The most effective way to finance an investment portfolio is to plan out your financing strategy 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 goals, risk profile and the investment strategies you choose to build your portfolio.
Once you have made your key determinations – the number of properties required to achieve your financial goals, the average price you can pay per property, and the total capital required to kickstart or grow your portfolio – it is time to answer three questions that will determine your financing strategy.
1. Where will the funds come from?
Due to the low interest rate environment and the fact that many markets have picked up momentum across Canada over the years, equity has become and will continue to be a primary source of funding for many investors. As a result, it’s important to position that equity the right way as you build your portfolio. This can be done through equity take-out and positioning strategies that give you access to equity in a cheap fashion – like secured lines of credit – and allow you to access equity easily as it builds up in your properties through products such as an advanceable mortgage.
Depending on the amount of equity you’re 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 use 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.
2. How can you avoid hitting the financing wall and get the best terms?
The financing wall refers to your inability as an investor to finance a property at favourable terms. This can have a number of detrimental effects, including:
- Forcing you to put more money down when you don’t have to
- Shortening the amortization when you could extend it to 30 years
- Adding insurance premiums to your deal, even if you are putting 20% down
- Increasing your cost of borrowing overall through lender fees or higher rates
To get the best terms on each rental property, your unique qualification mix has to fit the rules of the lenders that offer such terms. Your unique qualification mix consists of eight ingredients:
- Your credit
- How you derive your personal income
- The source of your down payment
- How you are structuring the deal (personal versus corporate holdings, as well as the involvement of joint-venture partners)
- The rental income your portfolio generates, as well as the legality of the units generating that income
- Your net worth (liquid and non-liquid)
- The condition and type of the property you are purchasing
- The number of properties you own
The biggest mistake investors make when building a portfolio is chasing the lender that offers the lowest rate, without understanding whether their qualification mix works for that particular lender or the long-term implications of financing the deal with that lender and how it will affect their ability to qualify for financing down the road.
That’s how deals get declined and how investors hit the financing wall. Speak with your mortgage broker or lending advisor about your unique qualification mix before you go shopping for your next deal.
3. How will you pay down the mortgages to generate ultimate cash flow?
At some point, you will have to exit acquisition mode and focus on mortgage pay-down mode. Aside from ensuring that you keep vacancies to a minimum so that your tenants pay your mortgage over the years, here are two strategies you can use to pay down the mortgages over time.
Use the bi-weekly accelerated payment option.
This option will not only save you thousands in interest fees, but will cut more than three and a half 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 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 dump it against the mortgage in an annual lump-sum payment. What you pay as a lump sum goes straight toward the principal rather than the principal and interest.
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 for the property you are buying today. There are many interrelated financing strategies available to you as you grow your portfolio. The key to successful financing is to be proactive about it and to develop the right plan to help you get there.
Dalia Barsoum is an award-winning mortgage broker, real estate investor and finance advisor with more than 20 years of experience in the banking sector. Dalia won 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 bestselling author of Canada’s number-one financing book, Canadian Real Estate Investor Financing: 7 Secrets to Getting All the Money You Want. To get in touch with her to schedule a complimentary consultation or to plan your equity take-out, email firstname.lastname@example.org or visit streetwisemortgages.com.