Tips For Financing Your First Investment Property

Real estate is a proven long-term investment, but if you plan to buy your first investment property in the coming months, short-term challenges like decades-high interest rates, rising unemployment and overall economic uncertainty could prevent lenders from offering you the mortgage you need.

Success in real estate investing often requires thinking ahead to make the journey easier and more profitable. Here are three proactive strategies that may help persuade a lender to fully fund your first investment purchase.

1. Decrease the risk your lender faces

Funding an investment purchase is risky for lenders because of variables such as unexpected vacancy, property damage and unpaid rent. With current mortgage rates and home prices as high as they are, and unemployment trending upward, expect lenders to be picky with the investors they choose to get behind.

“When we’re in challenging economic times like we are now, lenders definitely become more cautious, and they kind of tighten their lending criteria,” says Paul Stevenson, a Level 2 mortgage agent with Centum Financial Services LP in Ottawa. “If it’s someone who has never had the experience of buying a property before, lenders may take a second look at that.”

Stevenson says lenders will put a first-time investor’s finances under a microscope to ensure they’ll hold up if a property’s income stream gets disrupted. They may pay particular attention to your debt-to-income ratio and credit score, so improving either one is a smart early step.

“They want to make sure that you have established financial security, that you’re not fighting tooth and nail to get into this property,” he says.

You can also show lenders that you’re a lower risk by having ample down payment savings. If you’re buying a property intended solely for renters, the minimum you can put down is 20% of the home’s purchase price.

If you plan on living in a portion of your property, like the basement suite or one half of a duplex, you can legally get away with putting as little as 5% down. But a smaller down payment means a larger mortgage, higher monthly payments and paying more in interest, all of which can reduce the profitability of an investment purchase and increase risk. It’s generally best to put down more than the minimum if you can.

When trying to get an investment property financed, think of a lender as your investment partner, Stevenson advises. The less risk you pose as a borrower, the more likely they’ll be to go into business with you. But the property you intend to buy and where it’s located will also factor into their decision.

2. Try to buy for cash flow

Finding the right investment property can test even the most experienced real estate investor. As a first-timer facing a pricey, undersupplied market, it’s crucial to choose a property that stands up to analysis rather than nabbing one simply because it’s affordable.

Analyzing a property typically starts with two key metrics: cash flow, the amount of income it generates versus expenses, and appreciation, a home’s increase in value over time. Ideally, you’ll find a property that has potential for appreciation and positive cash flow, but that may not be realistic depending on where you’re buying or how much your mortgage costs.

If it comes down to choosing between one metric or the other, cash flow might be your best bet. Positive cash flow can help you manage mortgage costs and provide a cushion if appreciation levels off or dips.

“If it doesn’t cash flow, it probably doesn’t make sense to purchase,” says Nick MacDonald, a real estate agent with RE/MAX Charlottetown Realty.

Brett Ackerman, Realtor at Royal LePage Regina Realty, says he rarely encounters investors who have met financial ruin by investing for cash flow. The story’s a little different for those who chase rapid appreciation.

“I know a lot of people who have lost their shirts playing the speculative game,” he says.

Estimating cash flow requires subtracting a property’s monthly expenses from the expected rent. Expenses should include taxes, insurance costs and any property management charges you incur. For an accurate estimate, you must factor in the cost of your monthly mortgage payment using current mortgage rates as a guide.

When analyzing a property’s cash flow potential in the current economic climate, MacDonald urges investors to be cautious and conservative with their numbers — just like a lender.

3. Remember: Location matters for lenders

Where you purchase your first investment property can have a tremendous impact on how much financing you receive. A less expensive property in a sub-optimal location might be affordable and cash flow positive, but will lenders want to touch it? If it’s in an area where they’ll have trouble liquidating it for fair market value if you default on your mortgage, they may flinch.

Another consideration is your proximity to the property. Will you be onsite, nearby or in a different province?

Stevenson says lenders may view an owner-occupier scenario, where you live in part of a multi-unit property, as the least risky arrangement for first-time investors. You can cut down on maintenance costs by being your own property manager, and you’ll be able to quickly respond to tenant concerns or issues with the property.

Being an occupant is also the only way of getting into a multi-unit property with a smaller down payment. You’ll pay more for the extra square footage, though, so qualifying for the mortgage you need at today’s rates, especially once you factor in the mortgage stress test, may not be easy.

If you’re purchasing a property you don’t intend to live in, you’ll need a down payment of at least 20%, but you’ll be able to explore less expensive rental markets across the country.

When buying an investment property in a different city or province, it’s essential to find a reputable local, investor-focused real estate agent; one who understands the market and municipal rental guidelines, and who can introduce you to experienced property managers.

If you can show lenders that you’ve strategically chosen an out-of-town property that has short- and long-term revenue potential, and that it will be maintained professionally, they’ll sense less risk and more opportunity.