If you are investor who owns several properties or planning on building a portfolio of investment properties, you must have heard about the “financing wall”.
What is “the wall”?
Is there really one?
If there is one, how can you avoid hitting it?
If you hit it or believe you are about to hit it, what can you do?
The wall simply refers to the maximum number of properties you can finance as an investor.
Most investors are under the impression that once their portfolio reaches five properties; they will no longer be able to grow their portfolio. Others have heard you can finance up to sixteen.
I can tell you that the maximum is not 5, 16 or anything in between. There is actually NO LIMIT.
The only thing that can limit us at times is our personal belief and ceilings around what we can or cannot achieve.
From a financing point of view, you can keep your portfolio going using three techniques:
1. Planning portfolio financing in advance, prior to going shopping for your rental property.
2. Working with the right lending advisor – one who specializes in Real Estate portfolio financing, who has strong relationships with investor-friendly lenders and knows how to place and package your deals in the right sequence with lenders to keep the approvals coming.
3. Shopping for the right lender for the deal – who will approve your deal, get you a step closer to your goal and also offers a good rate.
Planning Portfolio Financing in Advance
It is important to understand what happens behind the scene when you submit an application in for approval. Many investors just chase rates and that is the primary criteria for choosing a particular lender.
This approach increases the chances of a decline and decreases the chances of financing more properties down the road because they may have placed the current deal – without knowing it – with a lender, where the numbers may not continue to work well down the road as the portfolio grows.
There are 3 broad group of lenders in the market today A, B and P ( private) ; with A offering the best rates, B’s offering mid-range rates and Privates being the most expensive.
When lenders review your application, they look at many factors including:
- Your credit,
- The amount of down payment you have,
- The type of property you are buying,
- The rental income the property will generate (and how much of it they will include),
- How you derive your income (as employed or self employed)
- The investment structure ( i.e. whether you are buying personally, under a corporation, or with a JV partner).
Unless you are in the lending business on a day to day basis, it is impossible to learn and keep up with the continually changing rules. An advisor who knows the rules for portfolio financing can advise you of what you need to do with respect to each criteria to keep the approvals coming.
The earlier you plan your portfolio in your investment career, the higher are your chances to get your deals approved with A lenders at great rates, best amortization terms and lowest down payment.
During the planning session your advisor can review your situation and make recommendations that can help squeeze as many properties as possible with the A lenders before starting to look into more expensive financing options.
Some of the things your financial advisor will look at (and you need to be aware of) when you are ready to finance your investment properties include:
1. Tax planning of personal and rental income:
Personal Income: When you’re self employed it’s really appealing to reduce your net income to minimize taxes. However, showing a higher net income on your tax returns could be a much bigger advantage to you in growing your portfolio. In this case, your advisor can help you weigh the pros and cons associated with paying more taxes on your income in return for getting your deals approved with A lenders
Rental Income: At some point it’s very likely you’ll be looking to finance your deal with A lenders that rely on the rental income reported on your tax returns for an approval. If that is the case, it is important to plan ahead of time and consider carefully the amount of property-related expenses that you should deduct.
2. Improving your Portfolio Debt Coverage Ratio (DCR):
The DCR ratio is calculated by taking the amount of rental income you receive from your properties and comparing it to the debts and expenses your portfolio has. Lenders like to see this ratio at 1.2. As your portfolio grows this is a common way A lenders will look at and approve your financing request. Knowing this and doing some critical number crunching early in the game plays a big role. You also should be aware of the impact that refinancing a property or buying a new property will have on your portfolio DCR . If you don’t know how to calculate this yourself, your financial advisor can take a look at the numbers and help you figure it out.
3. Increasing the down payment:
Most investors want to minimize the amount of capital they put into an investment property but sometimes the best way to get the most attractive financing options is to increase your down payment. Locking more capital into an investment property can however work out in the long run so that you get more favourable terms on this and future mortgages.
4. The parties on the deal:
One of the considerations is who is on title is who will be qualifying for financing. Buying under a corporation may result in different financing terms compared to buying under your personal name. Multiple people on the purchase agreement (And title) is not necessary either. The important thing is that the the individual (or corporate entity) from a credit, income and networth point of view can support the loan and the lender is best protected.
Dave tackled the topic of whether you should have a corporation as a real estate investor in this video:
5. Improving your credit:
Your credit score is pretty important as a real estate investor. Your goal should be to improve it and take measures to protect it. But, what is a good score? Anything above 600 is considered good and anything above 750 is excellent. Most banks are going to be very happy with any score above 700.
If you have poor credit then your advisor can help you determine why and that will help you to know what to do so you can fix it. But, the big things are always paying your debts back consistently and not maxing out the debt you do have. Maxed out lines of credit or credit cards will reduce the score you have.
6. A Joint Venture Agreement
If you’re not able to qualify for financing for any of the above reasons then bringing a joint venture partner could be an option. The person you JV with must strengthen the deal in areas that hindered a successful approval in the first place. For example: if credit was the reason to why a deal was declined and the lender requested a higher down payment that you did not have; then a Joint Venture partner with sufficient down payment, credit and income can help facilitate the approval. <More about joint ventures>
You definitely do not want to find out that you need a joint venture partner in the mist of a deal! This is where planning comes in.
Working With the Right Lending Adviser
Many factors drive the approval of your deal and the rules do change on a regular basis. You will get a bank’s financing if you meet the lender’s criteria and if the numbers work for that particular lender.
When you look for someone to work with to help you finance your deals, I recommend that you find someone who:
1. Is well-versed and up to date with all the rental property rules in Canada.
2. Has a strong relationship with investor-friendly lenders.
3. Is able to finance not only the property at hand but also understand the short and long term implications ( if any ) on your future portfolio financing.
4. Is able to provide you with proactive guidance on how to plan your financing versus speaking with you only at the time of the approval.
5. Ideally is an investor themselves with personal experience using creative and traditional financing methods for investment properties
Forming a long-term relationship with the right financing advisor will have a direct impact on the number of properties you can buy.
Shifting Your Mindset
While interest rate is a very important component of your financing strategy, it should not be the primary driver of how you shop and fund your deals.
Chasing the rate alone does not guarantee approval as you may not meet the lender’s guidelines in the first place and when you do, it is important to discuss with your lending advisor any implications to your long-term financing.
We have seen investor’s chase a 2.99 rate at 25 years amortization only to find out at their 4th property that they no longer qualified with the banks. Had they taken a slightly higher rate with a different lender, they would have had the opportunity to finance 2 more deals with the A lenders.
It is about taking the deal to the right lender who will also offer you a great rate given your finances and where you are in your investment career and will get you a step closer to your goals.
There isn’t really a financing wall that will stop you from growing your portfolio if you do some planning, get the right people on your team and are willing to be flexible with the financing options you take for each of the properties you buy.
Dalia Barsoum is a Portfolio Financing Strategist, a Best Selling Author of “Canadian Real Estate Investor Financing: 7 Secrets to Getting All the Money You Want” and is a recipient of the 2014 Mortgage Broker of the Year Award by the Canadian Real Estate Wealth Magazine. Dalia’s Canada-wide lending practice (CENTUM Streetwise Mortgages), focuses on strategically positioning investment portfolios for growth and success using traditional and creative financing techniques and products. Dalia holds an MBA in Finance and is a Fellow of the Canadian Bankers Association. For questions, contact Dalia at info@CanadianInvestorFinancing.com
Wondering how to set up your bank accounts? Here’s a great video discussing how to set up your bank accounts as a real estate investor:
1st Image Credit: © Tagstiles | Dreamstime.com
2nd Image Credit: Dalia Barsoum