As a property investor, one of the most important facets of managing your portfolio effectively – in order to reap the maximum financial reward – is to ensure you maintain control of your assets.
However all too often, we see clients who have managed to back themselves into a corner with their bank by handing unnecessary security to them on a platter, so to speak.
They believe that in order to borrow more, they need to give their lenders more collateral and by doing so, often end up in complicated structures that can be difficult and costly to undo.
We have already discussed concepts like cross securitization in previous blogs, and the different finance structures you can establish so that you never place all of your real estate eggs in one lender’s basket.
In this article, we continue our discussion on improving your security position with lenders in order to maximise protection of your assets, particularly if you happen to be a commercial investor.
Most people happily extend the life of their loan in order to minimise monthly repayments.
But the bottom line is, the longer your loan contract, the longer the banks have authority over your assets.
On the flipside, shorter loan terms mean the option of having your credit contract reviewed more frequently.
Before you sign up for a lengthy mortgage, ask yourself if locking in for the agreed number of years is worthwhile and see if you can negotiate a more flexible contract period.
When considering the long-term fiscal implications of a loan agreement, most of us focus primarily on the applicable interest rates and fees.
But let me ask you this… have you considered the consequences of a default against your mortgage and the effects that could have on your other assets?
With commercial real estate in particular, lenders will more often than not request personal guarantees, where you have to offer them additional security over the mortgage, other than the property you are borrowing against.
Before you accept any loan proposal, you should have a full understanding of the security being requested by the banks and ensure that this guarantee is limited to the value of the property in question.
It’s also a good idea to remove any superfluous personal guarantees that can be written into the agreement, such as those provided by a spouse even though he or she is not a party to the loan.
Beware annual reviews
Some investors like establishing loans that call for annual reviews, because they want to know how their portfolio is performing in terms of capital growth.
This provides an insight into their investment position, whether they can afford to secure further assets and if there are some underperformers that require a strategic re-evaluation.
However, as well as representing the potential for further costs (such as valuations, etc), annual reviews can increase your risk for default.
Let’s say you have a run of weaker valuations and decreased income over a two-year plus period.
This gives the lender scope to do some serious evaluation of your position in terms of security versus serviceability, and possibly remove the loan facility out from under you.
Here at Intuitive, we offer investors regular in-house performance updates regarding the market and suburb in which they hold their property investment(s), alleviating the need to conduct annual reviews with their lender, yet still affording them the opportunity to evaluate their position.
Clauses and covenants
Some of you may be shocked by the amount of discretion banks hold when it comes to terminating your loan contract.
Most people who obtain property investment finance understandably think that the only way they will ever be in default of their agreement is by missing one or more scheduled payments.
However, the fine print on some loan contracts will list a default as occurring in a number of other instances, including;
- Failure to meet financial ratios
- Rental income not being maintained at a certain level
- Lower asset valuations triggering a higher Loan to Vale Ratio than was first agreed.
These extra covenants are often applied to loans that lenders perceive to carry higher risk due to the complexities of the arrangement.
This is another good reason to avoid the mess that is cross-securitization as these loan structures, along with development or cashflow agreements, often come with this extra bit of red tape.
Hence, it’s a good idea to keep your borrowing arrangements as simple as possible.
These can be a borrower’s best friend when it comes to retaining control over your investment, particularly if it happens to be commercial property.
A non-recourse loan means you don’t have to provide any personal guarantees.
However in order to facilitate a non-recourse loan, you will need to provide more upfront capital in the first instance.
They are established on the proviso that your rental income is sufficient to cover your repayment obligations, hence the loan to value ratios applied are generally lower.
The bottom line:
Essentially as a borrower, your goal should always be to maximise your investment dollars, whilst reducing as much risk exposure to your assets as possible.
Given that the banks have much the same agenda and want more of your collateral to alleviate their perceived risk, you should always make sure you understand what types of guarantees you are giving them.