Follow up to "Financing is the Real Challenge Today"
As discussed in my previous article "Financing is the Real Challenge Today", financing investment properties has gotten tougher. Market cap compression and tighter lender guidelines have made it much more difficult to finance deals. As a result more deals are falling apart after their conditional period expires. While Schedule I Banks are a great option if you can fit into their perfect box, there are many other options available to getting deals done if you think outside of the box.
1. LOOK AT THE "B" LENDERS
The Schedule I Banks are great if you can get an approval as they tend to offer the most competitive interest rates. The problem is that their guidelines are so tight it's almost impossible to get an income property to qualify these days (at least in any of the major cities). A great alternative is the "B" Lender. Their guidelines are more relaxed and they are much more investor friendly. Another advantage is that "B" Lenders tend to use appraisals to determine loan value instead of just cash flow to service debt. This means that the "B" Lender's valuation will typically come in higher resulting in a higher loan value.
The downside?
"B" Lenders charge higher rates, usually 1-3% higher.
In some circumstances it's worth paying the premium to get the deal done. I've personally placed numerous deals with "B" Lenders and consider them a great resource for active investors.
2. "B" LENDER + VTB = MAX. LEVERAGE
For the more aggressive investor, this is one of my personal favorite techniques for achieving maximum leverage. Another major advantage of the "B" Lender is that most allow a VTB/second mortgage to be placed on the property. That means investors can get 75% LTV from the lender on their first mortgage and another 10% via the VTB resulting in a total LTV of 85%. I've even done a deal that resulted in 90% LTV. Rare but possible.
The downside?
1. "B" Lender rates
2. Too much leverage can be a risky proposition.
I wouldn't recommend this for novice investors, but if you know your numbers and have experience managing rental properites, this technique could help you expand your portfolio wth minimal outlay.
3. MAKE THE DEAL FIT THE FINANCING
A good investment property should provide healthy cash flow. One of the ways to achieve this is to source the cheapest cost of funds (eg. low interest rates). We've already established that Schedule I Banks offer some of the lowest rates for commercial properties so why not look for an investment property that fits their critieria. We know cash flow is a big deal and is usually the difference between success and failure. Look for geographic regions that offer higher cap rates than you would find in big urban centres like Toronto or Vancouver. As a rule of thumb look for properties with a 6%+ cap rate (its tough but not impossible) in smaller urban areas with good metrics (eg. pop. growth, GDP growth, low unemployment, low vacancy rates, healthy rental rates, infrasturcture projects, post secondary institutions, etc...). The cash flow from a cap rate of 6%+ will likely be a good candidate for successful funding by a Schedule I Bank.
If you want to get really aggressive with your cost of funds, consider tacking on CMHC insurance. You will get a discount of between 1 - 1.5% on your interest rate for the life of your mortgage. Another benefit of CMHC is that they allow up to 85% LTV, however, their appraisals are so conservative you never attain anywhere near that so the real benefit here is the lower interest rate. You are required to pay a premium up front which is added to your mortgage, but in the long run your cash flow is stronger and you will end up ahead financially.
The downside?
To find 6%+ cap rates you have to look outside major urban centres and focus on smaller urban centres like Kitchener-Waterloo, Cambridge, Guelph, Hamilton, Barrie, Pickering, Ajax, Whitby, Oshawa, etc... and even then it can be tough to find the right property.
4. MORE MONEY DOWN
This would likely apply to very few investors, however, if you need to get a deal done and are sitting on a lot of cash, banks are much more likely to finance a deal at a lower LTV (eg. 50%) as the debt service ratios are more favorable to the bank and it leaves them with less exposure.
The downside?
1. Many investors don't have deep pockets.
2. A bigger downpayment is counterintuitive as leverage is likely the single biggest benefit of real estate investing.
5. GET THE SELLER TO HOLD THE FIRST
Where a property is owned free and clear, investors can try to get the seller to hold the first mortgage, thus allowing the investor to by-pass the Banks altogether. While it may be rare to have the seller hold a first mortgage, it is not unheard of. This is typically done in situations where the property may be a little run down and rents are under market, making it difficult to qualify for conventional financing. With 25% down a seller may consider a short term first mortgage (eg. 2-3 years) to allow the buyer time to clean up the property and raise rents to qualify for conventional financing when the time comes. The downside is that the rate will likely be higher than that of conventional financing.
The downside?
1. Higher interest rate
2. Difficult to find a seller willing to hold a first mortgage
Author: Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor