With all the changes in the mortgage financing rules related to residential property, one of the hardest hit areas of the market is the rental property financing or investment property mortgage category.
In a nut shell, the new rules are going to require that you have a down payment or equity component of at least 20% (can be higher in some markets), and debt servicing across the board has tightened up as well.
Making money in as a real estate investor has long been based on understanding the market to secure value and then doing a solid job managing your properties. And while both of those things are still top of the list, an equally important aspect of the business is now managing debt or mortgage financing on your portfolio.
Here is a recent Globe And Mail Article that delves into rental property financing in greater detail.
The article provides a great overview of what the new world of investment property financing now looks like.
And without repeating everything that was included in the post here are some of the highlights.
First, there can be considerable variation from one lender to the next as to their lending and funding criteria for a rental mortgage application.
The primary areas of fluctuation can be found in the combination of loan to value considered, the debt servicing calculation, and the interest rate and term being offered.
Specific to the debt servicing calculation, there can not only be differences among lenders in terms of the amount of cash flow that can be used to service debt, but also the what amount of rents collected can even be used in the calculation.
Investors with existing portfolios are also being challenged to figure out how to both add to their property holdings and refinance existing debt with current or new lenders.
Refinancing in particular can lead to higher interest rates due to the change in the lending environment since the last term was put into place. Changes in your lender’s financing policies can now make a renewal more costly than what you may have been expecting.
The article goes on to mention that one of the keys to be able to properly manage existing rental property debt as well as acquire new mortgages for acquisitions is to be working with rental friendly lenders that are more focused on this space.
And its going to be a good idea to have access to a number of different bank and private lenders so that all your potential basis can be covered.
This makes working with an experienced mortgage broker almost a must due to the considerable variation among programs in the market and fact that these programs are somewhat in flux as time goes on.
If you’re looking for rental property financing for purchase or refinance, then I suggest that you give me a call so we can go through your requirements together and discuss the most relevant options available to you in the market.
But compared to other forms of commercial property, the financing process for owner occupied situations tends to be a bit different.
For non owner occupied, or investment properties, financing is accessed through a commercial mortgage program where the type of property and rents are the key determining factors as to what type and amount of mortgage you can qualify for.
In situations where the property is occupied by the owner and there are no third party tenants, business financing solutions tend to be the most relevant for directly financing the property.
This is due to the fact that the business that owns the real estate may have other debts to figure into the overall debt servicing assessment, and the cash flows to service existing and proposed future debt are going to be coming from the business operations, not from individual tenants paying fixed amounts on a monthly basis.
So while the assessment of property value and liability are the same, the lender needs to focus in on the balance sheet, income statement, and cash flow of the business operations to determine if property financing can be approved.
In effect, the borrower is trying to procure a business loan that will secured by real estate security, and potentially other assets of the company.
For instance, if applied for capital is going to be used within the business entity for business operations or to improve the existing property, there are going to be more “A” credit options available to the borrower as compared to situations where the owners want to do an equity take out for a different venture.
The use of funds can specifically be for the property such as acquisition, building construction, and refinancing, but can also be for cash flow, transaction bridge financing, equipment acquisition, etc., provided once again that the utilization of funds is within the business to either improve overall security value and/or cash flow.
If an equity take out of some sort is required to move capital outside of the entity that owns the property, then these situations are more the domain of secondary lending sources like private lenders or sub prime institutional mortgage providers.
The balance sheet of the business comes under its own unique scrutiny as business lenders are going to be interested in the total debt to equity ratio of the business before and after the completion of a new business loan against property.
For banks and institutional lenders, the debt equity ratio can range from 2:1 to 3:1 with higher debt equity ratios demonstrating higher risk and commanding higher interest rates.
When the debt to equity ratio exceeds 3:1 for the entire business, then secondary sources of funding will need to be considered at higher rates of interest.
The assessment of an owner occupied mortgage on a commercial property has similarity to a residential mortgage assessment with respect to how much of the cash flow will be required to service the total business debt.
Once again, if we consider “A” credit lenders, the debt servicing ratio can range from 1.20 to 1.5 depending on the lender, the type of property, geography, and industry.
The debt servicing ratio is calculated by dividing the projected annual debt servicing requirements by the available cash flow.
The available cash flow is determined by taking the historical operating net income and adding back non cash items or portions of non cash items depending on the particular lender.
Depending on the composition of a business balance sheet and amount of cash flow being generated, the loan to value ratio can vary dramatically from one lender to another as some programs may be able to lend more based on higher cash flow and additional security.
The business loan itself will also come with different lending covenants related to the financial statements that if not adhered to can result in account default.
The bottom line is the owner occupied commercial mortgage financing can be more complex than an investment based mortgage and can vary considerably from one application to another due to the unique financial characteristics of any one particular business.
For assistance with this type of financing, I suggest that you give me a call so we can go through your requirements in detail and discuss different commercial property financing options available to you and your business.
That being said, there are more and more active sources moving into this part of the market, but the movement is slow and rather cautious as individuals and merchant banks try to get a better feel as to what they are comfortable with.
To be clear, when I speak of sub prime commercial lending, this is basically commercial property financing deals that do not qualify for bank or main line institutional lending, but still have a strong enough basis to attract funding that will look at slightly higher risk levels.
While private lenders can also be thrown into the subprime space, the majority of money that is hardest to come by is for deals over $1,000,000 and over several million dollars.
Once you get into this level of commercial financing, there are not a lot of individual private lenders or lender groups that are interested in putting a large amount of their overall investment portfolio into one or two deals.
So the ongoing demand is for commercial lending that can fund the $1,000,000 to $20,000,000 deal for a one to three year period.
And while the major bank’s are getting more aggressive with their lending and funding criteria, there are still a lot of pretty good looking deals that do not make bank grade which are continually looking for money.
The goal of the borrower is to get access to capital quickly to take advantage of an opportunity, cover a capital requirement, or buy time until lower cost, long term financing can be arranged.
This area of sub prime lending is attracting more and more investors into the market where the lenders range from individuals to large financial entities that want to diversity into real estate financing.
The rates and terms can be similar to private mortgages with the biggest difference being loan size and broader acceptance of potential exit strategies.
In Canada, the Ontario market is primarily sought after due to its size and market stability. But most of the other provinces are getting interest as well for these types of opportunities.
Serious lenders can usually assess a deal in a week or so and fund within 30 days provided everything required for funding is in order.
This is always going to be more money available in the larger centers, but out lining areas are seeing more interest as well albeit with some amount of premium attached.
If you’re looking for a short term commercial mortgage or bridge loan for one or more of the reasons mentioned about, then I suggest that you give me a call at 416 464 4113 so we can go over your requirements together and discuss different subprime commercial options that may be available to you.