Recently I was approached to finance a commercial building in Hamilton, Ontario.
The property was a vacant and former rooming house and the clients wanted to transform it into a retirement home. The clients were a retired nurse and two personal support workers, all of whom had experience working with seniors, however they did not have experience operating a retirement home.
In this situation it’s important to know:
- Is there a business plan outlining how the business will be run?
- Will these clients be operating the business or hiring others’ to manage it for them?
- How did the previous operations affect the current status of the building?
- Is there a current appraisal to support the asking price?
- Are there any current issues with the property? Does it need renovating? Does it have any environmental issues?
- Was there an alternate plan to operating a retirement home? An exit strategy?
The business plan was the most important document to start with in this case. Because the clients did not have experience it was important to know how they were planning to transform the previous rooming house (19 rooms only) into a retirement home and why they wanted to do this in the first place. Not only would it guide them through their plans, but when the going gets tough, they could use this to refer back to.
Furthermore, the business and financing plan would allow them to operate on the numbers and not emotions. As investors, especially in the commercial space, it’s important to understand the numbers on the property. How much is it going to cost for this specific property? Will it cash flow? Does it support the goals of the investor? Does it make sense to do it at all? Can it be financed?
Always be prepared to walk away if the numbers don’t make sense and make sure the property fits with your business model – don’t force it!
When it comes to commercial financing, the lender is first looking at the property and then you the borrower. There is a huge misconception that in commercial financing, lenders are only looking at the property – this is a myth!
In this instance, the broker had already done the rounds with the banks and had been turned down because they either did not like the property or they did not believe the borrowers could manage the property and run it as a retirement home.
Commercial financing also takes much longer (anywhere from 3 months to a year) to complete, due to all the due diligence that is required. The clients and their realtor as well did not understand this and thought that they could have this closed in a month. While this is true on the residential side, it is rarely true on the commercial side.
Unfortunately when I got all the paperwork, the debt ratios were way out of whack – I’m talking triple digits! All three borrowers did not have good financial standing and therefore could not handle the payments if the property were to not support itself down the line. The strength of the deal though lied in the property itself and in order to get this financed, I turned to a private lender, who would overlook the debt ratios on the file, however even the private felt it was too risky with the plans for the property.
They also lacked the required down payment. With a residential investment they could get away with 20% down, however on the commercial side and depending on the deal, they would be required to put down a much higher down payment in the neighborhood of 30-35% and sometimes higher. Also location played a huge role as to marketability! Furthermore, because this was a previous rooming house, it required further due diligence.
Due to the lack of down payment and to give strength to the deal, the lender required the borrowers to put up their personal properties as collateral on the deal. This worked great because all the borrowers had equity in their properties. The banks would not consider this option, as they are not as flexible when it comes to financing.
So how did it fall apart?
The clients business and financing plan did not suit the property – they were trying to force this property to fit because it was in their budget. However, at only 19 rooms the cash flow projections and the renovations needed to transform the property would not support the monthly payment on the private loan.
Second, they would not agree to certain terms that the private lender was requesting, such as the collateral on their personal homes.
Third, they did not realize with their lack of experience, no lender will finance them or their business idea, no matter how well-thought it is.
Fourth, not only did they lack the required downpayment, but they also lacked sufficient liquid capital if the building were to not support itself. The lack of liquid capital meant that they could not budget for unavoidable expenses, such as repairs to HVAC systems or elevators to name a few!
Fifth and final, they now know that it will take much more than a dream to make their plans a reality so they are forced to go back to square one to rework their business plan and source a property to match their business plan and not the other way around.
Before going down the commercial route, make sure you have your ducks in a row financially and let your business plan lead your commercial acquisition and not the other way around.