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MORTGAGE MINUTE: Know your goal when creating a real estate portfolio

Over the past 10 years I've worked with literally thousands of real estate investors and I can definitely say that one of the most common mistakes I see is that investors treat the mortgage on their investment properties the same way they do their pr

Over the past 10 years I've worked with literally thousands of real estate investors and I can definitely say that one of the most common mistakes I see is that investors treat the mortgage on their investment properties the same way they do their principal residence. If you're

planning to build a portfolio - this can be a deadly approach.

One of the first things I learned when I started working with investor clients was that the way you structured their first mortgage could have a dramatic impact on the client's ability to accomplish their long-term goal. Part of this lesson was the realization that investors had goals in the first place. Like most mortgage brokers, I was trained to think in terms of 'transactions'. In other words; a client comes to me for a mortgage - I take an application and then determine if they 'qualify or not for that transaction'. It sounds simple enough - but what I wasn't trained for was to look beyond the 'transaction' and see the potential to build a 'portfolio'. I have since come to call this 'The Portfolio Approach'. Financial planners for years have been trained to look at your investment needs from a portfolio or holistic approach. Why should you as an investor or your mortgage broker treat your real estate

investments any different?

Step one is to identify your goal. Why? Why are you investing in real estate? What results do you hope to achieve by investing in real estate? What role does your real estate have to play in your future retirement plans? I learned the hard way that this is perhaps the most important question to ask an investor before embarking on a mortgage application. You may find it surprising, but the answer to these questions will have an impact on how you structure your mortgages and even help determine the type and order in

which you choose your lenders.

I refer to this approach as starting with the end in mind. Once we determine the end result as to what real estate needs to do for you, we can then 'reverse-engineer' the process and work backwards to today in order to determine the best way to structure your portfolio. In doing so, we will be able to identify your obstacles and then develop a business plan to help you overcome your

obstacles and accomplish the goal.

Let's look at some examples of

what I'm referring to:

Suppose you determine that in the next 5 to 10 years you will need an additional $4,000 a month in cash flow to augment your pension plan or supplement your current income in order to live the life you want to live. And you've chosen real estate as your investment vehicle to accomplish this goal. In other words; the role and purpose that real estate will provide for you is to create an additional $4,000 in net positive cash flow over the next 5 to 10 years.

Let's assume that in 5 years time you will be able to create a net $200 of positive cash flow per door. (*note - a duplex would be

considered 2 doors)

That means you would need 20 doors in order to

accomplish your goal.

Why would this information be important when buying and structuring the mortgage on your first property? Well the first thing to realize is that there is not likely to be one single lender who will finance all 20 properties or doors. That means you will need to engage a number of lenders over the course of the next 5 years

in order to accomplish your goal.

Let's take a closer look at that

scenario:

Virtually every lender has what I call a 'Cap Space'. This is the limit (usually unspoken) as to the # of doors or the amount of cash that a lender is willing to or comfortable with lending to an individual investor. It may not be a written policy and the number may

not be specific, but eventually you will hit your 'Cap'.

Now let's suppose that you have an excellent banking relationship with a chartered bank and your loans officer has told you that she'd be happy to help you get started with your investing process and any time you need

another mortgage, you'd have no problem qualifying at your branch.

Here's the part you don't know. If you bank with a chartered bank, your branch would be happy to do your first 4 or 5 mortgages. They'd also likely be

happy to do mortgages 15 through 20 - but they won't do all 20.

This

is where it gets interesting:

There are three types of lenders in

the marketplace:

The Chartered banks ( CIBC, RBC, Scotia etc)

The

Credit Unions

Non-chartered banks or Trust companies (MCAP, Merix,

DLC, First National etc)

We are all familiar with the chartered banks and the credit unions, but few Canadians are familiar with the Trust companies because they typically do not have store fronts and they utilize mortgage brokers as their distribution channel. Now at the risk of getting overly complicated, I'll explain the role that the Trust

companies may have to play in helping you build your portfolio.

Trust companies typically get access to their funds through third party institutional investors (such as Merrill Lynch or Deutsche Bank). These institutional lenders utilize the Trust companies to distribute millions of their dollars into the Canadian mortgage market on a daily basis. However, since the 2008 global credit crunch, a few changes have taken place in the way these lenders do business that impacts Canadian real

estate investors.

The institutional investors require that their funds be securitized - meaning that a lender such as MCAP must 'bulk-insure' the mortgages that they create. In other words, even though your mortgage is not 'high-ratio' the lender will need to have it

insured by either Genworth or CMHC on the back end.

CMHC has changed

their underwriting guidelines for rentals.

As a result, virtually every Trust company can no longer lend to an individual who has more

than 4 rental properties. So what does that mean to you as an investor?

If you know that as an investor you will need upwards of 20 doors to accomplish your goal, then you know you will need to utilize multiple

lenders.

If you have a great relationship with your branch, then they will be willing to do mortgages 15 - 20 for you as long as your

portfolio is positive in cash flow.

You know that a Trust company cannot do any mortgages for you if you already have 4 rental properties,

but they will be able to do the first 4.

So what is the consequence

of getting your first 4 mortgages done at your local branch?

You'll

never be able to utilize a Trust company once you hit your 'Cap'.

Bottom

line - you've now limited your maximum borrowing capacity.

So what

should you do?

The best way to structure your portfolio if you know that cap space will be a potential issue for you in the future is to utilize a Trust company for your first 4 mortgages, then shift to a chartered bank until they tell you you're capped, and then, after you have been capped at two or more chartered banks or credit unions, return to your bank and the personal loan officer or manager with whom you have a great relationship and give them the opportunity to do 5 more mortgages with you. This may sound counter-intuitive because you're initial reaction would be to go to your personal banker first - if for no other reason than loyalty. But the fact is you can still give them the business - just not the first 4. If structured properly, you will still be able to give your local branch as many mortgages as their system will allow without compromising your maximum borrowing capacity. But the only way you will ever know this is to start with the question

why.

Starting your investment portfolio with the question 'why' and determining the end result you need from your investments will provide you with a valuable filter for every investment decision you make. As an investor you will be faced with many decisions and the dilemma of having to make a choice. The importance of having clarity as to why you are buying real estate is critical. My philosophy is this: Every decision you make from today moving forward will move you a step closer to or further away from your stated goal. Therefore every decision you make should be consistent and congruent with the results that you need. Every time someone asks me what I think they should do, my answer is

always the same: Let your goal dictate the decision.

In the end, this is the difference between taking a 'portfolio' approach to developing your portfolio as opposed to a 'transactional' approach. When you start with the end in mind and develop a business plan approach to developing your portfolio, you will not only dramatically improve your chances of accomplishing your goal, but will be able to invest with the confidence and clarity that the actions you are taking today are consistent and congruent with the end result you require. And when you invest with confidence you conquer the one thing that holds most people back in life

- fear.

Take the time to identify your why and start with the end in

mind.

Happy investing, Peter Kinch

Peter Kinch is the author of The Canadian Real Estate Action Plan and co-author of the Canadian

Bestseller - 97 Tips for Canadian Real Estate Investors.

Peter Kinch Mortgage Team is located at Unit 201 101 Klahanie Dr. Port Moody BC V3H

0C3 Ph: 604 939 8326 www.peterkinch.com