The most effective way to finance an investment portfolio is to plan out your financing strategy ahead of time and implement it one mortgage 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’ve determined the number of properties you’ll need to achieve your ultimate cash flow or retirement goal, the average price per property, and the total required capital to kickstart or grow your portfolio, you’ll need to determine the various components of your financing plan.
Component 1: Where will the funds to build your portfolio come from?
There are three primary sources of down payment capital that investors rely on to build their portfolio: cash, equity, and secondary financing options such as joint ventures, private funds, gifted down payments and RRSP financing.
Equity has become, and continues to be, a primary source of funding for many investors, especially given the low-rate environment. 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, as well as products that allow you to access equity easily as it builds up in your properties, such as advanceable mortgage products.
It’s worth noting that as you grow your portfolio, cheap equity take-out becomes increasingly harder. While you’re adding both rental income and debts to your balance sheet, the percentage of debt considered by lenders is always greater than the percentage of rental income used. It’s important to actively manage your equity take-out, especially before you hit the sixth rental property.
Depending on the amount of equity you’re starting with initially and the pace at which you’re 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 work with your mortgage broker or lender on structuring it before you go shopping for your next property.
Component 2: How do you structure financing get the best terms and avoid hitting the financing wall?
The financing wall refers to your inability as an investor to finance a property at favourable terms. Construction of this wall starts when lenders ask you to put more down when you don’t have to, shorten amortization when you could receive 30 years, add insurance premiums to your deal even if you’re putting 20% down, or increase your cost of borrowing overall through fees or higher rates.
To get the best terms on each rental property (20% down, 30-year amortization, great rates, no fees), 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 (employed, self-employed, retired)
• The source of your down payment
• How you are structuring the deal (personal versus corporate holdings, as well as the involvement of jointventure partners)
• The rental income your portfolio generates, as well as the legality of the units that generate that income
• Your net worth - liquid and non-liquid
• The type and condition of the property you’re purchasing
• The number of properties already in your portfolio
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, the long-term implications of financing with that lender or their ability to qualify for financing down the road. Speak with your mortgage broker or lending advisor about your unique qualification mix before you go shopping for your next deal.
Component 3: How will you pay down the mortgages to reach maximum cash flow?
At some point, you will have to exit acquisition mode and focus on paying down your mortgages. Aside from ensuring that you keep vacancies at a minimum so your tenants pay your mortgage over the years, there are various strategies you can use to pay down your mortgages more quickly.
Here are two:
1.Use the bi-weekly accelerated payment option on all mortgages you have.
This option will not only save you thousands in interest, but will also cut more than three and a half years off the life of your mortgage. Switching to a bi-weekly payment option doesn’t cost you; in terms of monthly cash outlay, it’s the same as monthly payments.
2. Making an additional lump-sum annual mortgage payment.
If your property is generating residual cash that you won’t use to acquire more properties or that you don’t need as a reserve, I suggest that you save it and dump it against the mortgage on an annual basis in a lump-sum fashion. What you pay as a lump sum goes straight toward the principal on the mortgage.
There are other advanced strategies to pay off your mortgage faster, but the nature of these 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 or securing a mortgage for the property you’re buying today. 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. She is the winner of CREW’s 2017 Mortgage Broker of the Year Award, a regular speaker and contributor on the topics of investing and financing, and the best-selling author of Canadian Real Estate Investor Financing: 7 Secrets to Getting All the Money You Want. To learn more about financing for selfemployed investors or securing a private loan, contact her at [email protected] or visit streetwisemortgages.com.
This article originally appeared in Canadian Real Estate Wealth magazine. For your special discounted magazine subscription, click here
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