The most effective way to finance an investment portfolio is to plan out your financing roadmap ahead of time and implement it one mortgage/one property at a time. Financing has to plug into your bigger plans and align with your investment goals, risk profile, resources and your chosen investment strategies.
Once you have determined the number of properties required to achieve your ultimate cash flow or retirement goal, the average price per property and the total capital required capital to kickstart or grow your portfolio, you need to crystalize a financing roadmap to help you get there. On this roadmap will be three stops you must make before stomping on the gas and driving off into your real estate future.
Stop One: Where will the funds come from?
There are three primary sources of down payment capital investors rely on to build their portfolio: cash, equity and secondary financing options (JVs, private funds, gifted down payments, RRSPs). The first and third options are fairly straightforward, so let’s concentrate on the second.
Equity has become and continues to be a primary source of funding for many investors, especially given the current low-rate environment. As a result, it is important to “position” that equity the right way as you build your portfolio. This can be done through equity takeout and positioning strategies that give you access to equity in a cheap fashion (such as secured lines of credit), as well as through products that allow you to access equity easily as it builds up in your properties (like advanceable mortgage products).
It is worth noting that as you grow your portfolio, cheap equity take out options start drying up. While you are adding both rental income and debts to your balance sheet, the percentage of debt used by lenders is always greater than the percentage of rental income used; therefore, it is important to actively manage your equity take out – especially before you hit your sixth rental property, as taking out equity through secured lines of credit becomes more difficult at that point.
Depending on the amount of equity you are starting with and the pace at which you are purchasing properties, you may or may not have enough to cover the 20% down payment required to purchase. In this case, you can utilize secondary financing strategies to keep your portfolio going.
The key here is to plan the source of capital ahead of time and to work with your mortgage broker or lender on structuring it before you go shopping for your next property.
Stop Two: How best to structure financing?
The ‘financing wall’ refers to your inability as an investor to finance a property at favorable terms. Once you hit it, you may be asked to provide a larger down payment, have your amortization period shortened, or be asked to pay insurance premiums and lender fees.
To get the best terms on each rental property, your unique qualification mix has to fit the rules set by the lenders you’re approaching for financing. Your qualification mix consists of eight components:
- Your credit
- Your source of personal income
- Your down payment source
- How you are structuring the deal (personal vs. corporate holdings; JV partners)
- The rental income your portfolio generates and the legality of each rental unit
- Your net worth (liquid and non-liquid)
- The condition and type of the property you are purchasing
- The number of properties in your portfolio
The biggest mistake investors make when building a portfolio is chasing the lender that offers the lowest rate without understanding two important factors: if their qualification mix works for that particular lender and the negative long-term implications of dealing with the wrong lender.
Stop Three: How will you pay down the mortgages?
At some point, you will have to exit the acquisition mode and focus on mortgage pay down. Aside from ensuring that you keep your vacancies at a minimum so that your tenants pay your mortgage, there are multiple strategies you can utilize to pay down your mortgages more effectively.
- Utilize the bi-weekly accelerated payment option on all mortgages you have. This option will not only save you thousands in interest but will cut more than 3.5 years off the life of your mortgage.
Switching to a bi-weekly accelerated option does not cost you, and in terms of monthly cash outlay it is the same amount as a monthly payment
- Make lump sum annual mortgage payments. If your property is generating residual cash that you will not use to acquire more properties or that you do not need as a reserve, I suggest that you save it and put it against the mortgage on an annual basis in lump sum fashion. What you pay as a lump sum goes straight toward the principal.
There are other advanced strategies to pay off the mortgage faster, but the nature of the strategy will differ from one investor to another depending on their risk profile and cash flow.
Financing an investment portfolio goes far beyond getting a great rate on the property you are buying today. The key to successful financing is to be proactive about it and develop the right plan to help you get where you want to go.
Dalia Barsoum (MBA Finance) is an award-winning mortgage broker, real estate investor and finance advisor with over 20 years’ experience in the banking sector. Dalia is the winner of the CREW’s 2017 Mortgage Broker of the Year award and is a regular speaker and contributor on the topics of investing and financing. She is the best-selling author of Canadian Real Estate Investor Financing: 7 Secrets to Getting All the Money You Want”. To get in touch with Dalia for a complimentary consultation, email her at [email protected]. To learn more about Streetwise Mortgages, visit www.streetwisemortgages.com
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