There is no denying it, there are a lot of different options out there for financing investment properties. Finding the right lender, or lenders, might seem like a daunting task. Regardless if you own one rental property or a large portfolio, banks, credit unions and brokers alike are all competing for your business. Additionally, hard money lenders can provide realistic short term borrowing options, depending on how you’re operating your business. The options are many, but establishing the right financing relationship(s) for you is critical if you have aspirations to grow your rental portfolio. So where do you start?
First things first, a Real Estate Investor has the option of purchasing the property in one of two ways, the investors name or by taking title as a business entity.
Purchasing Investments Under Your Name
If you own or plan to purchase a rental property in your name personally, you may be eligible to seek out a long term fixed rate conventional loan. Nearly every lender will offer this option at some level, usually through a secondary market provider such as Fannie Mae or Freddie Mac. Having a 30 year fixed rate loan is certainly an attractive option for investors looking to lock in terms and optimize cash flow on their property. Underwriting guidelines will limit the total number of properties that one can finance under this approach at 10 properties under Fannie Mae/Freddie Mac programs. Using this approach, you also will need to demonstrate the ability to repay the loan using only your personal income. The current or potential rental income generated from the property will not be considered when qualifying you as a borrower for this purchase. Both Fannie Mae and Freddie Mac require two years of rental history in order to use the existing cash flow for the rental property in your personal income and for qualifying. These requirements may make it difficult to scale your investment portfolio quickly. Closing costs for these transactions are typically higher with those costs either paid out of pocket at closing or “baked” into a higher rate. While purchasing investment properties under your name may offer many financial benefits in terms of lending; owning the property in your name may place additional liability on you personally, should there ever be any legal suits filed.
Purchasing Investments Under a Business Entity
Real estate investors looking to grow their portfolio quickly should consider purchasing their investment properties under a business entity, obtaining commercial lending. This will protect the investor’s personal assets from potential lawsuits. The majority of financial institutions offer some form of Commercial Lending, however these programs can vary drastically from one financial institution to another. Investors will need to conduct their own due diligence to make sure they seek out and determine which lending relationship better aligns with their business plan and goals.
The most common comparison across financial institutions are the variations in the terms offered. What is the rate? How long is the rate lock and amortization? What are the closing costs? These are very important questions and can easily separate the competition based on what the financial institution will offer in each situation.
If you find yourself in a position in which you are being offered similar terms by multiple lenders, it is helpful to have a grasp on what some of those differences may mean for your investment/business on a larger scale. After all, the difference that a ¼% makes on $150,000 over a 25 year amortization is only $20-25/month. Sure that could mean an extra $300 in your pocket at the end of the year, but would that $300 annually be worth it if you were able to have a more flexible loan structure elsewhere?
Let’s consider investors that purchase “fixer upper” properties. Certain lenders are able to fund some or all of a project’s renovation costs immediately after closing, while simultaneously offering an interest-only payment for the period of time before the project is finished and the property’s rents have stabilized. This is a great way for an investor to keep more cash in their pocket and have the capital necessary to move onto the next investment. Meanwhile, value-add investors will often hear the term “seasoning”, which simply means the amount of time before you can refinance a property and “cash out” any appreciation realized, whether that is due to market appreciation or improvements to the property. Most financial institutions will have some sort of seasoning period, such as 6 or 12 months, but others will not and that can be a very valuable tool for those investors looking to grow their portfolio quickly. Have you considered having a seller finance the required down-payment for you? This is an excellent option to keep capital in your pocket! Some financial institutions will accept a seller funded down-payment, but others may not.
The examples I’ve given are only a few ways a good lender/borrower relationship can facilitate creative loan structuring. Whether some of these creative financing options would be worth paying a bit more on your interest rate will depend on each individual deal and the investor’s preference. Arguably the most important thing to look for when seeking financing for investment(s) is a lender that you trust and will continue to think outside the box and customize their terms based on your needs and goals. The relationship you build with your lender could be an important aspect of the profitability and speed of which you grow your wealth through investing. Some attributes to look for when building this relationship – trust, communication, transparency, knowledge/expertise, local, integrity, diligence, selflessness, and attentiveness. I know there are many more I could list, but you get the idea. You absolutely and unequivocally need to have confidence in the lender you work with. This will give you the assurance you need when writing offers on potential investment properties. Ultimately, personal relationships are the foundation of all aspects of anyone’s life and the lender/borrower relationship is no different.
As a real estate investor you need to have the right pieces in place to be successful in an ultra-competitive market and unless you’ve won the lottery, you’ll likely need financing from a financial institution at some point. There are a lot of great lenders out there, so take your time and do your homework to make sure you find the right one for you and your needs. It will serve any investor well on the journey to financial freedom.