Finance strategy when credit is tight

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The latest feature from our sister magazine Canadian Real Estate Wealth explains how you can get access to finance for your property investment clients despite the hurdles, as lenders continue to tighten their criteria

Canada’s real estate market is in the cross-hairs of a new round of global financial woes. This is a mixed blessing for investors seeking to enter the market.

On the one hand, anxieties regarding the potential for default in Europe and ongoing concern regarding the financial outlook for the U.S. means lenders have every right to be cautious. On the other hand, low interest rates give buyers an opportunity to secure cheap financing on real estate, a longstanding hedge again inflation – especially inflation driven by policies designed to stimulate the economy.

Boosting access to credit is no way for governments to eradicate mountains of debt, but for the savvy investor with some cash it could be a way to secure assets as a long-term game should inflation kick in.

“If you have a reasonable down payment and are purchasing a property with decent rents, then get in there – conventional mortgage money is really inexpensive right now,” says Hali Strandlund, president, mortgage investments with Fisgard Capital Corp. in Victoria, B.C. “Values for average single-family homes have declined in most areas but the rents have not. Investors are still able to get really good market rents.”

But lenders are reining in credit, tightening conditions and being less flexible when it comes to discounts on rates. While variable-rate mortgages are still available at a discounted rate, the worsening economic news in August prompted many banks to bring discounts closer to prime lending rates – typically from two per cent up to the 2.5 per cent range. This led many observers to forecast a shift into fixed-rate mortgages and the greater stability they offer. Brian Moskowitz, president of Moskowitz Capital Management Inc. in Toronto, worked with one of the country’s major banks prior to launching his own mortgage company, and says banks have several options for tightening credit, all of which impact borrowers.

The federal government led the charge during the 2008 financial crisis when it nixed 40-year mortgages, reducing the maximum amortization period on government-backed mortgages to 35 years and requiring a minimum down payment of five per cent. Ottawa also required that homebuyers have a minimum credit score of 620 and service debt with no more than 45 per cent of their total gross income before it would agree to insure their mortgages. Ottawa followed those moves earlier this year with a further reduction in the amortization limit on government-backed mortgages to 30 years, and required that any refinancing of a government-backed mortgage tap no more than 85 per cent of the available equity.

The major banks have followed suit, quietly tightening the terms on which they’ll lend to ensure a better quality of borrower, Moskowitz says.

The non-bank options If you don’t meet all your bank’s criteria, there are other options. These include:

Mortgage funds

“If they can’t get their mortgage from the bank, there’re many alternatives [like] non-institutional lenders. And there are many very credible professional mortgage funds,” Moskowitz says, urging investors who are considering an alternative lender to do the due diligence and ensure the lender is registered with the province’s financial institutions commission. “There’s a proliferation of niche lenders in the larger markets – Toronto, Calgary, Vancouver.”

His own firm is one, examining each deal on its own merits rather than through regional lending policies that pay closer attention to broad economic factors rather than individual situations. This has given firms like Moskowitz, Fisgard and others like it more flexibility.

“We will lend up to 70 percent on a commercial building, whereas the banks will be in the range of 50–60 percent, or not at all,” Moskowitz says. “We’ll lend into smaller towns. We’ll lend into a population of 5,000 people whereas the banks wouldn’t touch a town like that.”

One of the factors Moskowitz takes into account when it’s assessing a deal – besides the quality of the borrower’s credit rating, income and size of their down payment – is the buyer’s intentions for the property. This helps gauge the merits of the deal separate from what the rest of the market is doing, and opens up the taps for funding deals in more obscure or less favoured markets.

“We’re very situational lenders. We’re not making decisions based on macro-economics,” he says. “I don’t really care, necessarily, if I am doing a deal in Halifax, Nova Scotia, if the market is down 480 points ... [or ] what’s happening in Vancouver.”

Short-term financiers

An equally flexible approach is taken by Fisgard, where Strandlund says business is booming with the tightening of credit by the major banks. While money is cheap, it’s harder for some borrowers to access financing because terms are tighter.

It’s not uncommon for investors to secure partners other than banks or lenders in order to get the best possible deal when financing is tight – say, partnering with family, entering joint ventures or getting a vendor take-back mortgage – but sometimes an alternative lending source is necessary.

Strandlund positions such financing as a short-term fix, helping see the borrower through to a point where a conventional lender will take them on – because with alternative financing rates running double what the banks are offering, the stop-gap isn’t cheap.

“Of course, it’s going to be more expensive. Our private rates start at 5.99 per cent,” she says, noting that the typical term is a year or two. “We’re hoping that by the end of one or two years, they’ve either fixed their credit or have a more stable job, and they can go back to a conventional lender.

