Recent headlines are showing that resale activity has dropped, and some markets are also seeing softening valuations compared to six months ago. It is also expected that the rates of growth in residential property values going forward will be slower than what we have seen over the past two years.
This changing landscape will have an impact on the types of investment strategies you consider, the types of markets you invest in and the financing you should obtain from a cost-of-capital standpoint. The following strategies will help reduce the impact of this shifting environment on your ability to access capital and manage the costs and risks associated with financing.
Rising interest rates and softening property valuations can fuel financial distress, so now is the time to revisit your debt load (both secured and unsecured) to see if there is an opportunity to consolidate expensive debts, partially or fully pay down expensive loans, or reduce your monthly payments to create room for any potential increases in payments on loans that are sensitive to interest-rate changes. A qualified mortgage professional can help you with this exercise.
If you are planning on continuing to grow your real estate portfolio, having access to cheap capital is fundamental to your success. Given the expected future moderation in values, lining up equity now can potentially help you access more capital for future investing. The best way to line up equity, in my view, is through secured lines of credit, which do not increase your payment obligations until you start using them. Secured lines of credit also provide you a with a cushion of cost-effective funds that you can access during a slowdown or an emergency.
Test the sensitivity of your portfolio
How would the level of cash flow in your portfolio respond to any potential changes to interest rates? Will you be able to sleep at night if the rates rise by another 1% to 2%, or will you have to feed more money into your portfolio every month?
Whether to lock in rates, and how much to lock, depends not only on the direction interest rates are headed, but also on how your portfolio financing is currently structured (the percentage of fixed versus revolving loans and the maturity of those loans), the sensitivity of the portfolio (along with any other debts you personally carry) to changes in rates, your tolerance for such fluctuations, and your future investment plans and financial goals. A qualified mortgage advisor can help you run the various payment scenarios and offer advice on which portions of your portfolio you should consider converting to a fixed rate.
One of the emerging hedging strategies we are evaluating for our clients is the short-long mortgage. A short-long mortgage is one that is sliced up into components of varying terms and rates, which helps manage the risk of rate increases while improving your flexibility to access capital down the road without having to pay horrendous penalties at the time of a refinance.
Consider any upcoming renovations
Investors who are focused on a renovation/ refinance strategy have a larger exposure to financing risks due to the potential softening in property values by the time the renovations are completed. This impacts the investor’s ability to extract as many funds as they initially anticipated to fully recoup the capital they invested in the project.
We saw this play out in Ontario last year: Some investors who purchased at the peak of the market last March ended up being strapped by the equity take-out. By the time they finished their renovations in June or July – when some markets saw a drop in values – the value increase from the renovations did not fully offset the decline in value resulting from market shifts. Because those investors over-leveraged themselves during the renovation process, they couldn’t afford to keep the properties and were forced to sell to pay down the debts.
There are two lessons here. First, avoid stretching your financing resources too thin on a reno project, because you may not be able to fully pay back the debts or pay them in time due to shifting values or properties taking longer to sell. Second, invest in an ‘as complete’ appraisal by a qualified appraiser upfront. This will help you get a better grasp of the value of your property once the work is done. Having said that, I suggest that you take that value and adjust it down by 10% to 15% as a conservative measure in a shifting market.
Protect yourself going into the deal
Almost every offer we saw between October 2016 and March 2017 was a firm offer due to the competition inherent in a heated market. In today’s market, to avoid surprises with valuations – which are primary drivers of the loan amount you can get approved for – it’s in your best interest to put a financing condition of five business days in place to allow for the appraiser’s visit.
DALIA BARSOUM is an award-winning mortgage broker and finance advisor with more than 20 years of experience in the banking sector. She is the winner of CREW’s 2017 Mortgage Broker of the Year Award and is the best-selling author of Canadian Real Estate Investor Financing: 7 Secrets to Getting All the Money You Want. To develop the right financing plan for today’s shifting real estate and lending environments, contact her at [email protected], or visit streetwisemortgages.com.
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