Investment Property Mortgage Qualifications Don't Make Sense!

There have been many changes with respect to mortgage qualifications in Canada. Above and beyond the 4 major changes announced by the Minister of Finance over 4 years, there have been changes on the backend on how lenders qualify applicants.  The most recent one is mind boggling!

Investment Property Mortgage Qualification

For an applicant reporting a surplus on their T1 general (line 126), the surplus (line 126)  is added to their income.

Example: Applicant's income is $100,000 and line 126 is showing $5,000, total applicant's income is $105,000. If the applicant owns other investment properties, here is the part that makes no sense: The principal portion off the annual mortgage statement is deducted from applicant's income!

Example: Applicant has paid down $10,000 of mortgage principal in the previous year, total income: $100,000 plus $5,000 less $10,000 = $95,000.  This rule effectively penalizes real estate investors who build equity in their investment properties.  Last time I checked statements made by Minister of Finance, Bank of Canada, Bankers..... they all advocate paying down debt and building equity now while interest rates are low (Canadians are at record high debt to income ratio).

This rule effectively encourages not paying down mortgage principal. Had the applicant paid more interest than principal in the previous year, the mortgage principal deduction would have been less and therefore their net income higher!

If you are thinking of showing a loss on line 126, it's even worse: Income less loss on line 126 less mortgage principal.

Are you confused and frustrated with all these guidelines? Rest assured this is what I do on a daily basis and I am here to help you navigate through the mortgage qualification  land mines to build your real estate investment portfolio. It's all in the setup.....Happy Investing!

How To Mortgage 8 Investment Condos

There is no denial it is more challenging today to mortgage investment condos in Toronto.  Some of the changes over the recent years are:

• The days of 5% downpayment and 40 years amortization are long gone
• Some lenders have a minimum square footage requirement
• Some lenders require more than 20% downpayment
• Some lenders require borrower pay for insurance premium above 65% loan to value

and the list goes on.  But don't be discouraged. Here is mortgage underwriting 101 and a road map to help the investor mortgage 8 Toronto investment condos:

1. Start With The End Goal

The mortgage setup of each investment condo plays a critical role in helping or hindering the qualification of the next investment condo. Knowing what the investor's ultimate goal (8 condos or 3 condos) requires a different mortgage financing strategy. Some investors approach investment properties with "I'll buy another one" which is a problem in today's financing world. Over the years, I  have come across many situations where the mortgage was setup with a short amortization period or the wrong mortgage product which restricted qualifying for another property.

2. Focus On Cash Flow

Setting up each condo to positive cash flow helps to qualify the next investment condo.  There are 4 methods of cash flow analysis lenders would consider in mortgage qualification:

T776 Statement of Real Estate Rentals

Some lenders would use line 9946 to add to investor's income if the figure is positive.  This is where many investors go wrong. They try to show a loss which reduces taxable income however it hinders qualifying for the next investment condo since the negative figure translates into a liability on the mortgage application.  Showing a positive figure and paying some taxes is not a bad thing!

50% of Rental Income

This method is a deal killer.  For example, assuming the investment condo is rented for $1600 per month, the lender would only use $800 as revenue then deduct 50% of condo fees and mortgage payment.  Good luck getting a positive number without a large downpayment.

Rental Surplus Calculator

Lenders use the rental income generated by the condo and deduct mortgage payment, condo fees and 15% of the rental income figure.

The Wash Method

This is where the lender would look at the rental income being generated and as long as the rental income covers mortgage payment, condo fees and property taxes, the investment condo would not help or hinder in qualifying for a mortgage.

Stretching the amortization to 30 or 35 years and getting a variable mortgage would increase cash flow and help qualify the next investment condo.  In real estate it is location, location, location and in the investment property mortgage world it is cash flow, cash flow, cash flow which sometimes means a greater than 20% downpayment.

Keep in mind today's qualification guidelines could be different next month. The mortgage financing landscape changes frequently based on government requirements and lenders' risk analysis. So what works today, might not work tomorrow!

Mortgage Broker or Bank 

Most, not all, lenders have a cap of 4 investment properties per borrower. Understanding where the investor wants to be long term helps in structuring the mortgages appropriately and placing them with lenders who accept a portfolio of more than 4 investment condos. Choosing an experienced mortgage professional who knows where and how to place these mortgages can save the investor tens of thousands of dollars. No investor wants to be in a situation where they walk into the bank to finance their 5th investment condo and get "sorry, we can't help you since you are capped". Then what?

