If It Sounds Too Cheap, There is a Reason
As everyone is aware, the current real estate market is extremely fast paced. Just like in past “hot” markets, after the initial influx of business, we get a lot of borrowers looking for a “deal.” It is usually about this cycle in the market, that I start to get a lot of calls with people trying to finance very difficult-to-finance properties which are cheaper than normal properties all in an attempt to get into the market somehow… anyhow!
The old adage, “if it sounds too good to be true, it probably is” applies to many things in life, but most assuredly real estate.
Buyers have become increasingly sophisticated, and this has never been more true than in Vancouver where investing in real estate has become not just a financial decision but a social activity and dinner conversation. Finding a “deal” is extremely hard, and many buyers turn to hard-to-finance property types to get the space and amenities they want. It doesn’t take long, however, before the property that seemed like such a great “deal” becomes very hard to get a mortgage on and they end up paying a higher rate, fees, or not able to get financing at all.
My phone rings every day with someone attempting to purchase a property that is difficult to get a mortgage against. There are lots of different types of properties and oftentimes people don’t understand why getting a mortgage is particularly difficult on them. At the end of the day, “marketability” is the primary reason that getting financing on these properties is difficult. This article will highlight several hard-to-finance property types and provide an explanation of why the price may seem to be too good to be true. While it is not an exhaustive list, it highlights the most common hard-to-finance property types that cross my desk in the Greater Vancouver Area.
CO-OP HOUSING (Cooperatives):
Co-Op properties often appear to have a bargain basement price tag and are also often in established areas with larger layouts and sizes than are available in conventional strata apartments. However, the low price is an indicator that something might be too good to be true, as demand for these properties should be excellent, right?
The complicated ownership structure is where these properties are not easily mortgaged as a conventional condo. A standard condo unit gives you the right to buy, sell, and usually rent it out to whomever and whenever you choose. The building’s common areas and amenities are paid for by everyone according to a unit entitlement that is clear and precise. Your name goes on title, and the owner’s rights to the specific unit are clear and unambiguous.
In a Co-op, instead of buying the title to a specific property, you are (typically) buying shares in a corporation that owns and manages a particular property. Each co-op is run differently, with different bylaws, rights, and regulations from every other co-op. Further, the shares give you the right to occupy the specific unit, but you do not “own” the unit. You own the right to occupy it. As they are not a strata, they also don’t fall under the same strata rules regarding contingency reserve funds for maintenance, and various other requirements enjoyed by condo owners.
Many of the expenses of the property are shared amongst all members of the co-op with their monthly maintenance fees often including utilities and/or property taxes. While this might feel the same as a condo, it isn’t, as there can be restrictions on the shares of a co-op that require board approval buying, selling, or mortgaging their shares. This feature makes them far less desirable to the public at large (and lenders), meaning there are fewer buyers that will be available to buy the property. Fewer buyers means less marketability.
Most of the deep discount rates you see on mortgage broker’s websites apply to condos, but not to co-ops, as the lenders perceive a higher level of risk (or at least ambiguity as to their ability to enforce their security) on co-ops. Oftentimes only credit unions, private lenders, or friends and family will lend on them. While the price may appear attractive, they will certainly require a much larger down payment. This has the effect of limiting the number of buyers (and lenders) and affects the overall marketability of a property. Hence, many banks will not lend on them.
FRACTIONAL OR UNDIVIDED INTEREST PROPERTIES:
Similar to co-ops, fractional interest or undivided interest properties represent a financing challenge for most of the same reasons. With these properties, instead of buying shares in a corporation, the buyer is purchasing a percentage of ownership of a building. Along with that ownership comes the right to inhabit a specific unit in the property. However, once again, the buyer does not own the specific underlying real estate they inhabit; at least, not clearly.
Also like co-ops, fractional interest properties have a unique set of bylaws and regulations that is also unique to each property. However, they don’t typically face the heavy restriction that co-ops face whereby the board has to approval the purchase, sale, or mortgage of the buyer’s interest. In this sense, they are somewhere between co-ops and condos in their flexibility, and therefore in their marketability.
As you will see throughout this article, marketability drives the finance-ability of a property. With lenders unable to clearly point to the real estate that their borrower owns, their costs to foreclose can be higher or more onerous, and this results in many of the deep discount lenders that brokers and bankers deal with not wanting to finance them at all.
While both co-ops and fractional interest properties are able to get SOME financing, it typically is for a maximum of 65% of the value of the property and often at a rate ½ to 2%+ that faced on a condo of similar characteristics. Mortgage brokers may have some additional financing available up to 80% of the value of the home in some cases.
Leasehold properties represent an interesting property type that is very prevalent in certain markets, but, still also can be difficult to finance. Leaseholds can be apartments, houses, or even cottages located within a larger property. With a lease, you are pre-paying the right to occupy the property, typically but not always, for 99 years. At the end of the 99 year lease, the property reverts to the actual owner. However, you can mortgage you leasehold interest but with varying degrees of difficulty.
Unlike a co-op or fractional interest property, where it can be ambiguous as to what the person actually owns from a legal sense, a leasehold is more defined. Typically if there is a leasehold on a condo, it will be for that specific unit that will remain in the title of the government or corporation, but with specific rights in the lease agreement specifying the unit or property that is being leased.
