How can a property investor refinance a property portfolio for equity?
One of the Loop Financial Big 6 client questions, this time on how to refinance property portfolios.
This is one for all you property investors out there, or anyone thinking of taking the first step into the investment market.
Specifically, we’re talking about smart financing of your property portfolio. You might think that a loan is a loan and as long as you raise the funds you need at a decent rate, you’re sorted. Well, that’s not always the case, as Lauren Mamaj, Finance Stategist and Chief Number Cruncher at Loop explains.
Maintaining a financially balanced property portfolio
You’ll be familiar with the concept of having a balanced portfolio in terms of investing in different kinds of properties in different areas, but you also need to find balance in the sources you’re borrowing from, she says. Although a bank might dangle a carrot and offer you a lower rate if you finance all your properties with them, you could end up in trouble further down the line as your portfolio expands if you don’t check exactly how the bank is organising your finances.
Lauren cites one example of a client – let’s call him Steve – who had just purchased his tenth property and went to his bank manager to get finance approved, only to be told that he had hit his quota level with the bank and wasn’t eligible for any further investment loans. This is despite the fact that Steve held all of his other properties with that same bank, so they could quite clearly see that he had equity and a solid repayment history. It came down to the bank’s policy on exposure limits for each individual client.
“So he was referred to us and what we actually did was put him in a better situation by what we call ‘uncrossing his securities’,” says Lauren. “What he didn’t know – and what the bank manager didn’t tell him – is that every time he went to purchase a property through that bank, they tied each security to the next. That meant that he was able to obtain finance, but he was using the equity from investment property A to fund investment property B without realising it.”
Lauren offers her advice to avoid this situation: “One of the things that I always recommend is make sure that you have every single one of your properties as a standalone property, and that means the mortgage is secured against each property individually. You can have sub accounts against properties to help fund deposits on other properties, but they are all independent of each other,” she says.
When your assets are tied together, the bank will assess your overall asset value rather than considering the merits of each one, potentially making it harder for you to access any equity.
For instance, if you own two properties and one increases in value by $200,000, you might want to access that equity to fund another investment. But if your other property has, at the same time, dropped in value by $100,000 and you have them secured against each other, your bank will look at the overall value and only lend on the difference.
By ‘quarantining’ your properties – keeping them all separate from each other – you have greater control over your portfolio, explains Lauren.
“There are ways to balance the properties in your portfolio to put you in the driver’s seat to make sure we can position it so if one property in your portfolio outshines the others, you can capture that extra equity and use it to reinvest,” she says.
The other drawback of having all your properties crossed is that it can take a lot longer to get a decision from your bank next time you need an investment property loan. That’s because they will first want to value every single property in your portfolio to ascertain your equity position, and you can imagine how long that would take.
Complications with selling a property from your portfolio
You might run into similar problems when it comes to selling a property.
Say, for example, you have one owner-occupied property and one investment property tied to it. You decide to move house, and the property fetches $500,000 more than expected, woohoo! But before you see any of that cash, the bank will check the situation with your investment property. If it has devalued, the bank will take some of the proceeds from your sale to make up the difference before passing on the rest to you.
If, however, you have kept the two properties separate, the value of one won’t affect your profits from the other. This is why, Lauren says, it’s critical to maintain a good balance in your portfolio and avoid putting all your eggs in one basket.
Protecting your assets
There is an added layer of complication if you run your own business in addition to managing a portfolio of investment properties. It’s not a good idea to have your personal accounts, business accounts, personal mortgage, investment property loans, business overdraft, and business loans all with the same bank, says Lauren.
Why? Because if something happens to your business or one of your houses, the bank can reach into the other funds to recover their losses, she explains, as they are all cross-guaranteed.
“You don’t want to be in a situation where the bank that you’re with can take claim to other security that they’ve got no interest in,” she says.
If something goes wrong with one of your properties, for example, and the bank has to take claim of it, they won’t have any access to your business funds if you have that account with a different bank.
Or if you default on your business overdraft, and the bank has security attached to that overdraft, they can make a claim on that security. Keeping your assets separate gives you an extra layer of protection. The bank will still have a personal guarantee from the director who owns the asset, but actually going after that asset is a more difficult process when it’s held in a different place, says Lauren.
There is a lot more to asset protection than this, of course, but you can see how important it is to guard your finances and be completely aware of what you’re agreeing to when you sign on the dotted line.
Managing borrowing limits
Let’s go back to our friend Steve, who had a solid property portfolio but found himself being refused finance because he had reached his lending quota from the bank.
“Most banks will lend up to two and a half million per client or per applicant against the security,” Lauren says.
Of course, as a first time property investor this might not seem like an important consideration, but if you’re aiming big with your investment plans then it’s definitely something you should plan for.
Loop’s property management team might structure your portfolio so you hold two properties with one bank, two with another, and so on, says Lauren.
“There are a lot of factors that come in to play with looking at a client’s portfolio, and having a broker that understands property investments and how they impact you as the client is essential. Your broker should be looking to prevent problems ahead of time where possible. The key really is never, ever cross your owner-occupied property with an investment property,” advises Lauren.
Keeping your mortgages separate
This might all sound great in theory, but how do you make sure your bank isn’t tying all your property loans in together?
The “cheeky” banks will do this as a matter of course, says Lauren, but a good broker will be able to negotiate and make sure that your properties are kept separate from each other.
If you’re not sure where you stand with your existing mortgages, the first thing to do is to check your loan agreement which contains your loan offer. In every loan offer there’s a security section which lists the properties that the loan is secured against. If it lists two securities in that section then you are definitely crossed, explains Lauren.
In the past she has worked with clients who had as many as 10 properties crossed with the same bank. It can be a time-consuming and painful process she says, but uncrossing the properties puts the borrower in a much stronger financial position as the properties won’t impact one another in the future. In one case a client had been refused additional finance but after uncrossing all of his properties he was able to borrow again from the same bank.
“Things like this can be rectified with the right broker,” she says. “We do a lot of portfolio restructuring with the existing banks. We don’t always have to refinance to achieve that.”
So, what are you waiting for? If you have more than one mortgage, go and check that ‘security’ section to see what kind of a state your loans are in. If you’re worried about your properties being crossed and want to make sure you don’t run into trouble in the future, give the team at Loop a call today to see how they can help.
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