Looking to invest in Toronto condos or have an existing portfolio? Please contact Nawar to help you achieve your long term goals.

Legalizing Basement Rental Apartments

Basement rental apartments are popular in Toronto and make homes affordable for many in the city since they have the potential of generating $1000-$1500 per month in rental income. Legalizing a basement apartment requires meeting electrical, fire and building codes. It seems daunting initially but working with a knowledgeable architect can alleviate lots of headaches.  As a real estate investor, I have viewed many properties and found the most challenging part of legalizing a basement apartment to be the ceiling height requirement. There are 2 building code requirements; one for existing basement units and one for new basement units.If the basement rental apartment is existing, the code requires at least 50% of the floor area to be 6'5" high.  If the basement rental apartment is new, the code requires at least 50% of the floor area to be 6'8" high.  The majority of homes' basements built in the city of Toronto were used as utility /storage areas and not as living space.  Nowadays, basements are considered part of the living space for in-home offices, guest bedrooms, children's play area and entertainment space. Lowering the flooring to achieve legal height can be accomplished through underpinning or benching. Both methods can be costly depending on the house foundation conditions, soil conditions and existing interior walls.  In cases where the basement ceiling height is 4"-6" below the required height, there is a third more cost effective option: lowering concrete slab (see image below).

A bonus of this option is installing new PVC drains since the old ones are made out of clay and over the years have deteriorated in condition. This method requires drilling holes into the existing concrete slab to locate it relative to the wall footing.  In my experience, I had to underpin one property and managed to lower the concrete slab on another to achieve required legal basement height.  The cost of underpinning can range between $50-70,000 where as concrete slab lowering $15-20,000.

References For Adding A Secondary Unit in Toronto

• Carson Dunlop Basement Apartments Untangling the Web
• Second Suites
• Basement Accessory Apartment Specifications

If you are looking for an experienced mortgage broker to help you navigate through adding a basement rental apartment and analyze the investment property, please contact me.

**Disclaimer: The above information is for reference only and it is best to consult with a professional architect and a licensed basement lowering company as part of your due diligence**

2014 Ontario Rent Increase...The Good, The Bad & The Ugly

Quietly during the dog days of summer, the Ministry of Municipal Affairs and Housing released its allowable rent increase for the period between January 1, 2014 to December 31, 2014.  The rent increase for 2014 is capped at a maximum of 0.8%, yes zero point 8 of a percentage point. Click here for the Ministry of Municipal Affairs and Housing news release.

2014 Ontario Rent Increase: The Good

There are a few exemptions to rent control if one of the following conditions is met:

1. If you are real estate investor who owns a condo that was built after June 17, 1998, then it is not subject to rent control which means the real estate investor/landlord can increase rent to an amount the market can bare without the tenant moving out.
2. If the rental unit has not been rented since July 29, 1975. A good example if one decides to convert their basement into a separate rental apartment. Again in this case, the rental unit is exempt from rent control.

2014 Ontario Rent Increase: The Bad

When was the last time property taxes, hydro rates, heating prices, water & sewers and insurance costs all went up by a total of 0.8%? It is important as a real estate investor to have utility costs (heat, hydro, water & sewers) paid for by the tenant.  Having the tenants pay for utilities puts the responsibility on the tenants' shoulders to conserve energy and pay for what they use.

Controlling rental increase at 0.8% reduces the real estate investor's cash flow as expenses rise. No business owner (real estate investor) would be happy with less cash flow from their business venture.

2014 Ontario Rent Increase: The Ugly

One phrase caught my attention in the news release: "This year’s rate will be the second lowest in history". Is this something to be proud of? I will leave that for you to decide.

Keep in mind, if your tenant moves out, you are allowed to increase the rent to what the market can bare. However, if the tenant is staying, an N1 or N2 must be provided with 90 days notice of the rental increase per the Ministry's guidelines.

If you are looking to start investing  in real estate and not sure where to start or an existing real estate investor looking to grow your positive cash flow portfolio, please contact Nawar.

