By Eddy Boudiwan and George Hill
Obtaining a mortgage is an integral component of purchasing a rental property. You can expect to put between 20 and 35 per cent as the down payment and the rest is the mortgage. In investing, you have to use leverage to help you grow and increase the potential return on your investment.
For example, you buy a property worth $100,000 and you put down $25,000. If the property is now worth $110,000, the extra $10,000 in upside is approximately a 40-per-cent return on your investment. This is leverage at play – available in real estate but not in stocks or bonds.
A traditional bank mortgage is not the only way to buy and finance investment properties. Let us look at a few other options that can be used creatively. It should be noted that some tools are riskier than others and are better left for experienced investors.
Cash: This is a traditional method for down payment on a rental property, generally 20 to 35 per cent down. Cash can also be used to fully purchase the property with 100-per-cent down.
Bank mortgage: Considered the traditional way of financing a rental property, by placing a mortgage of 70 to 80 per cent of the purchase price. We are often asked, “Should I choose a fixed or variable mortgage?” The answer is, it depends. If you are buying an asset that is turn-key and you plan to hold it for a long time, you may want to fix your mortgage, so as to keep expenses predictable. When buying an undervalued asset it may make sense to use a variable rate while you are improving it. Once improved, refinance the asset at a higher value, with a new lower-rate, long-term fixed mortgage.
Private money and vendor take back (VTB): You can use these vehicles as a second mortgage or stand alone option. They will cost you more in interest as opposed to the traditional mortgage. VTB is typically used when the seller agrees to supplement your first mortgage with an additional percentage of down payment held by the seller, at a higher rate. For example, you take a 75-per-cent mortgage and the seller agrees to hold 10 per cent of the 25 per cent required down payment, for a premium. This drives your effective down payment contribution to 15 per cent, stretching your funds for investment.
Be careful with the VTB and private money mortgages, and run your numbers meticulously, to ensure that your net operating income from the property can handle the additional payments. We have used this method in the past, allowing us to improve on undervalued properties with the money saved via the VTB on the down payment. The improved properties were then refinanced at 75-per-cent loan-to-improved higher value, with a low interest mortgage. We were able to recover most of our initial capital tax-free while holding a stable asset, still with significant equity built in and a great yield from the ongoing rental revenue.
Home equity line of credit (HELOC): Another option is to tap into the equity in your home. Ensure that the cash-flow from the property covers the property expenses, in addition to the HELOC interest you are paying (which is tax deductible).
Joint venture (JV) funds: Investors who have exhausted their liquid capital typically turn to joint venture funds. The expert investor finds and manages the deal and invites money partners to invest the cash required, in a marriage of resources. Each JV deal encompasses the following components: debt (the mortgage), investment expertise (the work) and down payment.
The money partners put down the capital and the expert partner handles all the work, for a portion of the net profit on exit and some ongoing fees. When entering this type of agreement, you must be aware of who will be guaranteeing the mortgage. You must perform your due diligence on the operator and have your own lawyer oversee and manage the JV agreement.
In our next article we will explore in detail the process of analyzing a property.
Real Estate Rangers is a real estate investment team that locates, operates and maintains properties for investors. Eddy Boudiwan (eddyb@realestaterangers.ca) and George Hill (georgeh@realestaterangers.ca) are the co-founders of the company. They have partnered with Taft Forward Management as their acquisition arm. www.realestaterangers.ca
Real Estate Rangers is a real estate investment team that locates, operates and maintains properties for investors. Eddy Boudiwan and George Hill are the co-founders of the company. They have partnered with Taft Forward Management as their acquisition arm. For more information, visit www.realestaterangers.ca.
