Refinancing non-profit housing properties: Four key considerations
Your property has value, and refinancing can be a smart way to improve your cash flow. However, without the right expertise, the process can be daunting. ONPHA reached out to Heather Simpson, Director of Community Accounts at Alterna Savings, for advice.
What is your property really worth?
Unlike residential properties, lenders value commercial real estate based on the income it generates, which may not necessarily equal the appraised value.
A valuation may tell you the market value of your property is in the millions of dollars. However, that likely assumes that market rents are being paid and that the building is operated for profit. Instead, the lender will value your property based on its current use – as non-profit housing. This is done because they realize that market rents may never be charged on the property. Also, in the event of default, the lender will inherit the property in its current use, with all of its tenants, who can’t simply be evicted.
To calculate your building’s value, your lender will look at your Net Operating Income (NOI), which is equal to your revenue, minus a vacancy/arrears allowance and all expenses (including capital reserve contributions). This is basically the monies left over after all the day-to-day expenses are paid. They will divide the NOI by the market capitalization rate (CAP Rate) to determine the building’s value.
Here is a simplified example:
Two identical buildings are located right next door to each other. One building charges market rents, and the other is a non-profit apartment building generating significantly less income. The non-profit building also incurs higher expenses due to the support services the provider offers to tenants. The buildings may look the same, but from the lenders’ perspective they have very different valuations.
What can you afford?
Your lender will want to make sure that you can cover your debt by looking at your Debt Service Coverage Ratio (DSC). To calculate the DSC, your lender will again look at your NOI and divide this by the payments required to service all the debt on the property (the total amount of your principle and interest payments). Typically, Alterna Savings would look for a ratio of 1.2 per cent, meaning that for every hundred dollars you need to make in payments, you have at least $20 left over for other expenses that might arise. These figures will be obtained from your audited financial statements.
Going back to the previous example, if your property has an NOI of $5,000, the maximum affordable mortgage payment would be $4,167.
How much do you really need?
To properly understand your needs, you will need a full 30-year capital reserve plan. A good lender will work with you to ensure that you are only borrowing what you need, when you need it. They will also help you develop a savings plan that builds your reserves to cover maintenance and future repairs.
What additional costs will you need to cover?
On top of mortgage payments, there are costs to repay your existing debt (if applicable), legal fees, and disbursements. Before you can even be considered for a loan, your lender will want:
• A building condition assessment report
• An appraisal
• A clean environmental assessment report
• A reserve fund study
If your loan is for repairs, you will be required to engage a Cost Consultant. They will validate the budget and ensure that payments for building improvements are being made according to your plan. The lender will also require the Cost Consultant to authorize the mortgage advances.