How To Qualify For Investment Property Mortgage

The mortgage lending landscape has changed considerably in the last few years and investment properties qualification is more stringent nowadays.  A few years ago, one can qualify for an investment property mortgage with less than 20% downpayment. Nowadays, 20% is the minimum downpayment not to mention the amortization has been reduced to 30 years (Note 35 years amortization is available but at a rate premium).Understanding how investment properties are qualified with various lenders can sometimes be complex, however here is an explanation to help the first time real estate investor what they are up against.  The examples below are based on the following:

• Purchase price: $625,000 (duplex)
• Mortgage: $500,000 (80% LTV)
• Monthly mortgage payment: $2,127 (based on 3.09% amortized over 30 years)
• Monthly rental income: $3800
• Monthly property tax: $275

50% Rule

This is the most penalizing rule used by lenders where it only accounts for 50% of the rental income. Based on the above numbers, the net monthly result is a shortfall of $502 (50% * $3800 - $2127 - $275 = -$502). This figure is added to the liability section of the mortgage application hence reducing applicant's qualification amount.

70% Rule

This is more favourable method, where 70% of the rental income is accounted for.  The above example would net in a surplus of $258 which is added to the applicant's income which strengths the mortgage application. At the time of writing this blog post, this method will be scrapped in a few days.

T1 General Line 126

Some lenders allow the applicant to use line 126 in the T1 general for existing investment properties when qualifying for a new property.  Typically, real estate investors maximize capital cost allowance (CCA) depreciation and expense deduction to show a loss.  This might be advantageous from a taxation perspective, however the negative figure on line 126 would be added to the liability section of the mortgage application. Having a positive line 126 figure would strengthen the application since it is added as income (Disclaimer: Please consult a professional accountant to provide tax advice as I am licensed a mortgage broker only).

Rental Surplus/Shortfall

A calculator is used with set figures for vacancy, repairs & maintenance, insurance and management. This is the most favourable method as it nets $638 monthly which is added to the applicant's income.

If a real estate investor is buying a home to for personal occupancy, the above methods are used by lenders in assessing the the applicant's qualification. Qualifying for a mortgage when one owns an investment property can be a daunting task and stressful.  It is important to work with a mortgage professional who is well versed in investment property qualification guidelines to avoid future disappointments. How would one feel if they can't buy their dream family home because they own one or two investment properties?

To avoid disappointment in buying your family home or investment property, please contact Nawar.

Mortgage Fine Print: Collateral Mortgage

There are 2 types of mortgage registration in Canada: standard charge and collateral charge.  Homeowners usually don't inquire about the type of mortgage registration due to lack of knowledge or lack of disclosure by the lender/broker arranging the mortgage.  Mortgage registration is an important fine print detail.There are pros and cons associated with collateral mortgages:

Collateral Mortgage Pros

1. It allows the homeowner to access equity as they pay down the mortgage
2. Legal fees are not required (saving of approximately $1,000) to access further equity
3. Good product if homeowner intends to refinance/access equity prior to mortgage maturity

Collateral Mortgage Cons

1. Due to registration, homeowner will incur legal fees (approximately $1,000) to move the mortgage to another lender at renewal
2. Homeowner loses negotiation advantage if they need to access additional equity since they can't leave the current lender without paying a penalty (3 month interest or IRD) plus legal fees
3. Homeowner might not qualify with existing lender leaving no options to access needed funds
4. Some lenders register the collateral at 125% or 100% of home value, effectively blocking the total amount and restricting the homeowner from accessing equity

Collateral mortgage registration is designed to retain clients at renewal.  With slowing real estate market, less sales therefore less new mortgage originations, lenders want retain more clients.  Homeowners will be faced with a decision to renew at a less competitive rate or pay legal fees to move their mortgage to another lender at renewal.  CBC marketplace did a show on collateral mortgages where they focused on one banking institution. Be aware that other lenders employ similar strategy as well.

Understanding the costs of getting into a mortgage and out of the mortgage at renewal, is important in deciding which mortgage product makes financial sense.  There is more to mortgages than just rates.

