Financing your Real Estate Strategically. Why is your lender nervous?
In our post entitled Financing for Portfolio Growth. Think Strategically!, we talked about hitting the financing wall. You’ve financed two or three properties with the same lender, and all of a sudden they appear less than enthusiastic. What happened? You want to finance your real estate strategically. Why is your lender nervous?
Lets look at some of the factors at play
Your Risk Profile has Changed.
You financed your first property with your local Bank. You were their client. Now you’ve financed that third property with the same lender. Your still their client, but for all intents and purposes, you’ve become partners too. Your continued success is even more critical to your Bank than ever before. They are possibly wanting to see their existing loan exposure “season” a bit more, before extending further credit. If you stumble with one loan, it’s unfortunate, but manageable. If you stumble with three or four loans, its a much larger problem, for you and your Banker.
You’re a one trick Pony.
While many borrowers focus on one asset type, some lenders may not be comfortable. If all of your assets are multi-family residential, in sought after neighbourhoods, that likely won’t raise any warning signs. On the other hand, if you’ve invested heavily in specialty use properties, or locations which are considered “challenging”, you’ve introduced additional risk. For you and your Banker. Some lenders would prefer spumoni and you’re offering vanilla. Time to spread your business further afield perhaps?
Your Reporting capabilities are falling behind.
With added portfolio size comes the necessity for more sophisticated systems. This could mean standardizing your lease documentation, securing third party property or asset management capabilities, and ensuring you’ve got more sophisticated budgeting and reporting tools. Your Banker asked for a cash flow budget for the balance of the year, and it took you a week and a half to produce one. Are you surprised that they are concerned?
Your Infrastructure and Support is inadequate
Your first property was a triplex. You could manage that while you were still working at your day job. Now you’ve got 4 properties, and your still trying to manage the portfolio off the side of your desk. Your grown children are not participating. Your partner is employed elsewhere. You don’t have a “team” you can count on. Guess what? Your Banker is concerned!
You’ve got financing risk.
All of your assets have been acquired and financed over the past 36 to 48 months, during this recent period of prolonged low rates. The loan-to-value ratios were all fairly high. The upside potential for rates is real. Your Banker knows this. As well, the Bank regulator is reminding them too! Is there sufficient cash flow from your properties to withstand an interest rate increase at renewal? Or will you need to draw on other resources, or possibly liquidate an asset or two? This is often a problem when investing in particular asset classes. For example, while smaller multi-family residential properties are popular with investors, cash flow is often minimal. An interest rate increase could wipe out any profit you are now enjoying.
You’ve got leasing risk.
The corollary to financing risk is leasing risk. Several of your properties are substantially leased to a major (or single) tenant, whose lease matures in the short term. Have you secured a renewal? Can you reasonably expect a similar, or increased amount of rent? If the lease renewal is uncertain, how long can you reasonably expect to take to secure a replacement tenant? Your Banker will be asking you these questions. Have a a good answer ready!
Your Banker is uncomfortable with the real estate.
You were not having problems financing your triplexs in the neighbourhood close to the University or College. Now you’ve bought a self storage facility on the outskirts of town. Your Banker is unfamiliar with the asset type. He or she doesn’t really understand how it works, and is less than enthusiastic. Don’t waste your time trying to convince him or her. Find a lender who is familiar and comfortable with the asset type.
The take away here is the importance of educating yourself prior to your property acquisition. Align yourself with a competent commercial mortgage broker who can advise on market conditions. Knowledgeable brokers can also ensure that the lender’s criteria align with your investment goals. It makes sense to work with a lender who understands your big picture requirements, as you grow your real estate portfolio. A mortgage broker can be invaluable to you!