Eight factors to weigh (and discuss with your financing specialist) when considering equity takeout to fund your own growth.
There are a lot of borrowers out there who feel like their backs are up against a wall when it comes to growth. They think they’re tapped out. They know they have valuable assets, but perceive a lack of liquidity as a definitive obstacle to growth. There is also this sense of urgency, which unfortunately creates a sense of helplessness. The market is competitive, so how can I get enough money, fast enough?
If you’ve said any of these things and have halted your own growth plans as a result of any of these misperceptions, it’s time for some new perspectives. Perhaps you can’t see the forest for the trees, but that’s ok. A skilled financing specialist can and knows how to liberate your equity, so you can grow and achieve your real estate goals.
The following checklist includes eight factors that you and your financing specialist will weigh when considering equity takeout.
#1: Know your purpose
It may sound obvious, but it’s important to identify why you want the money. Lenders will always favour scenarios with productive capital (i.e. increases the value of your property or portfolio overall). It’s essential that you’re transparent with your lender and communicate openly about your plans for the funds. Once he knows your objectives, he can choose the right solutions and accelerate the process.
Some questions you can ask yourself include:
- Does my property require any capital repairs?
- Am I looking to purchase a new property?
- Am I interested in repatriating capital from a recently purchased property?
#2: Identify your target properties
Some of your properties may be better candidates for equity takeout than others. A financing specialist will review your portfolio to determine: how much debt you have on each property, the financing conditions on each property (amortization, term, closed/open mortgage, prepayment penalties, conventional or CMHC financing) and the current valuation of the property. The focus is on figuring out which property has both favourable loan to value and debt service coverage ratio.
#3: Know your financing options
There are two main ways to extract existing equity from a portfolio:
- Secondary financing: securing a second mortgage on a property
- Refinancing: restructuring debt on an existing property at mortgage maturity or prior to maturity by breaking the mortgage
Most investors are surprised to learn that securing a secondary CMHC mortgage is actually a cost-effective strategy for equity takeout because CMHC second mortgage rates are equally as competitive as first mortgage rates.
There are other debt structuring options available, but it’s best to explore customization with your financing specialist.
#4: Understand your potential barriers to equity financing
There are some complexities that can arise with equity financing. Depending on the structuring of your first mortgage, the first mortgagee may not permit a second mortgage on the same property. In most cases, the first mortgagee must provide consent for a second mortgage. In addition, a subordination and standstill agreement may be required from the second mortgagee (confirms that the secondary lender will not demand repayment of the loan in the event of a default). It is helpful to get the professional guidance of a financing specialist to navigate through these technicalities.
#5: Know your timelines
How fast do you need the money? Equity takeout is still a standard financing process. Depending on the option that you choose, there will be different requirements (third party reports, appraisals) and timelines. If you need the money quickly, there may be other solutions that you can consider (i.e. bridge financing) in combination with equity takeout.
#6: Determine how much equity you need right away
The timing of when you receive the equity is a key part of weighing your options. If you get funds too early, you can risk holding borrowed money that isn’t earning you a return. If you get funds too late, you can risk losing a buying opportunity. You may opt to get a certain amount of equity right away and receive the other portion at a later date. Your financing specialist can explain the impact of timing and the opportunities available to you based on a phased takeout.
#7: Understand your risks
Equity takeout is another form of debt, so there are inevitably risks involved. It is important to determine your risk tolerance by asking yourself some key questions:
- Can I support the debt if interest rates rise by x per cent?
- Can I support a larger debt if I am earning less income from my property?
- What are the terms on my properties and how will the maturities impact me?
- How much personal guarantee am I willing to give?
Your financing specialist can work with you to “stress test” your asset with the goal of identifying any potential concerns.
#8: Be clear about the costs
Equity takeout is still a borrowing transaction, so there will be costs involved. The type of equity takeout will determine the associated costs (i.e. CMHC second mortgage vs. conventional second mortgage vs. refinancing). For example, a conventional loan requires an appraisal and a building condition assessment. However, these requirements are often not necessary with a CMHC second mortgage. It is important to rely on the expertise of your financing specialist to clarify the tradeoff between the transaction and opportunity costs.