we discussed the importance of revisiting the financing (Capital structure) for your real estate portfolio to ensure that it withstands the storm and that you emerge out of it in a stronger financial position. We highlighted the three core financing areas where you can pivot as an investor: Stability, Agility and Opportunity.
With the strong anchors of stability and agility in place, which we discussed in parts 2 and 3 of this series, you will be in a position to continue to grow your portfolio. The focus here to set up a financing road map that enables you to sail forward and continue to build your wealth. It is crucial as you set up your financing going forward that you align your financing road map with the new lending policies and how lenders are currently evaluating applications and financing rental properties. Yesterday’s financing rules are no longer applicable in some cases as lenders have cut down on loan to values, have reduced heavy reliance on rental income, introduced new policies regarding leverage and how they use rental income and are taking a much closer look income in general given the risks of job loss.
Here is what we recommend you look into when exploring the opportunity phase:
STEP1: Pave the way
Paving the way involves clearing or restructuring any debts that stand in the way of your ability to qualify for financing at good terms for the next set of properties you wish to purchase. If you have gone through the agility assessment/restructuring of your portfolio. That exercise would have paved the way.
Paving the way also involves income planning. For example: if you are self-employed, have plans to grow your wealth and are not sure what income you need to pay yourself from the business during tax filing to qualify for the best financing, you should discuss that proactively with your mortgage advisor, including ironing out how much you pay yourself and how you pay yourself. For self-employed clients, there is a tradeoff most of the time when it comes to the amount of income required to report to qualify with the banks for a better mortgage and the taxes payable associated with receiving more income from the business.
STEP 2: Line up capital
If you are planning on growing your portfolio, we suggest that you line up capital upfront. For two key reasons: 1. As you add more properties to your balance sheet: the lenders will take 100% of the debt and only a % of the rental income into consideration (50% – 80%) into all future mortgage applications (whether you are applying for a mortgage to purchase or refinance). This means that as your portfolio grows, so does your debt load in a lender’s eyes, which limits your ability to tap into equity from your existing portfolio in a cheap way 2. Line up capital when you do not need it, not when you really need it. It is often too late to extract cash when you are in urgent need of that money. Lenders change their rules all the time and your income situation and finances may also change. The fact that you qualify today does not mean that you will qualify tomorrow.
The best way to line up capital is through secured lines of credit (LOC), ideally advanceable ones that increase automatically as you pay down the principal on the mortgage ) . LOCs do not add a drain on your monthly budget, you pay as you use them, you have the option to pay an interest only payment (therefore enhancing cash flow) or paying a principal and interest. Also most of them are convertible back into a mortgage, allowing you to amortize the loan when ready.
I do not recommend lining up equity through additions to the mortgage unless there is an immediate use for the capital or there is no other way to do it. Lining up equity through a mortgage means that you will have a lump sum of cash sit in a bank account that is costing you monthly principal and interest payment, which is not ideal. You also need to be careful about not turning your cash flow upside down at a portfolio level when lining up equity.
STEP 3: Plan financing
Planning financing goes beyond getting a pre-approval. It involves examining aspects of your next deals at a granular level of detail. In doing so, your mortgage advisor can help you draw a financing road map that outlines, in detail, how each of your upcoming deals will be executed. Doing it this way versus one transaction at a time will ensure that you get the best financing today without jeopardizing financing for your future properties and will ensure smooth closings of the transactions with no surprises.
Planning financing involves ironing out a number of crucial details before going shopping. Investors need to assess the source of the down payment, review all accounts where that money resides, review the finances (income/credit/assets) of all parties who will go on title and qualify for the mortgage. As an investor, you must discuss your investment strategy style and property types/locations with your mortgage advisor as that will have a large impact on the type of financing you will get. Further, discuss the impact of any corporations and partners on your ability to qualify, and finally understand what you qualify for from a mortgage standpoint.
Dalia Barsoum is president and principal broker at Streetwise Mortgages and a regular columnist for Canadian Real Estate Wealth. She leads an award-winning team of mortgage advisors offering strategic income property and portfolio advice to Real Estate investors across Ontario.
Click here to set up a complimentary planning session with Dalia or Streetwise Mortgage Advisor.