assumptions made in the report. The basis of the report and the
assumptions used may not be valid or could be incomplete.
II. Zoning and Legal Restrictions
We must understand the current zoning for the property. This
is generally done by confirming approved uses of the property
directly with the local municipality. We need to know if the property
has non-conforming uses (i.e. basement apartment, commercial
enterprise operating in residential) as that affects the valuation and
the lenders security.
In relation to files where the property has development
potential, we consult the municipality’s Official Plan and Secondary
Plan to understand the types of land uses and density restrictions.
If one intends to develop an environmentally protected area (EPA),
they may not be successful. The local conservation authority has
significant oversight.
Planned development of properties with heritage home
designations is also potentially problematic. Each municipality
has a heritage council that review applications and makes
recommendations to City Council. A demolition permit may not be
provided, which puts the project in peril.
You may require consultants to analyze these issues, including
planning consultants, heritage consultants, quantity surveyors,
engineers and lawyers.
III. Rent Roll
In funding a commercial property with tenants in place,
a detailed review of the leases and the financial strength of the
tenants is critical. Leases with strong tenants provide comfort to
the lender (a long term lease with AAA tenants is stronger than a
short term lease with a local business).
Intended Use of proceeds
You have a duty to ensure that the Mortgage is suitable for the
Borrower (affordability). A mortgage that goes into default affects
both the Borrower and the Lender, and the mortgage broker.
An important step is the detailed review of the “Use of
Proceeds” so you can understand where the money is going, and
if it is sufficient to address the funding concern. In some cases,
the lender may stipulate provisions as to how funds can be used.
Specific use of proceeds could be documented in a Financial
Projections (or Pro-forma) often used in construction lending.
Credit stressed borrowers are often forced by the lender to use
mortgage proceeds to repay credit cards and other debt.
Review of the Cash Flow, as well as how the cash flow differs
from a financial projection in that a financial projection does
not account for capital expenditures and principal repayments.
Preference should be given to reports prepared by accountants or
quantity surveyors.
Terms and conditions for the Mortgage
We need to understand and explain the specific terms and
condition of the mortgage to advise both the borrower and lender
as to the rights, obligations and other material issues.
A mortgage commitment is about more than the rate:
• Term
• Repayment privileges and penalties
• Recourse in case of default
• Costs and fees
• Obligations to carry insurance
• General security agreement and personal guarantees
• Assignment of rents
In private lending, the above are very important to both parties,
so we have to understand the impact of each and communicate
with our client.
Risks
As in any financing transaction, there are many risks. We
are required to discuss possible risks with both non-institutional
lenders and borrowers, including:
• Interest rate risk – the cost of a variable rate mortgage could
increase or decrease
• Market risk – the value of the underlying real estate could
fluctuate and impact the parties
• Development risk – the plan could be limited by regulations
• Default risk – a borrower could be unable to service the loan
Regulatory and Taxation
There are specific rules and laws in different geographical
jurisdictions which could affect the parties. In addition, there are
potential or real tax implications in every transaction, on both
sides. You have to be aware of these issues. Secondary properties
and the renting of basement apartments have tax implications.
Matrimonial homes and family law impact are specific cases
that require analysis. Also, you need to be aware of mortgages
intended for illegal activities – we have an obligation to report
these to authorities.
Documentation
Be sure you document your findings as well as ensure that
all required disclosures to Borrowers and Lenders are made, and
obtain acknowledgement from each respective parties that these
disclosures were made. Each party receives independent legal
advice prior to executing documentation. In Ontario, there is a
statutory 48 hour period of rescission, unless waived by the parties.
Summary
Most of the procedures that can be used to ensure compliance
with KYC, KYP and product suitability are similar to those in the
private capital sector. The real benefit of robust procedures is a
better understanding of the funding requirements, which will allow
you to develop a better relationship with your client (borrower or
the lender). Clients are always looking for money and institutions
are always interested in investing funds.
For more information contact:
Nick Tsimidis
ntsimidis@realwealthgroup.ca
