Mortgage Renewal Time: Should You Refinance Your Investment Property?

Hope you guys are enjoying this warm weather!  This summer, I have my student rental property’s mortgage coming up for renewal. I’ve been weighing my options on what I should do. One of the options is to refinance the property and pull out some equity, but this option isn’t best for everyone. Today I am going to discuss investment property refinancing and some important considerations.

Why Would I Want to Refinance My Investment Property?

Basically, to pull out the equity to use the cash for something else—hopefully not to buy a depreciating asset such as a new boat or SUV! To give a good example, say you had the opportunity to invest in something that you expected to return about 10% per year, but you didn’t have the cash required. You could refinance your property, pull out some equity and use that cash to fund the investment opportunity.

How Would the Refinancing Work?

Lets continue with the above example. Say you bought a property for $200k five years ago with a first mortgage of $160k (80% loan to value).   Assume your mortgage is up for renewal this summer and have approximately $150k left on the mortgage, but you estimate the property is now worth $300k. You could find a lender to refinance the property at 80% loan to value at the $300k, or $240k on the new first mortgage. Since you only owe $150k on your previous mortgage, you end up with $90k back in cash ($240k-$150k), aka “pulling out your equity”, after the refinancing closes.

Does Refinancing Make Financial Sense For Me?

It depends on the scenario. Continuing on with our previous example, if you have an investment that is estimated to return about 10% per year and you were able to refinance at market interest rates (as of this time I would estimate about 3.5%), then yes: it would make sense to do the refinancing. Earning 10% while using the bank’s money at 3.5% sounds good to me☺.

Will All Lenders Refinance My Investment Property?

Good Question. The answer is that it depends. Lenders have definitely pulled back in the last few years and investment properties are one of the areas they have pulled back the most. Some lenders will do 80% loan to value refinancing, while others will only do 65%. Some will do it with an entire first mortgage, and some will do it with a combination of a first mortgage and a secured line of credit.

Is It Easy To Be Approved For The Refinancing?

Not exactly. You will have to re-qualify with the lender based on debt ratios. If you are too indebted either in total debt owing or with number of mortgages (if you have multiple investment properties), they could decline you or not offer you the full refinancing you are looking for.

After I Refinance Will My Property Still Cash Flow?

That’s another good question and consideration. You will have to run the numbers!  It's possible that it won’t with the higher mortgage payments—something to weigh. If you are using the extra cash for a lucrative, high cash flowing investment, then you could now use that cash flow to service the shortfall on this property.

What If I Don’t Have A Present Investment Opportunity For The Cash?

Lots of good questions today! You should wait on the refinancing until you do have an investment opportunity. Or, instead consider getting a secured line of credit and that will not incur any interest costs until it is being drawn upon, but will be there when the opportunity arises.

Does My Mortgage Need to Be Up For Renewal to Refinance?

No it doesn’t. You can refinance anytime but there can be substantial penalties if breaking your mortgage early, especially if you have a fixed rate or if you have lots of term left. By staying with the same lender it is possible to waive some of these penalties. Refinancing around your renewal period avoids these penalties and will only result in minor mortgage discharge and legal fees.

Any Other Considerations?

You will need to get an appraisal for the lender from an AACI appraiser and any refinancing would be based on that amount. You should also think about how this affects your tax situation. By refinancing and increasing your mortgage amount and interest costs, you should technically be decreasing your rental income from that property from having higher expenses.

Final Thoughts

Unlocking your equity by refinancing can be a powerful strategy for investors building their wealth. It isn’t foolproof though, and should be used prudently. If it's something you are worried will stretch you too thin and cause you insomnia, then it's probably best to avoid it. Sitting down with a plan with your team (realtor, mortgage professional, accountant, etc.) should help you decide if it's right for your situation.

Readers, have you refinanced an investment property?  

Property Appreciation - Boosting The Return!

Historically, real estate markets have risen over time – be it 10-20-30+ year periods. Although there have been negative years or periods over time (consider 2008-2010) across many North American markets - but generally the overall trend is up when you look at the big picture. This is a basic ‘principle of investing’ for investors as they consider commercial property alternatives.

In recent blogs we’ve highlighted the importance of ‘ CASH FLOW ‘, but when you factor in ‘FUTURE APPRECIATION’ – the result is an unbelievable money-making & return-boosting combo. Consider the following simple illustration –

See Blog from 11/5/15 – same illustration

2000’ Building – Price - $180,000 (acquired in 2014)
Net Rental Income - $16,000
Cash on cash return - 13.4% - 5 yr return
Projected Sale Price (2019) - $230,000
Capital Gain at time of Sale - $50,000 (+ annualized return of $10,000/yr over the ownership period)

Source: Vancouver Sun

BOOSTING THE RETURN

$10,000/$54,000 (original cash investment) adds an additional 19% return at time of sale

Lots of assumptions made here - biggest of which is a 5% per year growth expectation on the real estate value itself. But this is made based on an assessment of the local market / economy, current stability of the leases /cash flow, and any anticipated capital needs for the property. Can this projection be off – sure, appreciation may be restricted to 2-3% per year or unexpected capital improvements on the property may arise , which can curb or impact our projected boost. But the bottom – line is , we believe in the investment property on a ‘forward thinking basis’ and fully expect it to appreciate over this 5 year period.