If they’ve been paying us, we’ll just renew, but generally we try and get them into something cheaper.”

How to get around the tight lending criteria Here are some tips to get the funding, you need:

1. Submit all the correct paperwork

Carolyn Heaney, area manager, specialized sales with BMO Bank of Montreal in Vancouver, says banks aren’t requiring any more documentation than they did in the past, but they are taking a closer look at it to make sure it squares with their lending requirements.

2.  Get a valuation before applying for a loan

Areas in which home prices posted significant rebounds through 2010 are receiving particular attention at BMO because the bank wants to make sure the financing investors are seeking is appropriate to the actual – rather than the market-inflated – value of the property in question.

3. Submit all your income

Statements, confirmation of income, confirmation that the borrower has the resources to make a down payment on the purchase, and past repayment history are all documentation the bank requests and reviews.

4. Keep an eye on your credit rating

An investor who wants to ensure they’ll be considered favourably should request their credit history and make sure there are no anomalies that would prevent the bank from providing financing. While income may be stable, and a down payment may take time to pull together, borrowers can take steps to loosen credit by bolstering their own worthiness to receive it.

The major agencies providing credit reports in Canada are Equifax and TransUnion Canada, which provide individuals with information about their own credit rating free of charge. Should any information on the credit report be inaccurate or out of date, be sure to provide immediate written notice to the credit agency. Your side of the story will be added to the report’s history, so that potential lenders will have your explanation and rebuttal of the rating. Contacting banks or other organizations that may have identified issues with your credit worthiness is also important, as the resolution of credit issues lies with creditors’ perception of your creditworthiness. So, if you can come to terms with your creditors and get on good terms with them, the improved relationship will be reflected in your credit record.

5. Build a strong credit record

Take steps to improve your credit history and financial reputation. Heaney recommends doing simple things such as applying for a department store credit card, making a few purchases, and paying it off. Gradually restoring lenders’ faith in one’s ability to manage debt is critical. “If someone has a bankruptcy and has fallen onto bad times but has made steps to restore their credit and has started with, say, some small credit cards or perhaps some department store cards and they’re operating satisfactorily, then yes, we are more willing to help that individual out,” Heaney says. “Sometimes it may require that they do put down more of a down payment. But we’re not talking exorbitant amounts.”

Borrowing on damaged credit

Nationally, consumer bankruptcies and insolvencies have been rising since 2006, with bankruptcies alone up a remarkable 11.2 per cent in the 12 months ended June 30, 2011. This means more people are likely facing the pinch from tighter bank policies. While investing in real estate sounds like a route to riches, it’s difficult for those whose own circumstances make lenders  shy away.

“If they’ve had a history of never paying and they still have outstanding debt on the bureau, it does make it difficult for any lending institution to walk around that,” says Heaney. “Bad credit is very hard to mitigate.” “If we’re 50 per cent on our loan-to-value, we’re probably going to ask less questions,” she says.  “If [it’s] a higher loan-to-value, [lenders] are probably going to ask more questions regarding the ability to make payments.”

Second mortgages are possible that are both low-key and effective at meeting investors’ short-term financial needs. They’re used by experienced investors and a way for less-advantaged investors to enter the market and establish a foundation for future success. If your difficulties are short term, and you can manage a property investment over the long haul, then the credit you’ve lost stands a good chance of being restored by virtue of your success.

While far from being investors with poor credit, Todd and Danielle Miller, the husband-and-wife team behind Edmonton-based Glenn Simon Inc., frequently use second mortgages to cover short-term financing requirements.

Glenn Simon was established nine years ago and finds deals in which it invites others to participate. It effectively manages the investments – primarily residential properties in Alberta suitable for tenants, but often ones in which the owner was motivated to sell (for any number of reasons) – while others provide the funding for the ventures. The Millers play a lead role in coordinating the joint ventures, getting to know the investors they bring onboard and knowing what their financial positions and investment goals are.

Glenn Simon typically seeks investments of $50,000– $150,000 in its joint ventures. The amount is higher than many syndicates, the Millers explain, because investors are sharing not only in an investment but in the direct liabilities of the project. The investor is a partner with the lead partner, a fact reflected in the greater financial commitment.

But participation can be from as little as $16,000 for second mortgages that make the investments work. The sums are just enough to reduce the loan-to-value ratio to a point where conventional lenders will provide financing at rates that work.

“With the second mortgage people, they don’t generally go on title,” Danielle Miller explains. “Basically, you just draw up another document saying they have this amount invested against the property, and that’s usually fine.”

Her one caution is that investors who secure a second and subsequent mortgages pay attention to the math, just as a bank would.

“You just have to make sure that your first mortgage payment and your second mortgage payment still allow the property to cash flow,” she says.

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