Commercial Real Estate Finance
Commercial Real Estate Financing in Canada: A Guide for Investors and Business Owners
Commercial real estate financing is rarely determined by the property alone. Lenders evaluate the asset, borrower, cash flow, capital structure and transaction together. Understanding how these elements interact can materially improve the financing strategy.
Contents
- What Do Commercial Real Estate Lenders Evaluate?
- Loan-to-Value and Debt-Service Coverage
- Different Transactions Require Different Financing Structures
- Bank Financing Is Only One Part of the Market
- Why Financing Strategy Should Begin Early
- Preparing for a Commercial Real Estate Financing
- Choosing a Financing Strategy
- How CFM Approaches Commercial Real Estate Financing
Commercial real estate financing is fundamentally different from financing a home.
While the property remains important, commercial lenders typically evaluate a much broader set of factors: the property's income and value, the borrower's financial strength and experience, the proposed capital structure, the quality of the tenants or underlying business, and the purpose of the financing.
As a result, obtaining attractive commercial financing is often less about finding a single advertised rate and more about structuring the transaction appropriately and presenting it to the right capital sources.
For investors, developers and business owners, understanding how lenders approach a commercial real estate transaction can help improve both the financing process and the eventual capital structure.
What Do Commercial Real Estate Lenders Evaluate?
Most commercial real estate financing decisions involve several interconnected considerations.
The Property
Lenders will typically consider the type, location, condition and marketability of the property.
An established multi-residential property, industrial building, office property, retail plaza and development project can each have very different lending characteristics.
The lender will also consider whether the property is stabilized, undergoing redevelopment, being constructed or being acquired for owner occupation.
Cash Flow
For income-producing properties, the ability of the property to support its debt is a central consideration.
Lenders may examine rental income, operating expenses, vacancy, lease terms and other factors to determine the property's net operating income and debt-service capacity.
The quality and sustainability of that income can be as important as the current amount.
The Borrower or Sponsor
Commercial lenders also evaluate the people and entities behind the transaction.
Relevant considerations can include:
- financial strength
- liquidity
- net worth
- real estate experience
- operating experience
- credit history
- existing leverage
- ownership structure
A strong property does not necessarily compensate for a weak borrower, and a financially strong borrower does not eliminate concerns about a problematic asset.
The complete transaction matters.
Equity and Capital Structure
The amount and source of equity invested in the transaction can materially affect lender appetite.
Lenders generally want to understand how much capital the borrower is contributing, where that capital is coming from and how other debt or investor capital fits into the structure.
For more complex transactions, the capital structure may include several components rather than a single mortgage.
Commercial real estate financing is a capital-structuring exercise, not simply a search for the lowest advertised rate.
Loan-to-Value and Debt-Service Coverage
Two concepts frequently arise in commercial real estate financing: loan-to-value and debt-service coverage.
Loan-to-value, or LTV, compares the amount of financing with the value of the property.
For example, a C$6 million loan against a property valued at C$10 million represents a 60% loan-to-value ratio.
But property value alone does not determine how much a lender will advance.
For income-producing real estate, lenders also consider whether the property's cash flow can adequately support the proposed debt.
Debt-service coverage compares available property income with required debt payments. A transaction can therefore satisfy a lender's loan-to-value requirements but still support less financing because the property's income is insufficient.
Conversely, strong cash flow does not automatically overcome concerns about leverage, property quality or borrower strength.
Commercial underwriting generally considers these factors together.
Different Transactions Require Different Financing Structures
There is no single commercial mortgage product appropriate for every transaction.
The financing strategy should reflect what the borrower is actually trying to accomplish.
Property Acquisitions
Acquisition financing must balance the purchase price, property value, available equity, income generated by the asset and the borrower's broader financial capacity.
Timing also matters because financing must normally align with conditions and closing requirements under the purchase agreement.
Construction and Development
Construction financing introduces additional considerations including project costs, borrower equity, permits, construction budgets, progress advances, contingencies, presales or leasing and the eventual repayment or take-out strategy.
The lender is financing both the existing asset and the successful completion of a future project.
Refinancing and Recapitalization
Owners may refinance commercial property to replace existing debt, improve financing terms, access accumulated equity, fund improvements or redeploy capital elsewhere.
