a vacancy history report for their building. It is important to maintain excellent occupancy information to help support future mortgage applications. Keep rent rolls for at least three years.



A property management expense is typically four per cent of the effective gross income - the income amount after allowing for vacancy. However, the percentage may vary slightly depending on the number of units in the building. Although a borrower may manage his own building, lenders will still apply a management expense for the property. Unfortunately part of the underwriting process is the consideration the mortgage may go into default no matter how remote the possibility. If that occurs the lender must hire a company to manage the property on their behalf.

The actual property tax expense is used for underwriting purposes. Be prepared that a lender may increase the amount by three to five per cent for the upcoming year depending on the unicipality. Have tax bills available to submit with the mortgage application.

The amount used for utility and property insurance expenses for underwriting purposes is based on the amounts disclosed on financial statements. An increase of three to five per cent may be added to the previous year’s actual expenses to account for potential increases by the utility and insurance companies.

There may be an additional increase to account for HST and one may also be required to produce bills to verify the actual costs. Having easy access to utility bills and insurance invoices for all of one’s buildings will help with the mortgage application process. Also, have the accountant provide a separate line item for each utility (water, hydro and gas) and insurance expense on financial statements.

Those who have recently completed energy saving retrofits to their buildings should be sure to tell their lenders. They may qualify for CMHC’s program that allows landlords to achieve a higher lending value and loan amount along with a rebate in their premium.

The amount used for repairs and maintenance expense depends on the number of units in the building and the overall condition of the property. Although one’s actual expenses may be less, lenders will use between $650 to $800 per suite annually to determine the total repair and maintenance expense. For townhouses, expect the number to range from $800 to a thousand dollars per suite annually. Similar to our comments regarding vacancy, lenders are taking into consideration required repairs to properly maintain a building over the full amortization period of the mortgage. They will also take into consideration the amount disclosed in financial statements if actual expenses are higher. Those who have expensed some major capital items on the property or completed additional repairs should be prepared to provide a summary with documentation supporting the additional work completed. Superintendent expense is typically calculated on a per unit basis ranging from $300 to $400 per suite annually. The larger the building, the greater the superintendent expense used for underwriting purposes. This amount typically includes free rent provided for the superintendent by the landlord.

Lenders will allocate a miscellaneous expense to cover items such as legal, accounting and other minor related items associated with running an apartment building. The formula is typically one to two per cent of the effective gross income.

Read Part 2

Source: http://www.firstnational.ca/docs/comm/CAMFinancingJan2011.pdf

Comments : Peter Cook and Robert Fleet are Apartment Financing Specialists with First National Financial LP. Together they have originated over $4 Billion of mortgages. Their combined 32 years experience with mortgage financing has lead to frequent speaking engagements across the country.
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