Real Estate Financing 101/202

Alright, we need to talk about financing now. Understand that if you get control of and understand financing it will take your real estate investing career to the next level faster than anything else that you can do! I have said it a bunch of times in the past, but if there is one thing that I wish I had learned quicker and earlier in my career it would be financing.There are a lot of things to consider when talking about financing, but where the real estate business is concerned financing is the engine that makes the car go, without it you have nothing. The next point that I would like to make is that you should always go to small banks. This does not mean that the big banks will not work for you, but it does mean that the small ones are going to be better and more flexible for what it is that you want to do. Also do not be discouraged if you get turned down the first couple of times that you go to the bank. You need to have a business plan ready when you go along with financials, either for your business or personal or both. The way you get approved in the financing arena is with packaging, that is what lenders look for; how the deal looks. Remember if it looks like you need them more than they need you, you are not a good risk. So let’s talk about the different types of financing that are out there.Lines of Credit: there are commercial lines of credit and also equity lines of credit. The best type to have is a commercial unsecured line of credit. This type of credit line can be used just like a check book. You pay for whatever you want whenever you want to(read no appraisal needed). These are also, of course the hardest to qualify for. With this type of a line you can close immediately. The other type is an equity line. This can be an equity line on your personal home or your rental property. Either way it is a secured line in that it is attached to a property or an asset of some sort. This means that your asset is at risk if something goes wrong, however you can write a check from this type of a line. These are the best types of access to capital that are out there. Most of these lines are tied to the prime rate and float with it. The norm is a point (one point equals one percent)or so above prime. You only pay origination once, and that is when the line is set up, and it should not be above a point or so. these types of lines are usually structured over a 2-5 year period. In order to get a line of credit that you will be able to use successfully in your business you will need a pretty strong credit score and some assets up front, or an available asset to leverage. Sometimes you can get a small line to start out with and then by proving yourself/business to the bank it will get increased. It will be hard to get enough to run your business with in the early going, until you have a couple of years of business under your belt, where the unsecured line is concerned. Guidance Lines: the next version of credit is the guidance line. This is just what the name implies. Your line is under “guidance” or guidelines and as long as they are met you can buy a house. Most of the guidance lines go up to 80% or so of the LTV (you will have to get a subject-to appraisal done for this)of the house including the fix up costs. Some banks require you to put some “skin in the game” and will want a certain amount of money down on each one of these deals. It will normally take 7-10 days to close. For example I have a $1 million line that is good for up to 10 houses and each one must be within 80% LTV and my investment is 10% net so 10% of the purchase and the fix up is the down payment. The interest rate is prime plus one and the origination is one point. A fifty thousand dollar purchase with ten thousand in fix up means sixty thousand total investment so I bring six thousand to the table to close. Guidance lines of credit are commercial lines and they are a version of a construction line of credit that builders use. Bankers love to give these to real estate investors, especially in this market when the builders are slowing down, and being that 80% in a house for us is a bad buy. This makes them be very secure in the investment that they have with us. I would suggest these types of lines even if you get a unsecured or secured line of credit. This enables you to use the guidance lines for acquisitions and the lines of credit for fix up and marketing/holding costs, etc. It is good to note that if they prior two options do not work for you that is not the end of the line for your financing options. There are a number of buy it and fix it financing solutions out there, but please beware of dealing with mortgage brokers for this type of financing. Nothing against mortgage brokers, but most of them are not going to have a program that will work with a house that needs extensive work. If it is minor work they may be able to help you. Hard Money Lenders: A hard money lender is simply a lender that loans money based on the value of the asset. Also called an equity based lender. These hard money lenders usually require the loan amount to be at a 70% or less LTV including the fix up of the house. Anything above that amount must be brought to the closing table including the closing costs. The cost of hard money is expensive, but not when you consider the cost you have when you don’t buy a house at all. Usually origination is 3-5% and the interest rate is 10-18%, so you need to know what you plan to do with the house and where you are going with it before you make your move. Closing time is normally 2-3 weeks. Be mindful of the costs involved and make sure you ask about all costs that you will incur from the HML so that you go in with your eyes open. If you have decent credit and can refinance, but cannot get a line of credit a hard money lender is a good alternative, once you own it and have it repaired, you can refinance it and cash out the hard money lender. You can use this technique even if you want to sell the house retail if you get a good enough deal on your take out lender, just make sure there are no prepayment penalties for the take out loan and you can get rid of the HML and get a better rate for the holding period. If you are going to move to your rental portfolio, then it is even better. It is important to note that an appraisal will be required for this type of loan.Temp to Perm: it is good to talk here for a second about temp to perm loans. I don’t know if that is a real type of loan, but that is what I call it. The smaller banks that have the lines of credit and guidance lines will have a temp to perm option where they will convert the short term loan to a permanent/semi-permanent loan. This is usually a 5 year loan with a balloon at the end of the 5 year term. It will usually have a 15 or 20 year amortization schedule as well to make it cash flow. When you have a property on your short term line or guidance line and get it fixed you will then want to have the ability to move it over to longer term financing to get it off of the line so that you can go do it all over again. These loans are going to be held in the bank, meaning that unlike most loans that are sold on a regular basis to other institutions these types of loans will be commercial and kept in house by the bank. These types of loans are usually attached to a dollar figure limit with the bank, for example with one bank that we use we have a 10 house guidance line (different than the one before) that goes up to 80% LTV, under the 80% we don’t bring anything to the table for closing and fix up is included. Once the property is complete we can move it to our temp to perm line which we have a 3.5 mill cap on, and the loans are on a 20 year amortization and a 5 year balloon. The conversion costs us $150 to move it to the perm side. So given this example you can see that it is necessary to have multiple versions of this at more than one bank. Until you get these types of lines set up you may need to have your financing done through your personal finances for permanent financing. For that remember that Fannie Mae guidelines stipulate that you can do 10 refinances under their guidelines in your personal name. These are the easiest loans to qualify for and have the best terms of all hold loans. The down side is that they are in your personal name and the debt to income ratios can be difficult and drag down your personal credit score. After those first ten you will have to find other sources, but most banks will then take you in house with the loans and usually will allow 3-5 per bank. Here is a good point for me to tell you that you need to start early working on your corporate credit. You WILL damage your credit in this business, if by no other way than piling stuff on to your credit. The best way to prevent that is to start early building credit in your business’ name. ALWAYS ask for the commercial lender in a bank or the commercial lending product with a credit card or supply company. ONLY allow for loans in your business name if at all possible. This will be hard at first and you will hear no’s a lot more, but it is important to go through this process until you find the lender that you can work with. You must go to the bank with a little of an attitude and let them know that you are interviewing banks to do business with and let them know up front that you want an unsecured line, a guidance line and a temp to perm type of line if you are going to give them your bank accounts. Also you will not pay any fees for wires or checks………ever! If you do not have that type of an attitude then you will have a hard time dealing with the banks. Wow that is a lot of financing stuff packed in there, but that is not the whole thing, next I will go into private lending, which is the ultimate in real estate financing.