Stress-test your portfolio
Stress-testing means looking into whether or not your portfolio can handle a rise in interest rates. In order to do so, property investors should be looking to the future instead of focusing on low interest rates now.
“If people are buying today, they shouldn’t run today’s numbers. Run much different numbers from the rates available today. Take a look at doing projections with different amortization periods and different interest rates. If [a property investor is] still cash flowing at those rates, then they definitely have a strong property that they’re investing in,” says Neil Uttamsingh,
real estate investor with Great Lion Investments.
Another way to ensure your portfolio is prepared for the rate hike is to practise making the increased payments now.
“Budget for the increase now. Start either making lump sum payments to your mortgage that equal how much the payments could go up, so you’re already comfortable applying that much money to your mortgage. Or cut other bills, and try to pay an increase amount to other bills, so you’re already budgeting that payment,” says Andrew Fox, financial adviser with Invis/Dundee Private Investors Inc.
Sometimes things come up and investors have to dip into their contingency funds more often than they anticipated. By practising making increased payments before the interest rates actually rise, you’re ensuring you’re prepared.
“This is the reality of real estate investment that many investors don’t want to admit. You really have to be committed to your investments. You have to be realistic, and know there could be a time when you have to draw on funds from another area, that wasn’t your contingency fund to begin with,” says Uttamsingh.
Pay attention to the market
It’s easy to get off track when your time and attention is split between various investment properties. However, keeping track of what’s going on in the market is of great value now, and for the future of your investments.
“By just paying attention to news and newsletters from mortgage brokers, it’ll pretty much tell you where things are going,” says Jessi Johnson, CEO and mortgage broker for Jessi Johnson Mortgage Team, part of the Verico Network.
Although it’s tempting to just go with the flow and allow your mortgage to linger on without paying much attention to it, this can be a costly mistake.
“It’s very important [to know what’s going on in the market]. With any business, people who are successful in business drown themselves in it. Owning a home is a personal business, and when the economy falls, people who are smart and pay attention to the markets, that’s where they make their money,” says Lisa Fibiger, mortgage and leasing professional for Dominion Lending Centres Harbour View.
Stay close with your broker
Having a close relationship and checking in with your mortgage broker frequently can offset some of the stress and confusion related to investing in multiple properties.
It’s easy to get flustered in the hectic world of real estate, so investors should “look at sitting down and looking at all the costs associated with owning a home; from insurance to property taxes. Look at the cash flow of the property and make sure there’s enough there, make sure you have enough personal cash flow as well,” says Fibiger.
A mortgage broker or qualified consultant can help educate you in areas you may not be familiar with, and can help you prepare for rising interest rates.
Furthermore, maintaining a close relationship with your broker can help save you time and money in the long run. They’ll be able to look at your personal financial situation, run the numbers, and make sure it’s a worthwhile proposition to be investing.
Have a contingency fund
It’s three o’clock in the morning, and one of your tenants calls you telling you the roof collapsed in the wake of one of the worst snow storms Canada has ever seen. What do you do? Where will the money come to pay for the repairs? How are you going to handle this situation?
Two words: contingency fund. As a property investor, having a contingency fund set aside for worst-case scenarios, such as the one above, is a crucial element to owning a property. It’s important to set aside an amount of money when unexpected costs arise. This way, it’s a lot easier to stay in line with your budget.
“Have a contingency fund. This is generally for repairs or if you’re short on property tax at the end of the year. If you’re an investor who’s potentially over-leveraged or very close to it, I recommend having a fund on the side in the event of covering unexpected costs,” says Johnson.
“You have to ensure you’re keeping sufficient reserve funds in the event that repairs or vacancies come up. That’s the most important thing. Make sure there are ample funds in the reserve,” says Neil Uttamsingh, real estate investor with Great Lion Investments.
Lock in now
With interest rates expected to rise in the near future, many real estate investors find themselves scrambling, wondering what their next move should be. Many mortgage brokers suggest that property investors lock in at the historically low rates now, to guarantee these rates in the future.
“Get the applications in and get the rate holds now. The market has tightened up a lot so people have to be smart,” says Fibiger.
Because these low interest rates aren’t going to stay forever, it’s best to take advantage of the hot market while you still can and know all the options out there.
“Even if you’re only thinking of investing, even if it’s in a year, go see your mortgage broker today. We’ve never seen rates this low and they won’t be there forever. [One option is] to get a rate, hold for up to four months and see what the other options are. A one, two or even three per cent difference is going to be huge. Looking at your options now will save yourself thousands,” says Fibiger.
Property investors can easily get the best of both worlds by looking into all the options out there.
“Any real estate investor who is heavily weighted into short-term or variable-rate mortgages without the ability to sustain the impact of interest rate increases should, at the very least, be getting approvals in place for fixed term rates if nothing else than to hedge themselves against the risk of interest rates rising,” says Calum Ross, senior vice-president and mortgage agent for The Mortgage Centre of Canada.