The best structure depends heavily on the reason for the refinancing.
Maximizing proceeds, minimizing borrowing costs and maintaining future flexibility can lead to different financing strategies.
Bridge Financing
Bridge financing can provide shorter-term capital when conventional long-term financing is not yet available or appropriate.
Examples may include acquisitions with tight closing timelines, properties undergoing stabilization, transitional assets or situations where a longer-term financing event is expected later.
Bridge capital can provide flexibility, but its cost and exit strategy require careful consideration.
Owner-Occupied Commercial Real Estate
When a business acquires the property from which it operates, lenders may consider both the real estate and the operating company.
This creates an important connection between commercial real estate financing and business financing.
The financial performance of the operating business, ownership structure, property value and proposed financing can all influence the transaction.
Bank Financing Is Only One Part of the Market
Canadian commercial real estate borrowers can encounter a range of potential capital sources.
Depending on the property and transaction, these may include:
- banks
- credit unions
- institutional lenders
- commercial mortgage lenders
- private lenders and private credit
- government-supported programs where applicable
- other specialized capital providers
Different lenders can have materially different appetites for property types, leverage, geography, borrower profiles and transaction structures.
The lowest nominal interest rate is therefore not always the only — or even the most important — consideration.
A financing structure should also be evaluated based on factors such as proceeds, amortization, term, covenants, guarantees, prepayment flexibility, fees, closing certainty and the borrower's future plans.
Why Financing Strategy Should Begin Early
One of the most common mistakes in commercial real estate financing is treating financing as an administrative step that begins after the major transaction decisions have already been made.
Earlier financing analysis can identify potential issues before they become closing problems.
For an acquisition, this may affect the amount of equity required or the conditions included in an offer.
For a development, it may influence the project budget and capital structure.
For a refinancing, it may determine whether accessing additional equity is economically worthwhile.
And for an owner-occupied property, financing the real estate without considering the operating business can result in an inefficient overall structure.
Financing should therefore be considered as part of the transaction strategy rather than simply as the final step required to close.
Preparing for a Commercial Real Estate Financing
The information required will depend on the transaction, but borrowers should generally expect to provide information regarding both the property and the borrower.
This may include:
- property details and purchase information
- rent rolls and leases
- historical property operating statements
- property tax and operating-cost information
- construction budgets where applicable
- corporate financial statements
- personal or corporate net-worth information
- organizational and ownership information
- details of existing financing
- business financial information for owner-occupied properties
- the source of the borrower's equity contribution
Complex transactions may require considerably more information.
Preparing a coherent financing package can help lenders understand the transaction more quickly and reduce unnecessary back-and-forth during underwriting.
Choosing a Financing Strategy
A strong commercial real estate financing strategy begins with the objective.
- Is the priority to minimize borrowing cost?
- Maximize available proceeds?
- Close quickly?
- Preserve liquidity?
- Reduce personal guarantees?
- Create flexibility for a future sale or refinancing?
- Fund additional acquisitions?
There is rarely one financing structure that optimizes every objective simultaneously.
The appropriate strategy requires understanding the trade-offs and determining which factors matter most for the particular transaction.
That is why commercial real estate financing should ultimately be viewed as a capital-structuring exercise rather than simply a search for a mortgage.
How CFM Approaches Commercial Real Estate Financing
CFM works with commercial real estate investors, developers and business owners on acquisitions, construction and development financing, refinancing, bridge financing, multi-residential properties, owner-occupied real estate and other complex commercial real estate requirements.
Our approach begins with understanding the transaction and the client's objective before considering the financing structure and potential capital sources.
The goal is not simply to identify a lender.
It is to help structure and position the financing requirement appropriately, evaluate available alternatives and support the transaction through execution.
Planning a commercial real estate transaction?
Discuss a Financing Requirement →
Sebastien Charles is the Founder and Managing Director of CFM Financial Consulting Inc. His experience spans entrepreneurship, corporate finance, M&A, capital raising, commercial financing, executive leadership and governance.
This article is provided for general informational purposes only. Financing availability, terms and underwriting requirements vary by lender, transaction and borrower circumstances. The information should not be considered financial, legal, tax or investment advice.
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