There are three general types of lease:
Government or Municipal Leaseholds
Government leaseholds are the most common and easiest to finance. They are pre-paid for 99 years, and many lenders will look at government leaseholds at their fully discounted rates. While not ALL lenders will look at them, financing is readily available for most city leases.
Native Leaseholds are leaseholds where a Native Band owns the underlying property. There are a couple chartered banks that will consider these properties, but depending on the band, location, and type of property they can also be difficult to finance. This area of financing is particularly complex with a variety of projects on native lands being deemed OK where others (even sometimes with the same band) are difficult to get a mortgage against. You will need the guidance of an independent mortgage broker to navigate these complicated waters.
Private Leaseholds are leaseholds where a corporation owns the underlying property. Like co-ops and fractional interests, each of these has a unique underlying lease and therefore bylaws. These are particularly difficult to get financing on as it requires the lender to have a full legal review of the lease to determine how comfortable they are on financing it. This takes time, costs the borrower a couple thousand dollars, and adds to “hassle factor” that banks generally eschew. Therefore, there are fewer lenders that will finance them.
Oftentimes, lenders will have an “approved list” of native or private leases they have already reviewed and are familiar with. You will need the help of an independent mortgage broker to determine which lenders have which properties on their list and are currently taking applications for leaseholds.
There is no standard pricing for the above leaseholds. Depending on the specific property, it could be a fully-discounted bank rate or it could be much higher private financing.
ACREAGE OR HOBBY FARMS
To many people the idea of buying a large piece of land, possibly with multiple dwellings on it or shop and outbuildings seems amazing. Truth be told, it’s a dream that I myself have had many times. However, financing acreages can be difficult and often requires far larger down payments than borrowers were prepared to provide.
One of the first reasons is land-value relative to house-value. If a property is 50 acres with an older house on it, it might seem like a great piece of buy and in the future build a new house on. But in this case, the land might make up 75%…. 80%…. 90% or more of the value. The deep discount rates that you see at the banks is intended for straight forward properties and parcels, not land. They want to lend on “improved property” meaning property with buildings on it instead of just dirt. When the land is large enough that it becomes the primary driver of value and not the dwellings constructed on it, this is when the banks tend to stand aside.
As one of my appraisers has told me, the first acre of land is gold. The second acre is silver and so on. After 10 acres it is just more room for your dog to run around on. While tongue-in-cheek, it is very true of lending.
Here is where the trouble is:
Most banks will use a valuation of house and 5 acres. A few will use house and 10 acres. This means that they will look at the value of the land based on the house and 10 acres even if it is 100 acres. This leads to problems where someone wants to buy a $500,000 property that is a house and 120 acres and put 20% down, but when appraised as a house and only, say, 5 acres as most banks will do, it might come in at $400,000. Meaning, the borrower will have to come up with the difference in CASH. For someone intending to put a lot down this isn’t an issue, but if someone is trying to buy with only 20% of the purchase price down, they will have troubles. They will only be able to get financing for 80% of $400,000 which is $320,000 and will therefore need at least $180,000 in cash to close on the transaction. This is quite a surprise if they thought they were going to only put $100,000 down (20% of $500,000).
A second reason acreages can be difficult is when they have substantial out buildings such as shops, storage barns, livestock pens, or secondary homes / cottages. In this instance, the bank will only finance up to 80% again of the house and 5 (maybe up to 10) acres. So if there is a second house, or a massive shop that adds a lot of value to the property, the exact thing that happened in my prior example could happen again. If a property was 20 acres with two houses and a shop and it was selling for $750,000 but appraises at $500,000 for house and 5 acres, then the financing will again be based on the $500,000 house-and-5 value and not the $750,000 value. The $250,000 difference will have to be paid in cash. This limitation still exists despite the potential rental income that the secondary dwelling or structure could generate.
Lastly, there is some protection afforded to farmers under various legislation making it hard for lenders to foreclose on active farms. So if a person buys a hobby farm and maybe has a few blueberry bushes growing or starts to raise some chickens, they can appeal under these laws and delay foreclosure. As a result, lenders don’t want their capital tied up on non-performing loans for long periods of time. They just want to get paid their interest. Whenever something has a farm component, whether it be livestock or produce, this possibility exists, and therefore lenders may reduce the loan they would otherwise do or not lend at all.
Some credit unions that conduct business within rural communities where acreages are more prevalent may have more relaxed rules than some of the big banks or broker channel lenders, but often at a small rate premium. You need to talk to an independent mortgage broker to assess if the particular property you have is fully financeable to the level you require.
While this is not an exhaustive list, it provides a glimpse into the mind of the lenders when dealing with the above properties types: co-ops, fractional interest, leasehold, and acreages. These are properties that exist numerously in the Greater Vancouver Area, and often are looked at by entry level buyers looking to get something that appears far below market value. While not impossible to finance, they can be harder and cause stress in the process. It is vital to work with a broker that understands these property types and can guide you to ensure the process is seamless and smooth as it should be.
Like anything else in life, if it sounds too good to be true, it probably is.
Rowan Smith, A.M.P.
Senior Mortgage Planner / Partner, DLC – City Wide Mortgage Services
Direct Line: 604.657.6775
Direct Fax: 1.888.282.5760
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