Financing multiple properties
We have all heard phrases like; “Buy land, they are not making any more of it.” Own land, my son and you will never be poor.” “No man feels more of a man in the world if he has a bit of ground that he can call his own.”
These and many similar sayings are weaved into the character of every real estate investor inspiring each to go forth and nobly create a substantial portfolio of properties. Too over the top? OK, maybe you just want the income real estate can provide and realize that building a real estate portfolio can help you reach your financial goals.
As a real estate investor, I have seen firsthand the effects the new mortgage qualification rules set down by the banks are having on both the individual home buyer as well as the investor. Many lenders have further tightened their own guidelines, in turn making it extremely difficult for many investors to successfully grow their portfolios. (Many lenders have eliminated their rental property “products” while others have closed their doors altogether)
So what are the current financing options, what lenders are available and how do we “present” ourselves to potential lenders to get favorable results in order to buy our first rental property or add to our portfolios?
First, let’s address the lender presentation. When we can present ourselves (and our portfolios) professionally, we stand a better chance of getting more mortgage approvals. Many real estate investors do not have a proper “financing binder” and consequently have a tougher time with financing. You want to show any potential lender that you know how to run a legit real estate business.
A professional financing binder should include the following:
1. A copy of a recent credit bureau. You must know your credit score and you “standing” with your creditors before the lender does. Almost 50% of people who have not seen their credit bureau discover errors. These errors are usually from poor reporting on credit cards, loans or car lease accounts. In many cases the client has completed and fully paid an account (perhaps years prior) but the account has not been documented as a closed account. These issues are easily repaired by contacting the credit bureaus as well as the creditor. In the meantime that “open account” can be adversely affecting your credit score.
Go to Equifax or Transunion to “pull” your bureau. These companies provide your credit score at low cost (or free) and provide an historic outline with your creditors. There is no negative impact on your credit score if you pull your bureau 2 or 3 times a year (which I personally recommend).
Speaking of credit, it is wise when mortgage qualifying to reduce or better yet, eliminate credit card, line of credit and other debts. High credit card balances, leases, loans or credit lines can impede the qualifying process, as these debts are part of your overall debt service calculations.
2. Your last 2 years of Tax Returns). If you have existing income properties, make sure your accountant is properly reporting your rental income and expenses in the “Statement of Business Activities” section of the return. This gives a lender a realistic view of your business and indicates the income, expenses and write offs you are taking.
3. Your last 2 years of Notice of Assessments. (NOAs) It indicates whether there are still taxes owing to CRA and provides your (net) taxable income amount, which appears on line 150, both which are key to any lender.
Regarding your line 150… The result of a higher line 150 means we pay more tax, but it is better in terms of receiving more mortgage approvals, so this is clearly a double edged sword situation.
4. If you are self-employed, include a business registration or business license as a sole proprietor or Articles of Incorporation if a Provincial or federally incorporated company. If you T4 yourself from your company, include your recent T4s.
5. For salaried individuals, include your most recent paystubs and a Letter of Employment which includes your length of time with the company, your position and your annual salary.
6. Include statements for any non- real estate investments such as registered funds, stocks, mutual funds or insurance policies.
7. Include the latest mortgage statements from all the properties you own including your principal residence. These statements should include the current balance, interest rate, monthly payment and maturity date. It is also helpful for the lender to know the original purchase and original mortgage amount.
8. A current property tax statement or tax assessment is important to have for all properties.
9. If you hold any condo style properties, all up to date condo/strata documents such as minutes from the most recent Annual General Meeting (AGM), maintenance and engineering reports should be included.
10. A recent appraisal on your properties gives the lender an idea of the equity amount of your portfolio.
11. A net worth statement should give the lender a cross section of all income, assets, liabilities and expenses. Your assets may also include vehicles, precious metals as well as jewelry, furniture and art (providing it has real value… I’m not referring to your synthetic diamond earrings, Ikea couch or your black velvet Elvis painting… not that there’s anything wrong with these!)
12. Finally, you’ll need a section which outlines your properties. This should include pictures, all current leases, a list of repairs, a breakdown of chattels (if applicable) and a DCR or debt coverage ratio spreadsheet.
DCR is a calculation which equals a ratio that lenders consider (especially if you have multiple properties) for the purposes of understanding if your property or portfolio is “carrying” itself. Basically lenders want to see the ratio at 1.2% or higher (although some lenders only require 1.1%). What this means is the property is generating enough income to carry itself without the owner having to go into their own pocket to service the mortgage.
Once you have a well put together financing binder you increase your options as to the lenders you can go to and your chances for approval. That said, adding another mortgage to an already significant portfolio, even with a slick financing binder can still be challenging. It is entirely possible to exhaust the traditional ‘A’ lender’s risk tolerance, forcing investors to utilize alternative lending sources.
Most alternative lenders are less concerned with your personal financial situation and more concerned with their equity position in the property, often resulting in lower LTVs. You should be prepared for slightly higher rates, possible fees and shorter loan terms… usually 1 year. They are also concerned with the marketability of the property should they have to foreclose, so “geography” and current market activity are major factors in the approval process.
Loan of this nature can be accessed through mortgage brokers who have relationships with “Alt A” or “B” lenders, private individuals/estates and Mortgage Investment Corporations (MICs). Let’s break these lending sources down for clarity.
An “Alt A” or “B” lender can be owned or a subsidiary company of an “A” lender (although as of this writing, many of the A lenders have closed these divisions). Other alternative sources are trust companies and credit unions. Many of these institutions have both A and B lending divisions. Because many of these lenders are regionally based, they are often more favorable to purchases in smaller communities where many national “A” lenders are hesitant.
Private individuals or estates which are often represented by a lawyer can be excellent sources for financing. These sources often lend their own money or pooled money from a few investors. They each have their own guidelines as to the loan amounts, types of properties and geographical areas they are comfortable with. Some of these sources advertise locally but are commonly known to well-connected mortgage brokers.
The other alternative source which I am quite familiar with is Mortgage Investment Corporations (MICs). These entities are relatively unknown to many mortgage brokers and investors alike depending on where in Canada you are located. MICs came on the lending scene in the 80s but have gained significant momentum as of late, making their presence known initially in single/multi-residential properties, with some MICs lending to development projects and commercial properties.
MICs are governed by the Income Tax Act (Section 130.1: Salient Rules) and must operate in a fashion which is similar to a bank. In a nutshell, MICs get their mortgage funds through a pooled source of investors; the MIC then carefully lends the money out on first and/or second mortgages. The investors/shareholders make a return on their investment and mitigate their risk by being invested into many mortgages. MICs may also own properties like single for multifamily homes, apartments, commercial buildings and even hotels. All of the net income is returned to the investor/shareholders often on a quarterly or annual basis. MICs can also use leverage similar to a bank. (For more info on MICs, refer to my article entitled “Optimizing MICs” in the March 2011 issue of this magazine)
As stated previously, many of the above institutions may only lend 65% or 75% loan to value which can often fall short of the required amount needed. This is where you can enlist a combination of lenders. Using an “A” lender or any other lender for a 1st mortgage and getting a 2nd with another lender at a higher LTV is possible. Some lenders will offer both a 1st and a 2nd with different rates.
Other financing challenges may stem from the property itself. Lenders have become increasingly more concerned with the property’s age, condition and usage. Lenders want to make sure your properties are well maintained and the units are safe.
Remember, lenders are always concerned about the implications of resale should they have to foreclose, so a well maintained and well located the property is easier to finance and to market… which is good for the investor as well.