An article series on navigating the private lending world.
There are many choices to consider for financing your rehab project. Plenty of lenders today are active in the short-term private lending space, and they each have credit boxes that vary based on their risk tolerances and expected rate of return for their capital sources. There’s institutional capital from Wall Street, private debt funds with capital from wealthy individuals, and bank lines. There is also crowdfunding capital, which allows small investors to fractionally fund fix-and-flip loans. And, not to be overlooked, are the many loans still funded by private individuals (i.e., friends) looking to earn a 10%-12% return on their money.
As real estate investors seek funds for their projects, it is important to understand which type of lending partner best matches your funding needs and, importantly, complements the way you want to conduct business.
Let’s consider a couple of scenarios.
Quick Closing Strategy
As a real estate investor, your property acquisition strategy may be based on being able to purchase a property and close within 10 days. This strategy may give you an edge in negotiating the lowest possible price and/or beating out conventional buyers. Aligning your business with funding sources that can deliver your strategy is critical.
In this case, consider securing a lender with significant lending flexibility and speed of processing (desktop appraisals, responsive staff, clear requirements). These lenders often command a higher rate and fee, but if you can win those properties at the price you need for deal viability, this strategy can work well.
Desktop appraisals, with physical inspections, have become more commonplace with lenders that promote the speed of closing in exchange for higher rates and fees. Many of these lenders have staff appraisers and use Automated Valuation Models (AVMs) and MLS data to help them evaluate your project and After Repair Value (ARV). These lenders know they can win business by closing your loan fast, giving you a market advantage.
Least Amount of Funds Strategy
If you’re a real estate investor with limited capital reserves but want to simultaneously complete multiple projects and recycle your capital many times a year, you might look for a lender that allows for the least amount of your money in the transaction.
The least amount of funds in the transaction is generally the sum of the required down payment (determined by the loan-to-cost), origination points, fees and closing costs, plus the required excess liquidity requirements of the lender. Most lenders determine the loan-to- cost based on the experience of the borrower, meaning how many similar projects have been exited (sold or refinanced) in the last few years. The more documented experience an investor can provide means the higher loan cost the lender is willing to risk.
Origination points and fees are also important to consider. They are a key factor in your profitability equation. Most lenders will charge 2%-3% origination points plus lender fees ranging from $995-$2,600. If you are looking to finance properties with very low property value, the origination points and fees can greatly impact your decision about whether to acquire and rehab a property. In most circumstances, for a light rehab project, the overall points and fees are a more meaningful criteria for making a decision than the interest rate. If your exit is quick, you won’t be paying interest for the full 12-18-month term of the loan, but you will have paid the full points and fees at closing.
With that said, you should consider whether interest is being charged on the full loan amount or just on the amount drawn against the loan. In the case of large construction holdbacks, this factor could dramatically impact the profitability of your project. With interest rates at 10%-13% currently, a construction holdback account with $50,000-$100,000 in it for 12 months would cost significantly more than if you were paying interest only on the amount drawn for a completed construction.
Additionally, a few lenders are offering deferment of payments and fees to the exit (i.e., sale or refinance) of the property. This may help you stretch your available funds to complete more projects at once.
Finding the best options for investing the least amount of funds into the transaction is challenging, given the number of factors you need to analyze. Working with a commercial mortgage broker to help you calculate all the costs and weed through the various lender benefits can help you match your investment objectives.
Educating yourself about the real estate investment lending experience is key to your success. There are many educational resources available to help you learn from the experience of others.
Here are links to a couple news sites. They are completely free, without subscription costs, to help you gain insight into what lending design best works for your business: www.reinvestornews.com and www.reinewsnow.com.
Damon Riehl is the founder and CEO of Investment Property Loan Exchange. He has more than 35 years of lending experience in a broad array of asset classes, including commercial and residential mortgage, small business, and construction lending.
Riehl held top leadership positions as head of commercial lending for Ocwen Mortgage, head of unsecured lending for Citibank, global mortgage leader for GE Capital, and head of construction products at Fannie Mae. He is a member of the Harvard Joint Centers for Housing Studies.
Riehl has built six de novo lending platforms and used that knowledge to build and grow Investment Property Loan Exchange and the fintech platform LoanBidz.com.
