While it takes an extraordinary amount of education and expertise to become a reputable source in all mortgage-related investments, the realm of investment properties is one where brokers/agents particularly have to do their homework.
If potential borrowers don’t fully understand the logistics of property investments and feel like they are getting in over their heads, they will want a mortgage broker who can clearly explain the fundamentals. And those borrowers who know what they’re doing, will want a mortgage broker who can keep up.
That’s why it’s important to understand what type of client you’re gearing your services towards if you’re thinking about investing time and effort in the rental property niche.
Are your clients going to be savvy individuals who make a living out of purchasing and renting large numbers of investment properties, or are they novice investors who are looking to add to their existing investments and retirement pensions?
Choosing your clientele
Betty Anne Tarini, a Calgary-based realtor and investor, lands on the experienced side of the spectrum. Along with her business partner, she owns 23 investment properties with 55 rental units – and when she wants to add to her portfolio, she wants to add to it quickly.
“We don’t need a lot of hand holding. We want the process to run quickly and smoothly – like a conveyor belt,” she says. “We don’t require the steady coaching that a mortgage broker would provide with a one-off residential deal.”
Tarini does a lot of research and is extremely educated in this area of investments – and she expects the same from her mortgage broker. She currently works with Nikki Harrison, a mortgage associate with TMG The Mortgage Group in Calgary, and likes how Harrison is constantly planning for the next big purchase.
“Nikki is always looking down the road – discussing plans for future purchases and explaining how those plans affect our current purchases,” Tarini says. “She always has a plan regarding what lender she is going to use.”
Tarini also likes Harrison’s ‘can-do’ attitude. Rather than simply telling Tarini a deal isn’t possible, Harrison explains the steps required to make it happen – and lets Tarini and her partner decide if its worthwhile.
Being able to offer this type of advice requires education and experience – and shouldn’t be attempted by brokers/agents that aren’t willing to learn the ropes, Harrison says.
“Honestly, the role of real estate investment advisor only comes from years of working with sophisticated investors and learning the process through others,” she says. “It’s much more than simply knowing what products are offered through lenders or insurers – it’s working with them to manage their portfolios and create a long-term strategy for growth, while keeping their goal of cash-flowing properties in line.”
Chad Robinson, broker/president of VERICO Best Interest Mortgages in Ottawa, agrees – and suggests that if residential brokers/agents are looking to get into the rental property realm, they start with smaller investors.
“You definitely need training and support when you’re just starting out in rental property mortgages. It took me a long time to learn how to do it right,” he says. “That being said, anyone who’s had some experience in individual residences should be able to handle smaller investors.”
Starting small
Smaller investors require an educated broker just as much as their larger counterparts. These clients often need someone who can patiently and eloquently explain the ins and outs of rental investments.
“When the author of Rich Dad Poor Dad did a seminar in Ottawa, my phonerang off the hook with people that didn’thave a job or any money saved up,”Robinson says. “I’d say about two-thirdsof the clients that call me don’t end upbuying because, once they find out what’sinvolved, it’s too much for them.”
Robinson tells all novice clients coming through his door to prepare for at least two to three months worth of lost rent and additional rental expenses – in case the unit remains vacant or extensive maintenance is required. He also suggests that, if they’re living paycheque to paycheque or if their credit cards are maxed out, they should really wait until they’re in a more stable place in their lives.
“You have to scare them a little,” he says. “If they’re still interested, then you can move forward.” Next, Robinson finds out everything he can about the client’s financial situation by examining the necessary documentation first-hand – such as property titles, financial statements and income tax receipts.
“Finding the right questions to ask the borrower and making sure they tell you everything is key,” he says. “They don’t necessarily lie, but they often forget to tell you some things. A lender could have given them a second mortgage years ago and they just got into the routine of paying it. They completely forgot it was there.”
Typically, Robinson finds that most individuals that are in the right place to purchase a rental property can easily afford their first. After that, things get a little tricky – and that’s where mortgage brokers really have to know their stuff, and help their clients devise an investment plan.
Know your client
When it comes to offering your clients the best possible rental property advice, it’s important to know what their future plans are – right from the beginning.
If your client is looking to simply buy one property and personally manage it, that’s one thing. If there’s a possibility they’ll want to build on that property in the future, you have to ensure they’re set up with the right foundation.
That’s why many rental professionals, such as Edmonton-based Collin Bruce, a mortgage agent with Dominion Lending Centres Stellar Mortgages, make sure to set clients up with mortgages that are qualified according to a rental offset system, rather than a rental add-on.
The difference is significant. With a rental offset – which typically is offered up to 80% –the borrower is qualified according to the difference between the rental payment and the mortgage/ expense payment.
