Marc Prefontaine of KV Capital knows a thing or two about commercial real estate. With twenty years in the Canadian mortgage banking and brokerage industry, he has first-hand experience – across the full cycle – in underwriting, originating, adjudicating, servicing, account management and default management. Marc is recognized as an industry leader in structuring and sourcing various debt and equity arrangements including pari-passu loans, A/B loans, club deals and structured finance deals. Over the course of his career, he has been involved in financing over $3B in real estate debt transactions.

We recently sat down with our Managing Partner of Commercial Real Estate Finance to learn more about owner-occupied real estate and the unique financing structure that enables business owners to own their own commercial property.

What is owner-occupied commercial real estate?

Owner-occupied commercial real estate (sometimes referred to as owner-user commercial real estate) is typically any commercial property that is owned by the business that operates out of that property or by a separate holding company with ownership of that business. A good example is a manufacturing company that owns the land and buildings from which it runs its manufacturing operations.  

Owner-occupied commercial real estate may be classified into one of the following property types:

  • Office (such as office buildings or office condos)
  • Industrial (including warehouses and manufacturing facilities)
  • Retail
  • Agricultural
  • Health care
  • Special purpose (that is, a property built for specialized uses, with limited utility and marketability other than for its original purpose)

Most banks and lending institutions do not recognize properties such as unimproved land or revenue-generating assets such as multifamily dwellings, residential income homes, lodging(hotels, motels, bed and breakfasts, etc.), or golf courses as owner-occupied commercial real estate.

What exactly is owner-occupied financing?

As the term suggests, owner-occupied financing is financing secured against property that is owner-occupied. Some lenders will categorize a particular property as being owner-occupied if the owner uses at least one-third  of the property for its own use. Other lenders are more stringent and require at least 50% of the property to be owner-occupied.

What’s the difference between owner-occupied financing and other commercial financing options?

When a commercial property is purchased, it’s classified as either an owner-occupied property or an investment property. The distinction between the two classifications lies in how the property is ultimately intended to be used – or not used – by the owner. Most commercial properties where the owner leases the property to third-party tenants and collects rents are viewed as investment properties.

There are key differences in how lenders typically view financing an owner-occupied building versus an investment property.

Financing owner-occupied building vs. investment property

Who is owner-occupied financing appropriate for, and when is it used?

Owner-occupied financing is appropriate for those companies who wish to purchase commercial real estate with plans to use at least one-third of the premises for running a business.(We have seen instances where banks are willing to extend financing to those owners with plans to use as little as 25% of the premises for their business.)

The reason owners typically need to use at least one-third of the property to qualify for owner-occupied financing is to ensure the mortgage payments are not heavily dependent on the rental income received from tenants, but rather from revenues generated by the owner’s business located at the property. The bank will conduct a business profitability analysis as part of the application for owner-occupied financing and this process partially serves the purpose of ensuring the owner can make payments towards the mortgage from the cash flow of their own business.

Owner-occupied financing is used, for example, when an individual wishes to purchase a two-storey building with plans to open their own boutique clothing store on the first floor and rent out the second-floor unit.

In other instances, owner-occupied financing may simply be the only option available to a buyer who is looking to acquire the property for investment purposes, but who might not otherwise qualify for a traditional investment property mortgage.

For example, if the interested buyer of the property cannot afford the full down payment and subsequent payments towards the property’s mortgage based on a pure investment purpose, then the lender may be willing to provide a mortgage to the prospective buyer if they intend on using the property to run their business operations while simultaneously collecting rental income from willing tenants when the property is leased to support the property’s mortgage payments.

Traditional investment properties are considered higher risk to lenders, so their lending criteria are stricter.

What are the requirements of owner-occupied financing?

The most obvious requirement of owner-occupied financing is that the owner must operate their business out of the property in question.

Owner-occupied financing includes a unique set of considerations and requirements compared to financing for a traditional investment property. From a lender’s perspective, there are two reasons this type of financing is more attractive owing to the decreased risk presented by the borrower:

  1. Operating Cash Flow: Owner-occupied financing is generally viewed as a less risky investment since additional revenue is generated from the operating business, above and beyond traditional market rents from tenants.
  2. Understanding the business’s profitability: The lender will require a full understanding of the profitability of the business through the     owner’s application for owner-occupied financing, which helps mitigate overall risk.

What are the criteria for owner-occupied financing?

There are several criteria that must be met before owner-occupied financing will be considered by a lender:

  • The owner must typically use at least 51% of leasable space to generate income through their own business
  • The owner’s net operating income must be sufficient to service the loan payments with some buffer (generally 1.20 to 1.25 times greater than the annual loan payments)
  • The business securing the property will need to be assessed on the viability and profitability of the business
  • The prospective owner must also pass a personal credit check undertaken by the lender
  • The owner must have been in operation for a minimum of three years and have supporting financial statements

What are the benefits of owner-occupied financing?

For borrowers, several benefits exist in comparison to financing opportunities presented for traditional investment properties, including:

  • Favourable borrowing rates and lower expenses associated with insurance coverage, since the loan structure is considered less risky
  • A lower down payment – we have seen scenarios where 100% financing is available
  • Potential tax benefits to the owner (an owner considering owner-occupied financing should always consult with their tax advisors when assessing potential tax benefits)

Learn more

Owner-occupied financing allows business owners the ability to begin building equity in their real estate while running their business. As well, it permits individuals who might otherwise be denied financing to start generating passive income.

At KV Capital, our experts will take the time to explore suitable financing options that meet your needs. Our team will assess your unique circumstances and preferences to identify the most suitable financing structure available. We help our clients navigate the jargon-ridden lending commercial real estate space, removing doubt and uncertainty.

We encourage you to reach out today to speak with one of our experienced team members and learn more about how KV Capital can support you in your real estate financing journey.