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Mortgage Market - Oct 2011

FINANCING A MIXED-USE PROJECT IN ALBERTA

The vast majority of commercial real buildings in Alberta are designed, constructed, and financed as a single use. Typically, mortgage financing is secured by one , with income derived from multiple tenants with a common use; retail, office, residential, industrial, or hospitality. Less common is , technically a subdivision, which is already frequently used for multi-residential , but is increasingly being used as well on mixed-use projects. This market comment shall present an alternative to a Mixed-Use Condominium, known in Alberta as a Strata Subdivision, which, in the opinion of MillarForan, is a much better way to finance projects with more than one type of use. Through discussions with developers we also believe it is a better way to own and manage mixed-use projects.

A Strata Title and a Condo Title are often confused but in Alberta they are not the same thing. A Condominium is governed under the Condominium Property Act and involves Condominium Bylaws, a Condominium Board, and cost sharing by Unit Factor. A Strata Subdivision is governed under the subdivision provisions of the Land Titles Act. It creates stand alone titles that are legally defined by volumetric spaces that are physically linked and coexist through , Covenants and Restrictions registered on title. In a Strata Title there is no need for Bylaws, Condo Boards, or unit factor allocation.

From a Lender’s point of view, a Mixed-Use Condominium is uncommon and generally thought to be awkward. Even modest sized Mixed-Used in major markets are problematic because the majority of lenders simply do not want to have term loans on projects that are governed by Bylaws and Condo Boards, particularly if there is a need for discharging portions of the project to accommodate the sale of certain condo units. If a project is large enough to require two lenders (say greater than $50 million), and/or the project is located within a small market, then the choice of a condominium ownership, coupled with those factors, will dramatically reduce financing options and definitely lead to a higher cash equity requirement on behalf of the developer.

The choice to create a Mixed-Use Strata Subdivision rather than a Mixed-Use Condominium is driven by the desire to achieve the most competitive long term financing and the lowest cash equity requirement, all other things held equal. The mixed-use financing is structured by MillarForan and the developer by studying the economics of each use. The budgeted cost and projected revenue considered together with a few other factors will help to establish a realistic long term loan amount for each use. As part of the mixed-use finance structure, two or more uses can be designed into one Strata Title, or one Strata Title may only have one use. It depends on the longer term objectives of the developer.

The construction loan is initially secured by only one title but it may be funded by two or more lenders. MillarForan has negotiated inter-lender agreements between lending institutions that govern the release and transfer onto separate Strata Titles once the project has progressed to the point where a Surveyor can measure volumetric space and create a Strata Subdivision.

Certain uses like Hospitality or Residential may be created within its own Strata Title in order to allow for separate operating control. This allows a specific long term lender to finance only one specific use, or a specific construction lender to transfer onto one specific use at subdivision, and/or it allows an eventual Condominium to be created within that specific Strata Title at some point in the future.

Underground parking can and often is its own separate Strata Title which allows the parking to be separately owned, financed and/or allocated to the other Strata owners or their tenants. The Strata Title Parkade can be later converted into a Condominium, or the parking stalls can be leased under a agreement. The Strata Titled Parkade may generate income and therefore can be pledged with another Strata Title to increase the aggregate long term loan amount.

The choice to use Strata Subdivision is a choice that ideally should be made at the very beginning of a development project, because it starts with design. The architects, engineers, and surveyor under the direction of the developer and its financial advisor must create a project where each Strata Title is built to code as a free standing building, particularly with respect to fire separation and life safety systems, which does add cost to the project. However, depending on the construction methodology and code requirements existing buildings can also be subdivided, with or without renovation, in order to benefit from a Strata Subdivision.

The multiple departments of the local municipalities may or may not have experience with Strata Subdivision, so one should expect slower approval from the local authority. A solicitor that is knowledgeable with Strata Subdivision can greatly assist in accelerating the process at the Municipal level, and his or her help is invaluable in designing and drafting functional Easements, Covenants and Restrictions which deal with things such as reserves for repair and replacement, shared operating costs, and joint access.

Ultimately, the choice of Condominium vs. Strata Subdivision should reflect the long term ownership goals of the developer, but from a financing perspective a Strata Subdivision is immensely more cost efficient as it results in a lower cost of financing, less developer equity, and much greater flexibility in how the overall financing package is structured.

As always, competitive pressure, full market knowledge, and speed of execution are necessary in every mortgage transaction.

MillarForan recognizes the valuable contribution of Darryl Barber at Bennett Jones LLP, an expert in this area, in preparing this comment.

For more market commentaries, visit www.millarforan.com

MillarForan Suite 205 – 407 Eighth Avenue SW Calgary, AB Canada T2P 1E5 Phone: 403-262-9200 Fax: 403-770-8327