So if a borrower is paying $1,000 per month for their mortgage – including expenses such as heat and maintenance fees – and taking in $1,000 in rent, the lender will take 80% off the rent (in this case, $800) and the borrower will be qualified on the $200 per month difference. In these situations, an appraisal usually has to be done to determine the market rent for the specific rental property.
This process allows borrowers to qualify for multiple rental properties, but Bruce cautions that brokers/agents have to do their homework before setting up these mortgages.
“If you’re working with a client and can’t make the TDS work, the offsetting really helps,” he says. “But once you get up to five or six properties, you can no longer go with a conventional mortgage.”
In addition, while this program is offered through mortgage default insurers, it’s not consistent across the board.
While CMHC and AIG will do 80% offset on all properties, including the individual’s primary residence, Genworth only offers it on the primary residence. After that, it qualifies borrowers according to a rental add-on – where the 80% rent is added to the income. This limits an individual’s purchasing power.
Bruce adds that these types of high-ratio mortgages are not for the ‘fix and flipper’, either – mainly because of the extremely high insurance premiums charged on them.
“If you’re buying rental properties merely to fix and flip, it’s not worth it,” he says. “High-ratio rental properties have to be long-term investments.”
Bruce likes to sit each client down and explain this notion to them – face to face. In some cases, a 100% LTV will warrant a 7.25% insurance premium on a 25-year amortization.
Another trick of the trade Bruce occasionally suggests – to clients who want to own more than a couple of rental properties – is to purchase the properties in a company name, for tax write-off purposes. But this strategy also comes with a catch.
“In Alberta, if you have a property in a company name, you have to guarantee it personally,” he says. “So if the bank forecloses on it, they can sue you.”
This isn’t possible with personal residences because the bank or lender can only legally retrieve the value of the home – they can’t sue the borrower personally.
A broker’s role
With so many details to keep track of – and so many products available on the market – it’s easy to understand how clients can get in over their heads if partnering with an inept mortgage broker/agent.
It’s one thing if a mortgage broker/ agent doesn’t explain things clearly and the borrower fails to recognize the risks associated with their investments. It’s quite another if the broker/agent doesn’t care and is merely thinking about their commission. And the situation can become magnified if the borrower is introduced to products from an equity-based or private lender.
While these lenders are an excellent alternative for experienced, educated individuals who are looking to purchase a difficult-to-fund rooming house, or are self-employed, they are not meant for the uneducated investor.
Because they qualify borrowers according to the equity in an individual property – rather than looking at the entire portfolio – whether a client can technically afford the property, and the responsibility that comes with it, doesn’t come into question.
“Even though our company won’t decline someone who shouldn’t technically be taking on a rental property, we do encourage a common-sense approach,” says Matt Oberle, a business development manager with Capital
Direct. “We always feel better when the deal makes sense. We don’t have a lot of guidelines like the banks do, but we rely on the broker a bit more to make sure the deal makes sense.”
According to Oberle, a deal that makes sense is one where the client has money left over after purchasing the home – preferably in the $10,000 range. And, of course, they have to be able to afford the mortgage payments if the place is unoccupied for a few months.
Despite the risks, rental properties can be an excellent revenue source for clients. And with the vast array of products available through the mortgage broker channel, it can be a perfect opportunity for mortgage professionals to tap into this increasingly popular arena.
Featured product
- Bridgewater Bank’s new Rental Property Program, which launched in May, is suited to both novice investors – who are looking to get into the rental property game – as well as those on the ‘second stage’ of their journey, who already own one or two properties.
- Under the program, homeowners can obtain up to five mortgages and each mortgage can be obtained with a maximum 95% LTV and a minimum Beacon score of 650. The program is available in most major urban markets and secondary markets across the country.
Investing in the US
- While the high Canadian dollar and plummeting US housing market might make US rental properties an appealing notion for your clients, make sure they know all the details before jumping in.
- Although it’s possible for Canadians to purchase inexpensive properties in the US, stricter lending guidelines are making it increasingly difficult. Canadians are best served to have at least 25% down, and many lenders are often only offering 65% LTV.
- And while the original price tag might be cheap, foreign residents are often dinged when tax season rolls around. In states such as Florida, for example – where there is no state income tax and, as a result, higher property taxes – many foreign homeowners foot the bill.
- According to the Canadian Snowbirds Association, permanent Florida residents are given an automatic $25,000 reduction on the assessed value of their principal residence, and their annual income tax increases are capped at three per cent or the rate of inflation, whichever is lower. On the flip side, foreign homeowners have been known to pay property taxes that are 10 times greater than those of permanent residents living nearby.
- All this must also be added to the cost of maintaining a distant property – and employing the services of a property management company. If your client is dead-set on purchasing a rental property, however, it might serve them to wait a little longer because many experts say the credit crisis is still far away from reaching rock bottom.