You might have heard about the CMHC MLI Select, which is a relatively new commercial mortgage that can give better financing terms.
And with all the hype surrounding it, we’re getting more questions asking us what the upsides and downsides of investing in commercial residential real estate are. Well, not only is the financing different, but there are also other risk factors and the returns can vary too.
So in this video, we’re going to break it all down!
Understanding Financing: What's The Differences
Let’s start by diving into the financing aspect because this is definitely our top question.
Traditionally, commercial properties didn’t have the same appeal as residential properties because the financing options just weren’t that great. They had lower loan-to-value ratios, and lenders often charged higher rates.
And then enter CMHC MLI Select – once this program got introduced, suddenly, you’re looking at potentially snagging financing that’s way with an improved 95% loan-to-value ratio, better rates, and up to 50 year amortization, which does look a lot more attractive compared to a typical residential mortgage capped at a 80% loan-to-value ratio.
To be fair, let’s not overlook the fact that if you’re considering residential properties, there are CMHC financing options. You could potentially get financing with up to a 95% loan-to-value ratio up to $1 million here – but you have to live in at least part of the home.
Before I move on from here, I want to touch on something that can trip up new investors.
There’s a key distinction between the type of property and how you structure the purchase. How you structure your purchase (a corporation or your personal name) – determines your liability, government penalties, privacy, and tax planning. Your property type (commercial or residential) dictates the type of mortgage and financing terms, so I just wanted to clear this up.
Market Valuations: How They Are Determined
Moving on, let’s break down how the type of mortgage you choose can impact valuations and how much you can borrow – crucial factors if you’re aiming to refinance and expand your real estate portfolio.
Here’s the thing – when it comes to residential properties, there’s more market noise. You’ve got end-user properties being bought and sold based on emotions, and the property’s value is largely determined by an appraiser looking at market comparables.
And if your property is more unique, it’s tougher to get an accurate valuation without a sale. So valuations on residential properties are definitely a lot more subjective and susceptible to bigger market swings.
With a commercial mortgage, the amount you can borrow hinges on the rents you’re able to command. If your rental income is strong enough to cover your mortgage payments and operating expenses, you’re in a position to secure a larger mortgage, capped at 95% of the property’s value in the case of the MLI Select, which is also calculated based on math using market cap rates.
So, with commercial mortgages, valuations are definitely more predictable – which is one of the big advantages of commercial mortgages.
Comparing Returns: What You Can Expect
From a returns standpoint, I would say they’re different but it’s harder to say for sure that one is better than the other.
From a rent yields standpoint, commercial properties can have better cap rates than a smaller multiplex if you build from scratch.
But, if you buy a big single family home which is then converted into multiple units under 5, there also have the potential to hit great cap rates here in Toronto too.
In terms of market appreciation, Toronto commercial properties tend to be more stable because buyers and sellers are driven by numbers.
However, because commercial properties cost more, they also don’t see the same amount of demand as residential homes, and history tells us that Toronto properties at a higher prices do lag a bit in terms of appreciation.
But at the end of the day, real estate in Toronto tends to move together, so commercial properties never fall too far behind, especially when values are tied to cap rates.
Alright, let’s talk value-add. When you jump into a big commercial project, you’re diving into larger projects, so it does give you the potential for significant gains.
However, smaller residential projects can also deliver solid ROI even though absolutes gains won’t be nearly the same.
Other Things to Think About
There are a couple of other things to keep in mind. Right now, with the government’s focus on the “missing middle,” smaller builds get a big break on development charges, which are waived for the first four units in a multiplex in Toronto. But when we look at building apartments, DCs run around $50,000 per unit here, which will add a lot to your build costs.
Then, there’s GST rebates on the build. Here, commercial properties get the full federal GST rebate, while smaller builds only get a partial rebate. So again, pros and cons for both.
Adding it All Up: Total Returns
So to sum it all up, let’s try to look more objectively at the big picture – balancing risk and return on investment.
With conventional financing, it’s possible to hit the same ROI for both types of projects in Toronto. Add that to the fact that smaller residential projects need less capital and time, and we’d lead towards residential projects for newer investments to build up your experience.
As you gain experience, transitioning to CMHC MLI-approved projects can eventually look more attractive. It all comes down to better refinancing terms, which can drastically help you receive your money to invest faster and improve your stabilized return on investment.
How We Can Help
Honestly, it’s tough to miss the mark when it comes to multi-unit residential real estate in Toronto – you have potential for solid long term real estate gains either way you go.
And if you’re wondering which one might be better for you, our team is here to help!
We’re not your typical real estate sales brokerage. Instead, we focus on using numbers to make better real estate investing decisions in Toronto. That can mean looking for stronger investments with positive cash flow, thinking about risk management, and looking for ways to boost returns like value-add renovations and gentrifying areas.
If you want to discuss your private real estate situation with us, just go to this link below to set up a time to chat!