“By having a fixed rate in place while simultaneously keeping the investment portfolio in variable or short term, you effectively get the best of both worlds. You’re able to take advantage of the short-term advantages, while protecting yourself against the risk.”
Make a business plan
Every property investor knows that it’s easier to stay on budget and keep track of things when you’ve got a physical plan laid out in front of you. By creating a business plan, property investors can not only protect themselves from increased interest rates, but they can also stay on track with their budget.
“Regardless of the interest rate environment, every real estate investor should be doing quarterly if not annual reviews of their mortgage financing,” says Ross.
Investors really have to have a business plan because it’s one of the best ways to keep in line with their budget. It’s easy to stray every now and then, but having a physical document tracking every move of your investment property expenses, can make it easier to keep on track.
“It makes sense to keep a spreadsheet of the expenses for [each] particular property. [Investors should] know their expenses from the get-go and track them with the expenditure that they have. Allocate certain amount of funds for the down payment, certain funds for the contingency fund and stay in line. It makes a big difference when you’re physically tracking it,” says Uttamsingh.
“Budgeting is to financial health what dieting is to personal health, it’s absolutely essential,” says Ross.
Remember that competition among lenders remains fierce, despite what they tell you. They are all dead keen to get your business.
Try twisting their arm a little bit. Asking your lender for half a per cent off their rate might not work, but see whether they will give you a break on establishment costs or the ongoing fee.
Pay off your mortgage ASAP
It seems to be easier said than done, but paying off your mortgage as soon as you possibly can has endless benefits for property investors.
“[If you] stick with 25-year amortization periods and not 35-year amortizations, you’ll pay your mortgage off a lot faster,” says Johnson.
To ensure you don’t over-leverage yourself when interest rates rise, start making larger or faster payments towards your mortgage.
Accelerated bi-weekly payments are a great way to pay off your mortgage faster – by splitting your mortgage into two repayments each month, you’re still paying the same amount of money each month, but you are paying more on your mortgage. That’s because there are only 12 months, while there are 26 fortnights in a year.
Making the occasional lump sum towards your mortgage or even making regular payments above the minimum can cut a number of years off your mortgage term.
One loan at a time
If you’ve already got one loan going from your first investment property
, and you’re looking to purchase a second property, you could run the risk of having two loans going at the same time. Is it best to put them together, or keep the loans separate?
According to various mortgage brokers and financial advisers, it’s best to take one loan for each property at a time.
“I generally suggest for investors to take an open variable product if they feel they may be owning a property for less than the fixed term,” says Johnson.
Choosing an open variable or an open fixed rate can save investors from penalties if they have more than one property to take care of, and more than one loan going at the same time.
Aside from ensuring you take one loan on at a time, many brokers suggest it’s best to sell the first property before buying the second, and only if you’re in a sound financial condition to do so.
“Really be cautious if purchasing more than one property at a time. An investor has to be in a very good financial condition to do that,” says Johnson.
Although this isn’t the only option, and inter-alia mortgages do exist, they’re not normally recommended, as they cost more legal-wise, and should only be used in an emergency.
“If [you don’t take one loan out at a time for each individual property], you can use an inter-alia mortgage, which you should only use in an emergency,” says Johnson. “It links all the properties together. If you do that, what happens is if you need to refinance one of the properties, you’re going to be breaking the inter-alia mortgage, so you’ll be facing a penalty.”
If a property investor breaks the inter-alia mortgage, he or she could face a three month interest penalty also known as an interest rate differential (IRD).
“An IRD is essentially if you were to cancel the mortgage today, it’s the cost of lost revenue [the bank] wants back. So if you have a five per cent interest rate with three years left, the best [the lenders are] going to get back is four per cent so they want that missing one per cent. [In order to get that one per cent back,] they’ll charge it against your existing balance and the remaining term, which can be very expensive.”
Ensure positive cash flow
Aside from planning ahead and ensuring financial stability if interest rates rise, it’s important to make sure your properties actually produce positive cash flow. This is because when there’s adequate cash flow in a property, it essentially takes care of any risks that can occur down the road, says Uttamsingh.
“Buy for cash flow today. An individual has to ensure that when rates rise, that they’re forecasting that into the projection. For example, if interest rates rise two per cent, will their property still remain cash flow positive? Anticipate that rates will go up and know that if rates go up by x amount, then you’re still able to cash flow,” says Uttamsingh.
One way to do this is to have a certain amount of equity available.
“Have at least 20 per cent [equity] available to avoid insurance premiums, so you have a better chance of generating positive cash flow from your property,” says Johnson.
“When you have less down payment [on a property], you run into insurance premiums, which can be costly and more difficult to refinance. This is because in two or three years your property could have lower value, so if this happens you need to be prepared for that,” says Johnson.
In the end, a
real estate investor can’t go wrong by planning for the future.
“All too often people get greedy building their net worth, but real estate investing is a long-term, long-run game,” says Ross.
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