The mortgage market has been through a host of changes over the last couple of years, and it has changed significantly for investors, in particular. Thus, never has the ‘how’ of financing your investments been so important. While some experts will claim that investors are being shut out, that’s not entirely accurate. It simply means there is more to overcome.
“These aren’t mortgage hurdles, these are mortgage realities,” says Calum Ross, a leading investor and mortgage broker based in Toronto who notes that recent changes aren’t necessarily negative because, “investors shouldn’t have been doing high-ratio mortgages anyway. There is no possible way that that was a sustainable market.”
From the bank’s perspective, altering the way the real estate investment market works in Canada makes sense. As Peter Kinch, an investor, author and broker in Vancouver puts it, “real estate investments comprise only four per cent of overall originations in the market, yet upwards to 70 per cent of frauds, foreclosures and defaults that banks experience are with the investment niche.” He’s quick to point out that this doesn’t mean that 70 per cent of investors are guilty, but it’s important to appreciate the other point of view. “If you were a bank would you be going after the 96 per cent safe market or going out on the skinny branches?” he asks.
That doesn’t mean investors are cut off from financing, of course, but it does mean that they are typically treated somewhat differently. So the new obstacle becomes how best to qualify and stretch your credit as far as possible.
Addbacks versus offsets
One of the most significant changes for the investor stems from mortgage insurer CMHC no longer accepting an 80 per cent offset, just the 50 per cent addback. There remains some confusion in the marketplace as to the precise impact of this, but as Kinch says, “the rental offset is very valuable to an investor – an addback is not.”
To break it down in layman’s terms the addback system uses rental inclusion, meaning that they include the rental income in your income before calculating debt service and qualification numbers. An offset on the other hand is the more progressive, and favourable of the two. An offset means lenders include the rental income as a direct offset against your debt carrying costs before determining debt servicing.
With an addback-only system, the average Canadian will not be able to qualify for more than two properties, and while some people think this only effects mortgages with less than 20 per cent down (therefore requiring insurance), it’s also the case with conventional lending.
“If you go through the lenders that rely on mortgage-backed securities, the institutional lenders that they get their funding from will have criteria that say they have to bulk insure it with CMHC,” explains Kinch. “Just because the premium isn’t passed on to the borrower doesn’t mean it’s not a CMHC loan.”
As the proverb goes, every cloud has a silver lining, and that is definitely the case with this situation. According to Dustan Woodhouse, a broker and investor based in Port Moody, B.C., the CMHC changes have made it easier for him to qualify certain clients.
“With the way CMHC is calculating rental income and lenders following suit, if you’re an organized property investor and have been reporting your rental income on your T1 for at least two years, you’re able to subtract the full property expenses from your income,” says Woodhouse. “It doesn’t call it a 100 per cent offset, but essentially that’s what it is.” It’s important to note that this is only ideal for the investor who has been reporting their schedule of rents on the T1 form for at least two years, and even then it only applies to certain lenders. “On conventional financing, it’s business as usual for balance sheet lenders,” he adds. That means a 50 per cent addback for some, but then there are interesting cases like First National, which has always used a 50 per cent addback policy. Woodhouse says they are actually more flexible and friendly to investors under the new guidelines.
The most critical thing when it comes examining how the addback and offset may affect you is to speak with a professional – a mortgage broker or financial planner, who is well versed on the dynamics. It could mean the difference between going with a lender who offers a full offset, or one who sticks to the 50 per cent addback.
Cap rates are another impactful component – and a reason to consult an expert in financing – when exploring mortgage options. Banks only want to loan so much to one person, and when it’s gone, it’s gone. “No matter how wealthy my investor clients are they are always faced by a finite amount of capital,” says Ross. “Whether that amount is $10,000 or $1 million, the key to building the most amount of wealth means effectively managing that capital and using it as effectively and efficiently as possible.”
What this boils down to is the structure of your multiple loans, or, simply put, what order do you borrow from certain lenders? It’s something Kinch has written and spoken about at length. “The average investor is going to say, ‘I have a great relationship with my bank.’ But they forget about cap space – at one point or another they are going to cap you. The order in which you organize your mortgages becomes critical,” he says.
As he explains it, the first five mortgages you acquire are the easiest ones to get. Any lender will write those for you, so he suggests going to the Mortgage-Backed-Securities (MBS) lenders first: non-deposit taking lenders you rely on for funding. After four or five, most MBS lenders will cap you. For loans six through 15? That is what chartered banks are for. In fact, they are set up for those types of mortgages.
“What is the biggest mistake an investor can make? They’re inadvertently limiting their options by going to the charter banks first,” says Kinch.
Beyond 15: where to get the financing
Even following this order, it’s inevitable that you are still going to reach your limit with lenders, and with housing values no longer going through the roof, re-financing is becoming less of an option. The consensus is a contingency option known as a joint venture (JV) partnership, where you contribute the knowledge and market research accumulated throughout your first 15 mortgages, and someone else offers the capital.
“Engaging in long-term mutually beneficial arrangements with those who have deeper pockets is not only an opportunity in today’s more conservative lending environment,” says Ross. “It should more likely be viewed as a rite of passage for those who wish to build something of significance.” He says that all of his top investors rely on JV partnerships, under the pretense that they will be the “students of the industry with the promise of long-term gain,” while the partner provides the capital.
The best way to do this, of course, is to systemize how you work, keep records, and develop a skill set. Kinch suggests keeping a journal for every purchase you make, tracking everything that was required of you, time- and money-wise, in order to get the deal done. “Eventually a partner is going to ask you how much money are you putting into the deal, and when you say nothing, they are going to say that’s not fair,” he says. With a journal on hand, you and your potential partners will start to realize the value of your time.
One way to help you develop these skills is to list 10 things you would want to see in someone else before trusting him or her with your money. It’s something Kinch has all his investor clients do as part of his five-year plan.
If attracting and securing JVs is the new reality for you, having invested for a protracted period of time, presenting yourself properly is just one small hurdle to newfound success. And like most of the hurdles discussed here, with the right team of experts behind you and proper due diligence on your end, you should have no problem clearing them.
Top 10 tips for long-term investing
If you plan on investing for the long haul, it’s inevitable that you are going to run out of financing and will have to look at forming a joint venture (JV) partnership with somebody. But before you can do that, it’s even more important to prove that you know what you are doing. To do that, keep these things in mind as you continue to grow your portfolio. You never know when a JV partner will ask you what exactly you’re bringing to the table.
1. Character and integrity. This goes well beyond just not being a slum landlord. All your investments are on the up and up and reported properly.
2. A track record of success. It’s important to show partners that you have been successful managing your own capital. This will make you trustworthy.
3. Become an expert. As you spend your money, what are you learning, what are you becoming? Hopefully it is an expert in the area you want to focus in.
4. Earn your stripes. It’s OK to make mistakes with your own money, especially since it shows you what to avoid when working with someone else’s.
5. Know how to find deals.
6. Understand how financing works.
7. Know how to find quality tenants, and quick.
8. Never use someone else’s money to educate yourself. Experiment on your dime. This can’t be stressed enough.
9. Have a team of experienced professionals on hand, including brokers, Realtors, lawyers and financial planners.
10. Systemize. This is where a journal will come in handy for you. Once things are systemized, success from one project will easily be transferred to others.
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