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Could You Have Too Much Equity? 

By Peter Cook and Robert Fleet

Many apartment building owners have been raised in the “old country” tradition of paying down the mortgage and aspiring to become totally debt free. It may feel wonderful to see a large equity component when the bank statement arrives but is it really sensible? It depends on your goals. Even if you are planning to sell the property in the near future, it may be beneficial to refinance. The equity you take out, if applied appropriately, could be leveraged for a variety of uses.

Refinancing To Purchase
Purchasing another building is the primary reason that many of our clients choose to refinance their properties. If you are planning to expand your portfolio, one of the most common and cost effective methods of doing so is by leveraging the equity in an existing income property.

Converting the equity to cash will provide the down payment for the acquisition of the new property. The ideal time to refinance is on the mortgage maturity date to eliminate the prepayment penalty.

There is an important issue to consider if you are planning to refinance. It typically takes between six to eight weeks to refinance a property. Plan ahead and leave sufficient time to complete your equity take out. To be sure, allow yourself a two to three week window from the anticipated funding date to the planned closing date for the property you are acquiring.

Refinancing to Sell
If you are planning to sell, your initial reaction may be there can not be a legitimate reason to refinance at this time. It seems to fly in the face of reason to refinance prior to listing the building for sale however; we have had clients do so. Here’s why: Their building had a mortgage maturing in 24 months bearing an interest rate two percent higher than those currently available. They reasoned the property would be more attractive if buyers could acquire it with only 15 percent down payment. This would also reduce the probability of the buyer asking for a vendor take back mortgage.

Our client (the seller) decided that the prepayment penalty and other expenses would be a small price to pay in exchange for a new mortgage at 85 percent loan to value. Prospective buyers could then make the purchase decision with peace of mind knowing that current CMHC financing was in place and the phase one environmental report had been completed. The new assumable mortgage will make the property more attractive to potential buyers. This would eliminate the need for the buyer to make their offer conditional on new financing.

Although this can be an effective strategy to help you sell your property, there is one word of caution if you are considering this tactic. The buyer must qualify to assume the new mortgage and you may be required to stay on the covenant along with the buyer, depending on their qualifications.

Refinancing For Tax Savings
Very few of our clients are willing to pay income tax taxes on a low-levered or free and clear building. The majority of our clients would rather have a mortgage on their property which enables them to expense the interest.

The size and terms of the mortgage should support your business plan and personal goals. We recommend you have a conversation with your accountant to establish the size of the mortgage best suited to your situation. The proceeds can also be used for a variety of tax strategies.

Refinancing For Capital Improvements
As existing apartment inventories age and new condominium products continue to provide rental competition, this is an excellent time to take out equity for capital improvements. Equity withdrawal for items such as updating suites, hallways, lobbies, recreational amenities and landscaping will enhance your building to compete with all the modern amenities typically found in the condo market. You can also take advantage of current government incentives by investing in energy efficient products such as thermal windows, HVAC systems, water-saving devices, Energy Star appliances, and roof systems. This will lower your future costs and serve as an ongoing benefit if you plan to keep the building for the long term.

Refinancing To Increase Cash Flow
You may improve your cash flow by increasing your debt. Lower interest rates and increasing the amortization rates back to 25 years or longer may improve your cash flow considerably.

Take Advantage of Current Low Interest Rates And Capitalization Rates
Borrowers are currently enjoying historically low interest and capitalization rates. With current five year CMHC insured rates below four percent and 10 year rates below five percent, this is an excellent time to consider refinancing.

The economy is expected to recover in the next year or two and historically, recovery brings inflation and positive economic news. The side effects are often higher interest rates that put upward pressure on capitalization rates. This may result in lower loan amounts available due to restrictions on debt coverage ratio requirements and possibly lower loan amounts due to decreased values. Although you may have to consider paying a prepayment penalty today, it may be offset by a higher principal loan amount locked in at these extremely low rates and current values.

When prepayment penalties make refinancing the first mortgage too costly, many of our clients opt for a CMHC second mortgage. CMHC’s second mortgage program allows financing up to 85 percent loan to value with second mortgage interest rates that are usually the same as first mortgage rates.

Refinancing can make sense when purchasing new properties, selling existing buildings, to facilitate capital improvements, improve cash flow and save taxes.

It is our goal to provide our readers with valuable information and creative strategies. Every property owner’s situation is unique. We recommend that you seek the advice of your lawyer, accountant and lender to help you make an informed decision that is right for you. Regardless of the lender you choose, we are pleased to answer any questions you may have regarding the information shared in this column.

Peter Cook and Robert Fleet are “Apartment Financing Specialists” with First National Financial LP. Together they have originated over $3 Billion of mortgages.
Their combined 32 years experience with mortgage financing has lead to frequent speaking engagements across the country. If you have questions, Peter and Robert may be reached by phone or email. Peter Cook—(416) 593-2913 pcook@firstnational.ca; Robert Fleet—(905) 301-3449 robert.fleet@ firstnational.ca.