Financing Options for Your Income Properties

When it comes to finance rates and an income property's cash flow, the math is pretty simple.  There is an inverse relationship between the two which in essence means the lower your finance rate the greater your potential cash flow.  As such, you need to ensure you are aware of your options as rates can vary widely which can be the difference between healthy and anemic cash flow (If you're actually in a negative cash flow situation the property had better have significant upside potential or you've done something really wrong).

Financing an income property is almost as important as finding the right property as both play a significant role in dictating how much cash flow the property will eventually spit out.  Without the right financing in place what may look like a great deal initially may not look so great once you take the financing into consideration.

While interest rates are at historic lows, there is still quite a bit of disparity with respect to financing rates depending on where you get your deal financed.

Schedule 1 Banks

Generally, for the most aggressive financing rates Schedule 1 Banks are your best bet.  This category includes behemoths such as TD Canada Trust, Bank of Montreal and CIBC.  You can get rates as low as 3.5% for a 5 year term (in my last transaction of a 12-plex in Ontario I received a rate of 3.48% with no CMHC).  These kinds of rates are impossible to beat and help you to generate a very strong cash flow.  The caveat however is that you have to fit with a very tight set of parameters as these Banks will not "work with you" to get a deal done.  Either you fit into their box or you don't.   Having a history with the bank, a great credit score and verifiable employment income will go a long way in getting you approval.  The other drawback is that the process can at times be cumbersome and drawn out and the representative you are dealing with may not be from the banks commercial department so their knowledge of commercial deals may to be limited.

Canadian Mortgage and Housing Corporation ("CMHC")

 To get really aggressive with your finance rate you can apply to have your multi-unit residential property insured by CMHC.  By adding CMHC insurance to your property, you become a risk free investment to financial institutions as the property's mortgage is guarantee by CMHC in case of default.  As such, financial institutions are willing to discount their interest rate by between 1/2% to 1%.  If you couple an already aggressive interest rate from a Schedule 1 bank with CMHC insurance you are talking about financing a property at rates as low as 2.5% to 3%. (I recently came across a listing of a 20-plex in Ontario with financing at 2.6%).  The other benefit of CMHC insurance properties is that you can get a high ratio mortgage and put as little as 15% down.  Unfortunately, there is always a catch.  CMHC insurance is not free (there is a signficant premium that must be paid based on how much you initially put down on the property and the process tends to be tedious and drawn out which has discouraged many an investor, myself included.)  If you have the patience and the right deal, this is your best bet for the cheapest financing.

Schedule II and III Banks, Trust Companies, etc ...

For those deals that are tougher to place for any number of reasons which can include your Debt Service Ratios, verifiable employment income, property location or condition, there are other financial institutions that focus on financing the deals that the big banks won't touch.  These are the institutions will typically "work with you" and will show much more latitude to get the deal.  However, it comes at a price which is a higher financing rate.   While the asset itself is a very important part of the equation, they place a significant amount of weight on the borrower as well.  In the past few months I secured financing with 2 such institutions which included rates of 4.75% for a 3 year term on a 24-plex in Ontario and 4.5% for both a 12-plex and 9-plex (5 year term) in Ontario with another institution.

Private Money, Secondary Mortgages and VTB's

In some situations to get a deal done you have to look at private money.   While private money can be a first mortgage, it typically tends to be secondary financing.  This will typically be the most expensive money as it reflects the risk of the lender.  In some cases this is the only way to get a deal done so paying a premium on the cost of funds is a necessary evil.  I recently negotiated a VTB for a 12-plex in Ontario at 7% for a 5 year term which I thought was very respectable given the overall structure of the deal, however, this can vary widely from deal to deal.

Guidance

As a novice, this can all be very intimidating the first time around.  One avenue would be to seek the help of a commercial mortgage broker as they can guide you and help place your deal at the right institution (which may not always have cheapest financing).  I've worked with brokers in the past and good ones can help to get tough deals done and get you the best possible rates based on the specifics of your deal.  The one caveat here is that commercial brokers are different from residential mortgage brokers as they get their fee from you the client and not from the bank such as resideintial mortgage brokers so you have to be prepared to dish out between .5% to 1% of the mortgage amount secured.

In closing, make sure you know your options as  the right financing is just as important as finding the right property as it will dictate the strength of your cash flow.  The process gets easier once you've got a few deals under your belt as you will have developed relationships with these institutions.  Establish a history of being a good operator and making all your payments on time and these institutions will tend to welcome your future deals.

Author: Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor