What type of lender do you need to finance your portfolio?

[Julie Toh]

Real estate investing is an exciting venture! Before you run out and buy that first or second rental property, it is important that investors use strategic financing for their rental properties and put a plan in place with a mortgage broker who understands rentals. But there is also a specific order in which to approach lenders for portfolio financing. It's like a game of chess. [Caveat: Starting off, everyone's financial situation is different. The following may require adjustments along the way.]

1. Ideally, the first lenders you use will be non-depository lenders. They typically have a parameter of no more than five properties, which includes one principal residence. If you can fill your first three-to-five portfolio slots here, that would be a great start.

2. The second type of lender is a lender that limits the portfolio by door count. This is especially important for investors who are buying multi-units, such as duplexes, triplexes, etc. Note that five-plexes do not fall in the category of residential mortgages. They are a grey-area product and will typically have to be financed by a commercial lender. There are only a few exceptions of lenders that will consider five-plexes as residential, but this is all on a case-by-case basis.

5. The third type of lender is the pool that will debt coverage ratio (DCR) your portfolio (without liquid networth requirements). The DCR (see below) will have to be above 1.1-1.2 as a portfolio average. You will also have to pass the liquid networth requirement parameters. With some lenders, real estate owned will not be included in the calculation for liquid net worth requirement.

6. The fourth type of lender is the same as the third without the liquid net worth requirement. The third and fourth type of lender will not impose a limit on the amount of properties brought into the portfolio. They will just have to be run via the DCR sheet (provided by the specific lender). The higher the DCR, the better.

7. After this comes the private lending space. Primarily, they lend based on the equity in the property. Alternatively, most lenders start moving toward apartments (six-plexes and above) that are now financed under commercial underwriting rules (outside the scope of this article).

What is DCR? Debt Coverage Ratio

The requirement for debt coverage ratio varies from one lending institution to another. Some institutions will use rental offset for qualifying purposes, while other lending institutions will use 1.1 per cent debt coverage ratio, which is arrived at by dividing the net operating income by the debt service. The debt coverage ratio is used in banking to determine an individual or company's ability to generate enough income (rental) in its operations to cover the expense of a debt.