By Christopher Seepe
If you have not purchased a multi-residential property before, especially in Toronto and especially if the number of units is greater than six, you may be surprised by the myriad costs involved.
In southern Ontario, traditional lenders generally consider a four-plex or smaller to be a residential transaction, while six or more units in a property is considered to be a commercial transaction, the latter usually bearing more expenses.
Here is a list of some of the types of closing costs you could expect to pay. The prices are approximate and will vary wherever you are. This list is for a purchase of an 11-unit apartment building in a city outside Toronto (hence no Toronto Land Transfer Tax). The zero-dollar values are costs that might arise, depending on the deal structure and commercial mortgage or financing.
|HST on purchase price||$0|
|Ontario commercial Land Transfer Tax1||$11,775|
|Toronto commercial Land Transfer Tax1 (could be an additional $11,000)||$0|
|CMHC insurance premium2||$32,110|
|CMHC premium PST (8%)2||$2,568|
|1st mortgage prepayment penalty||$0|
|CMHC application fee2||$1,650|
|Government registration fees||$0|
|Survey (no survey usually covered by title insurance)||$0|
|Incorporation4 (of numbered Ontario company)||$1,065|
|Phase I Environmental Assessment5||$1,840|
|Lender’s inspection fee6||$250|
|Lender’s legal fees6||$4,100|
|Existing mortgage assumption fee||$0|
|Legal (your lawyer’s fee for the work, not including fees on the Statement of Adjustments, below)||$2,800|
|Statement of Adjustments and Legal Disbursements (includes blue values below)||$2,059|
|Mortgage Interest Adjustment (if any)||$0|
|Mortgage Insurance (if any)||$0|
|Co-op Brokerage Commission received||$0|
|Listing Brokerage Commission Paid||$0|
|HST on Commission||$0|
Note 1: Land Transfer Tax – incorporate a company
Land transfer tax is a significant expense and is triggered whenever there is a change in title ownership at the Land Registry Office (LRO). An additional land transfer tax is also triggered if the real estate transaction occurs in Toronto.
If you incorporate a company and the company’s only asset is the commercial investment property, when you decide to sell it, you can sell the company with all its assets (and liabilities), not the property itself. Since title ownership is still held by the company, no land transfer tax is triggered. This can be a notable advantage to the buyer, which the seller can leverage in its negotiations.
Note 2: CMHC Insurance – do it but be aware of the ‘money-grab’
Canada Housing and Mortgage (CMHC) offers mortgage insurance to traditional lending institutions to cover the loss if a mortgagor defaults.
Lenders generally consider multi-unit financing to be much less risky when it’s insured by CMHC so they offer lower interest rates, sometimes 200 basis points (2%) or more. The amount of interest saved over the term of the loan can be more than CMHC’s heavy insurance premium. Do the math.
For example, on a $500,000 mortgage, a 2% lower 5-year rate would save about $34,000, after accounting for CMHC’s $11,250 premium and $750 application fee (currently $150 per unit). Moreover, the property enjoys a 16% better cash flow because of the lower mortgage payment.
This is one of those cases where the adages, “pay to save” and “penny-wise, dollar-foolish” are appropriate.
CMHC’s premium varies according to the amount of the deposit applied against the value of the property being purchased (loan-to-value or LTV); the higher the LTV ratio, the higher the premium. CMHC will insure up to 80% LTV. However, CMHC does not use the appraised value of the property as determined by independent appraisers or market comparables. CMHC sends its own appraiser and their appraised property value is very often much lower than the purchase price. This forces the buyer to either:
(a) Put in a higher deposit than was originally planned;
(b) Pay the additional CMHC premium for an 80% LTV that is actually perhaps 70% of the market value LTV.
On a more positive note, the CMHC premium (and certain other expenses) can be rolled into your property’s mortgage amount but does not count as part of the LTV ratio calculation. PST (Provincial Sales Tax) on the premium amount is due upon closing and cannot be rolled into the mortgage.
The majority of multi-residential mortgages (excluding perhaps purchases by corporations) are CMHC-insured. Therefore, it is possible that you may come across a multi-residential property for sale that is already CMHC-insured, which is a bonus. CMHC’s insurance premium is a one-time fee for the life of the mortgage. You may want to explore whether to take over the existing mortgage, with a new CMHC insurance premium but possibly without having to go through another appraisal. Consequently, there may be a CMHC credit.
Note 3 – Building Insurance
A lender will sometimes require you to have an independent insurance consultant review your building insurance, which you must have in place before closing, to determine whether you have enough and appropriate insurance for your property.
Insure your building for the replacement value, not the purchase price or appraised value. Otherwise, you could find your investment completely wiped out if your building has been destroyed.
Part 2 of 2 of this article discusses why you should put title of the property into a company you incorporate, and what you should know about the necessary environmental assessment, lender’s fees, mortgage commission, and title insurance.
Christopher Seepe is a commercial realtor, and maintains www.multiresidentialexpert.com, a website dedicated to providing expert advice and sharing his personal investment and ownership experiences to those investing, or looking to invest, in multi-unit residential, income generating properties in southern Ontario, Canada. You can contact him directly at firstname.lastname@example.org