Based on our experience, property investors come to us with various criteria, investing models, and expectations. But the one common denominator is consistently the expectation of “PROPERTY APPRECIATION” – meaning it will be worth more down the road and they pursue property investments according.

An expectation of APPRECIATION over time is fundamental to property investing – and real estate markets historically have delivered for the most part. Again, our illustration is actual and we will continue to report on it in future posts.

How are things ‘forward thinking’ in your market?

Again, always ON CALL to respond to your interest in the Windsor – Essex market.

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Mark Lalovich
mark@lalovichrealestate.com
Office: (519) 966-0444
Cell: (519) 259-5434

Positive Cash Flow = Positive Debt Coverage Ratio (DCR)

After you determine an income property yields a POSITIVE CASH FLOW, the next step is to calculate the property’s ability to service mortgage financing costs out of this cash flow.

The standard measurement within the investing world is referred to as the DEBT COVERAGE RATIO (DCR). DCR is simply comparing the property’s net operating income (NOI) to the projected mortgage financing costs – typically on both a monthly and annual basis.

Banks/Lenders typically look at DCR closely, wanting to confirm that the cash flow is sufficient to cover the related debt cost (aka monthly mortgage payment). In fact, most often they are looking to see a positive margin, which exceeds the mortgage servicing costs.

Source: Politico

Using a ‘break –even’ analogy, if the cash flow just meets the debt service costs - this would be a simple ‘break even’ outcome.

Consider the following illustration:

Property 1 
Net Operating Income - $75000
Mortgage Costs (Debt) - $50,000
DCR – 1.5

Property 2
Net Operating Income - $45,000
Mortgage Costs - $50,000
DCR - .9

*All $ amounts are annual

In the case of property 1, the cash flow exceeds the funds required to cover the mortgage requirement. In the case of property 2, a deficit is created ($5,000) which is not only an annual loss, but creates a negative return on actual cash invested.

In layman’s terms, a DCR of (1) is a ‘break-even’ - a DCR of (1.5) is ‘positive’ - a DCR of (.9) is ‘negative’. For investment purposes, this is how you should approach your analysis.

Just a final word on the bankers/lenders, you’re ability to negotiate favourable mortgage terms are clearly impacted by the property’s DCR. This gives you some insight as to how they evaluate risk in underwriting mortgages and how it ultimately impacts your proposed purchase.

How are lenders approaching DCR in your area? How does it affect rates offered and other terms proposed? 

Feel free to reach out to us, should you have interest in the Windsor-Essex market. As always, appreciate any feedback in the comments!

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Mark Lalovich
mark@lalovichrealestate.com
Office: (519) 966-0444
Cell: (519) 259-5434

Property Investing - CASH FLOW IS KING

Better yet -- “POSITIVE” CASH FLOW is king.

In any financial analysis of a potential investment, this should be at the top of the list as you review the opportunity it presents. In fact, as markets and prices continue to march higher, cash flow margins continue to feel the squeeze which only increases the overall investment risk.

Source: Polus Capital

Look at the following simple illustration to better understand what we refer to as CASH FLOW –

2000’ – 2 unit building
Purchase Price - $180,000
Net Rental Income - $16,000 (*)
(* NRI after all property operating costs – ie. taxes, mgmt., ins. are recovered from the Tenants)

This $16,000 represents an 8.9% return ($16,000 divided by $180,000), if we are looking at a straight cash purchase. However, when we consider arranging financing on the property, this cash flow becomes the source of dollars to make the monthly mortgage payment. If we assume a 3.5% mortgage rate on 70% of the purchase price ($126,000 - 5 year term & 20 year amortization) – the monthly payment is $729.12. After covering the monthly mortgage payment, the net annual income (after debt) is approximately $7250. Based on the cash flow in this example and the mortgage assumptions , the cash-on-cash return increases to 13.4%. This again highlights LEVERAGE, but it is only made possible based on the strength of the CASH FLOW.

Seasoned investment pros focus almost exclusively on properties that are cash-flow positive and make any assumptions based only on realistic projections. What assumptions are we referring to:

• Lease rate projections on upcoming renewals
• Leasing current vacancies and based on what rates
• Improvement allowances/incentives required to keep or attract tenants
• Impact of overall property upgrades (ie. roof , parking lot replacements) on cash flow
• Cash flow requirements to service the financing on the investment (aka DEBT SERVICE)
• Market trending up/down/sideways and its effect on your “EXIT STRATEGY”

Be a KING - a POSITIVE CASH FLOW KING, and wear your crown as you pursue every property investment! And for the record, the above example is an actual deal from 2014 and the investors are very pleased with this particular investment.

Let us know how you see things from your market area, and of course, we are always ON CALL to respond to your interest in the Windsor-Essex market.

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Mark Lalovich
mark@lalovichrealestate.com
Office: 519-966-0444
Cell: 519-259-5434