Real Estate Talk:
Income property / 6

A look at promise to purchase conditions: Financing

By Joseph Marovitch

Updated December 11, 2024

Last week we discussed the four conditions that must be in the promise to purchase for an income property, to protect the buyer, and we focused on the third condition, the Inspection. Today we are going to discuss the fourth condition, Financing.

Four conditions that allow the buyer to verify the information:

1. First visit.
2. Review of expenses, leases and any other financial documentation
3. Inspection
4. Financing

It is possible to purchase an income property in cash, however, few investors use their own money to finance an income property. There is an instance in which paying in cash can be of value. This is when the seller, for an all-cash deal which is much quicker than financing, is prepared to reduce the price of the property further, causing the Cap Rate to increase. The buyer, after possession of the property, can apply for a mortgage if they choose to. Money should work for you and not the other way around.

 As time goes by and the property increases in value, the owner can refinance the first property to buy a second and then a third income property to increase their portfolio.

Money can be borrowed from your financial institution and used to purchase the income property. With a Cap Rate that allows for a profit after expenses, and after a period, the mortgage will reduce as the property pays for itself. Also, as time goes by and the property increases in value, the owner can refinance the first property to buy a second and then a third income property to increase their portfolio.

Acquiring a mortgage to finance an income property takes time and investment. Unlike a mortgage for an individual residence, an income property requires 15% to 30% down and can take up to 40 days or more to obtain from the bank. The bank will evaluate the property and determine the value based on a calculation by the CMHC (Canadian Mortgage and Housing Corporation). The CMHC is the government institution that insures all bank mortgage loans.

There are many rules in place the CMHC must use to determine the value of the property and how much the buyer is required to put down. One of the factors includes whether the buyer intends to live in the income property. If the buyer does not intend to live in one of the units, the buyer is then required to put down a minimum of 20% of the purchase price.

If there is an advantage for buyers, the buyer can save time and bypass the CMHC by putting down 20% or more of the property value and acquiring a conventional mortgage not insured by a government-backed CMHC loan. These days, the CMHC is backed up with loan requests for income property and acquiring a CMHC-backed mortgage can take up to three months. By going with a conventional loan, the mortgage can be acquired in a month or less.

In setting the condition for financing, the offer must contain the following:

• The amount the buyer intends to borrow.
• The maximum interest rate the buyer is prepared to accept.
• The number of years the mortgage shall be amortized over.
• How many days the buyer require to attain the mortgage

Should the buyer’s financial institution approve a loan with the amount the buyer wants to borrow, at the interest rate or lower than the buyer requested, amortized over the period requested, and within the time period stated to attain the loan, then the condition is satisfied and the property is purchased.

‘Unlike a mortgage for an individual residence, an income property requires 15% to 30% down and can take up to 40 days or more to obtain from the bank.’

Should the buyer’s financial institution not approve the loan, provide an interest rate that is higher than the buyer requested, amortize the loan over a shorter period than requested, or not provide the loan within the time period required, the buyer can cancel the offer in writing, however, the seller has the option to insist the buyer apply at another financial institution at the seller’s expense, which rarely occurs.

There are many other options possible other than cancelling the offer if the buyer is motivated. The buyer can accept the terms of the bank. If the loan is not approved, then the buyer may have to go to a private lender.

PHASE 1 AND/OR PHASE 2 ENVIRONMENTAL TEST

Next week, I will be discussing the landlord’s obligations, however, there is one other condition, when purchasing an income property, that is both recommended and may be requested by the buyer’s financial institution. That condition is a phase 1 environmental test to determine if there are any contaminants in the ground under or around the property.

The seller cannot sell an income property if there is spilled oil or other contaminants under or around the property. Therefore, a condition of a phase 1 environmental examination is placed in the offer. Who pays for this is determined between the buyer and seller. The price ranges from $1600 to $2500 plus, depending on the size of the property.

If the phase 1 indicates no contaminants, then the condition is satisfied. If the test does indicate an issue, then a phase 2 is required. A contaminated property can be very expensive to clean up and is the responsibility of the seller unless the buyer and seller agree to share the cost.

The information I provide in these articles is a summary. Should you have questions or comments, please refer to the comments section at the bottom of the page. As well, to view past articles, click here.

Next article: Income property /7 – Landlord’s Obligations

State of the market

There is great news. The Bank of Canada reduced the Canadian interest rate by 50 basis points to 3.25% in order to bolster economic growth and keep the inflation rate around 2%.

This move has significant consequences for home buyers, sellers and owners. For buyers, the lower interest rate will provide more options to purchase and lower mortgage payments. For sellers, demand will increase causing property prices to rise. For owners with mortgages up for renewal, they may have lower mortgage payments and for those with variable mortgage rates, they will see reduced mortgage payments.

‘The Bank of Canada reduced the Canadian interest rate by 50 basis points to 3.25% in order to bolster economic growth and keep the inflation rate around 2%.’

If this trend remains, the real estate market will start to move forward rapidly benefitting all. However, there is still the threat of a tariff war emanating from the incoming U.S. administration. A tariff war can cause a recession with rising inflation and interest rates. If buyers and those refinancing do not want to take a gamble, it would be very wise to lock in an interest rate with a pre-approval in December.

Have a great week and happy holidays!

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Feature image: Philip Taylor via StockPholio.com

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