This week turned out to be an interesting week.

I have a client, let’s call her Mary, who is in the process of doing a refinance of one of her rental properties. From my perspective, we have someone with a large portfolio (say 16 doors), high equity position on most of the rentals, high networth as a result and above average income. Properties are all well managed and maintained. She runs it like a business. The DCR (debt coverage ratio) as calculated by the lenders works out to 1.3. Well above the minimum 1.1 requirement.

This should be a no-brainer. Right?

So I thought until I discovered that those silly lenders decided to apply the new CMHC rule to her entire portfolio. Which rule is that? The rule that says for any variable mortgage you are requesting, the borrower must qualify at the MQR (new acronym -mortgage qualifying rate). My understanding was when you have a portfolio, you examine the current DCR and if all is well we focus on the property at hand. Much to my surprise (and dismay) the lender applied the MQR to ALL her rental portfolio. All her variables jumped from 2% or less to 5.99% and if that wasn’t bad enough, they also randomly decided to shorten all the amortizations to 25 years.
What I had expected was they would simply reduce the rental income from 80% to 50%. Well, they did that too.

Guess what? The lovely cashflow that she enjoys, well according to CMHC she barely breaks even. I couldn’t believe it when I saw the DCR calculation.

At this point, we had to explore different options.
Accept the measly increase the lender offered. Look for a way to treat the refinance as a commercial deal. Find another lender who will not apply the MQR to the portfolio and accept the fact that she has been running this as a business for the last 5 years and has paid down significant equity in that time. High networth, etc. etc.
The last option is a restructuring of her assets into corporations.

What’s the point of putting real estate into corporations? There are several reasons. The main one I’m going to cover here is a form of asset protection.
Right now when the lenders ask about what Mary owns, she must list everything where her name appears on title. Trust me the lenders do searches on their own to verify.
Let’s say Mary moves all of her rentals into 1 or 2 corporations (holding companies – see Real Estate By Numbered post for more details)
The title is now in the number corporation name and Mary is the guarantor for the mortgage.
Big deal, right? All just semantics.
Except when it comes to the question of what real estate does Mary own? She can now list just her personal home. If the lenders search, they wont find her name on title any more, except her personal home.

Now she qualifies for the new property using her income and the rental income. The portfolio is now excluded. Again she becomes the guarantor for this new mortgage and places it in a new company or into an existing HoldCo.

Naturally this takes time to set things up and there is an expense to transfer existing holdings to a corporation, etc. I’m not an accountant, nor do I play one on the Internet, but I do know an accountant just loves to talk about how to do this and explain all the other advantages to structuring your portfolio this way. He’ll even set things up and explain the reasons why things must be done in certain ways.
I’d call him “creative” however the term “creative accountant” has a few negative connotations. Let’s say he fully understand the real estate investment game and ensures you pay the least amount of tax.

Along the same lines, we had a speaker at the OREIO meeting www.oreio.org that spoke on the importance of asset protection. He along with several other successful investors all start with the same piece of advice. Put your primary residence in your spouses name. That way if something happens and you have to declare bankruptcy, you wont lose your house along with everything else.
The other tidbit the speaker left us with was eventually your corporations grow to a point where you no longer personally guarantee the mortgages. Your corporation stands as an entity on its own.

Post #1 for this week. #2 is on it’s way.