Securing a mortgage for rental purposes is an entirely different kettle of fish than securing a mortgage for a primary residence. With a mortgage for a primary residence, it’s generally a good situation where you go in with as much cash as you can upfront, and look for the mortgage with the lowest interest rate with the most flexible features.
Perhaps most important than the specific features of a mortgage for your investment property, however, is how you approach financing.
Examine your motivation
Claire Drage, a mortgage broker
with Mortgage Alliance, urges first-time investors to really question their motivation for buying real estate as an investment vehicle. Typically, she says, there are two key reasons that someone wants to become the owner of an investment property: one is that you want quick cash, in the instance of a flip or a rent-to-own type of situation. The other reason might be cash flow, with the profits from your rental property either going back into your portfolio or generating an income for you. Drage calls this distinction the acquisition strategy.
The second thing to consider is the exit strategy, which is when you’re planning on selling/liquidating your asset. If you’re buying for quick cash, then you may only need financing for as little as a few months. If you are doing it for cash flow and aren’t planning on selling the property for decades, then you’re looking at a different strategy and needs altogether. For example, for someone who’s buying for cash flow purposes might want to be with a lender who has a longer amortization, so they’re not going to go with a lender who only does 25 years.
“When you know your acquisition strategy and your exit strategy, that really does determine the right financing options,” Drage says.
Would-be investors also need to be realistic in terms of the options available to them if they are conventionally employed versus self-employed, says Amina Mohamed, a mortgage broker
with the Mortgage Processing Centre in Newmarket, Ontario. There are fewer options out there for borrowers with stated income, and they’re more expensive. If the property of interest isn’t going to be owner-occupied, she says, you’re limited even further.
“At the end of the day, if you’re an investor and you know how to do analysis, you know that cash is king. However, if it comes down to, ‘am I going to get a property or not?’: Do I now learn how to mitigate that rate by saving some other way? Do I build a secondary legal suite in that bungalow that I just bought? Or do I look for a duplex or a triplex? . . . Or do I look into [other] markets?” Mohamed says. “Look at all of your options. Really do your homework before you get in the market. Don’t just assume that if you own your home and are employed, that [if] you own a home with equity, you’re automatically going to get approved.”
A good mortgage broker will work with you to analyze your situation and what you can afford, whether you’re able to qualify for an A rate or a B rate. If you don’t have the ability to afford a property, then look at other investment options that will help you save for when you can save for a property. “The trick is able to make your money work for you,” Mohmaed says.
Plan it out
Something else to consider is your overall investment plan. There are multiple ways to begin investing in real estate, but it starts with a plan that looks at the big picture and your long-term goals, including how many properties you might want to buy and your ideal time frame for doing so.
“A good real estate investor has to have what we call a real estate investment financing plan,” Drage says. “If an investor comes to me and says, ‘I want to buy 12 properties over the next 12 months for cash flow and I’m going to keep them until I retire in 20 years,’ I therefore know which lenders will allow us to have four rental properties in the portfolio versus six, versus 15, versus unlimited. So we’re going to strategically place that client with the right lender based on that plan.”
Financing investment properties is more than simply finding a lender to service the loan as quickly as possible. If you don’t have a plan and you don’t have a strategy, then you could end up using lenders earlier on in the process when you could have used them later on down the road when you needed them more.
“The financing doesn’t come down to rates, or terms and conditions,” Drage says. “It really is acquisition, exit, and your real estate financing plan.”
Coming up with the extra cash
When buying a home for a primary residence, you only have to come up with 5 per cent as a down payment on properties under $500,000 (and 10 per cent for any amount above that), whereas for an investment property, you may have to come up with 20 per cent down right off the bat, depending on the number of units and whether or not it’s going to be owner-occupied. It can be daunting for someone who is trying to get their foot in the door to come up with that chunk of cash – especially if they already own a home and are dealing with making their regular monthly mortgage payments, property taxes, and other associated maintenance costs. But there are ways that an investor can break into the arena.