How To Increase Cash Flow In An Investment Property

In a hot Toronto real estate market where sellers are getting what they want (and sometime more), finding investment property opportunities requires a skill and having good team members.  In my search for a duplex or triplex, I focused on the Beach / Upper Beach area where the tenant profile is strong and potential for long term appreciation is in place.  We found a duplex that generated $2,500 monthly income, however it had potential for higher rents once the property was updated. Here is a video shot by my realtor, Andrei Angelkovski (www.BeachInvesting.com), who specializes in investment properties in the Beach area, walking through the property and explaining the work to be done.  I'll be posting updates over time showing the progress and explaining why certain things were done.http://youtu.be/1QUw_tvVwNc

Happy Investing!

To discuss your personal investment property goals and opportunities, please contact me.

Don't Get Hung Up On The Dollars When Investing In Real Estate!

I recently met with a client who wants to invest in real estate. In the initial meeting where I find out about the client's long term goals, desired mortgage freedom date, why they want to invest in real estate and how many properties they plan to acquire, the client stated their criteria is to have $400 or more in cash flow on a monthly basis.Cash flow is key in investing in real estate, however I was perplexed since they only wanted to invest $50k.  Based on my quick calculations (downpayment is 20% therefore total purchase price is $250k and using 8% gross rental income rule, the property would generate $20k annually or $1,667 monthly), it would be very difficult for a property to cash flow 20+% of gross rental income (in this case it's $400/$1,6667 = 23%).

Real estate investors want to maximize cash flow which is a great goal, however, it's important to consider ratios since an investor with $100k capital will generate more cash flow than someone with $50k capital, and an investor with $150k capital will generate more cash flow than someone with $100k capital.

Click here to see a comparison between 2 properties ($240k vs $500k) based on 2 actual investment property listings that I have recently come across illustrating the ratios (CAP rate, DCR, cash on cash...) are very similar to each other although the cash flow is double for $500k property.

Investing in real estate is about cash flow and ratios as well.

To discuss your real estate investment goals, please contact me.

Turn Down The Noise And Take Action

A new year is upon us and we are hearing the same things: "Real estate is overvalued by 10%, 25%...", "We are due for a correction".... I agree that real estate prices, and I'll only speak for Toronto since this is where I live and conduct my business, have appreciated over the last few years, however, one can't generalize since real estate is very local.  As per my previous posts "2 Factors That Can Affect Your Home Value", interest rates spike or unemployment spike are the 2 factors that can derail real estate prices. The other factor, is some major global disaster such as a country defaulting on its debt, would affect everyone and everywhere.There is lots of information on TV, radio, newspaper and on the internet. It can be overwhelming and paralyzing.

I am a firm believer in putting a plan together and taking action.  Since it's early in the year, it's a great time to put a financial plan (when you want to be mortgage free or think about buying an investment property to create long term wealth or topping up your RRSPs or consolidating debt to improve cash flow) then take action.  It's best to look back at year end and be grateful for taking action this year as opposed to wishing had done something 12 months earlier.

Please feel free to contact me to discuss your personal mortgage and financial goals.

How BAR Can Grow Your Real Estate Investment Portfolio

BAR??  Yes BAR, which stands for buy, add value and refinance.  The toronto real estate market is hot and finding good deals can be a challenge especially when supply is low and there are quite a few interested buyers (I wonder how many are frustrated with their stocks and have decided to invest into real estate).A property that shows well in a good area will probably go for over asking or very close to asking price.  I have come across listings where the sellers were disappointed for not getting multiple offers which resulted in increasing the listing price the next morning!

It can be frustrating since real estate investment is about numbers and not getting emotionally attached to a property. Working with a realtor who specializes in real estate investment is critical since they are knowledgeable in a local area, know local rents and understand how to add value to a property to create additional income.

Here is an example of a property I came across in Toronto: a 2 bedroom, 2 bathroom semi-detached with a finished basement in the "beach".  The potential was to separate the main floor from the basement (creating an additional income suite) and adding a powder room w/ laundry on the main floor.  The strategy is to create a second income suite up to code and refinance the property once the renos are complete to recover the renovation costs.  This accomplishes the following:

1. Increase property value
2. Increase rental income (2 incomes versus 1)
3. Create positive cash flow property

BAR (buy, add value & refinance) is one strategy for real estate investors to create long term wealth.  It's key to have a strong experienced team (realtor, mortgage broker, contractor and other trades) who understand what the objective are and have done work for real estate investors.

To discuss your personal real estate investment portfolio or questions regarding real estate investment, please contact me.