The most obvious option if the would-be investor owns a primary residence is to refinance their mortgage and take equity out of their property. You can take up to 80 per cent of the equity you have in the home, and if that’s enough to cover the 20 percent down payment requirement, you can be good to go.
But there are other circumstances that may prevent borrowers from exercising that option. If they don’t have equity in their home, for example, or if they have a lot of debt. In the opposite situation, a would-be investor has capital, but no time or energy to devote to being a landlord, or for whatever reason can’t qualify for a mortgage. In these instances, a joint venture may be the answer, where two parties fill in the missing pieces for each other.
Mohamed warns that it may not be smooth sailing just because the partners look good together on paper.
“It’s like being married to somebody,” she says. “You’ve got to date them because you don’t know that it’s going to be a successful relationship. I’ve seen so many joint venture relationships fall apart because people didn’t do their due diligence on each other at the beginning.”
She alludes to a client who entered into a joint venture with someone who didn’t keep their end of the agreement and is out hundreds of thousands of dollars because the pair didn’t want to spend the money to draft an agreement with a lawyer and structured their deal on a napkin instead. Unsurprisingly, the pair has no recourse for grievances that have arisen.
“It’s all about doing your due diligence, knowing who you’re getting into bed with,” Mohamed warns.
Other options for getting into property investment include borrowing funds or taking advantage of the vendor take back (VTB), where the seller (vendor) of a property provides you with a some or all the mortgage financing for purchasing his/her property. There are also more passive ways of investing in property, such as investing in a syndicate, where several investors combine funds together to create a mortgage; a mortgage investment corporation (MIC), where an investor gets shares in a lending company designed specifically for mortgage lending; and something called an arm’s length mortgage, where you invest in someone else’s property using your RRSP
, RRIF, RESP, LIRA or TFSA. There are restrictions to an arm’s length mortgages, such as you can’t use this option to fund your own investment property, but Drage says that it can be a good option if a would be investor’s cash isn’t getting a reasonable return where it’s currently parked and real estate could be a great opportunity for getting better returns while being secured in bricks and mortar.
Investing in the future
Drage cautions property investors who are speculators.
“[In] my personal opinion, relying on capital appreciation is speculative investing. So if it’s a cash flow, then let’s focus on your cash flow,” she says. “But if you’re buying a property that doesn’t cash flow just because in five years it may be worth $20,000 more, does that really fit your portfolio growth plan and your current net worth? I mean, if you don’t have a pot to pee in and you’re living paycheque to paycheque, you shouldn’t be buying investment property based on capital appreciation! You need cash flow! So you’ve got to look at your current situation, where you want to be, and smartly invest in real estate, because it’s not for everybody.”
Thanks to the new mortgage guidelines
, property investors are more restricted in terms of choices when it comes to mortgages. Mohamed mentions that some monline lenders have already started sending out notices that they won’t be doing lending for properties that aren’t owner-occupied anymore. “Unless you are able to qualify at the BoC rate of 4.64, you’re not going to be able to get in with a monoline, you’re now going to be forced to get in with a B lender . . . their rates are always horrible so now your cash flow is reduced,” Mohamed says.
Drage agrees, adding that consumers will have to seek out brokers that work with every lender in the marketplace in order to provide them with a complete array of options. She is also quick to point out that lending rules were always tighter when it came to financing rental properties compared to primary residences.
“New legislation won’t prevent property investors from growing their portfolios, but it will limit their options, she says. “Where there used to be eight lenders that client could select from, now there might be five or six.”
Investing in rental properties, whether you’re a landlord or not, is not for the faint of heart. But if done right and with the right mentality, it can be a secure way to build your net worth.
“We all know that bricks and mortar is a good investment. But real estate is not a get-rich-quick. That’s the biggest mistake. People watch these programs [on television] and see someone make 50 grand in two weeks and think that that’s easy. You can do it, but it’s not easy. There’s work. So if you’re prepared to put in the time to learn, build the right power team, have a plan, stick to it – that’s the hardest thing – don’t be influenced to steer away from your plan.”
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