Financing of Investment Properties: Options, Pitfalls, Recommendations
By George Riley
When it comes to the financing of investment properties, there are many
methods and combinations of methods - almost as many as there are deals.
Some you're no doubt familiar with; others may be new to you. Read on for
an overview of your investment financing options.
The first approach that comes to mind of course, is the old fashioned way
of financing: the investor makes an offer on a property and seeks a
conventional mortgage, usually putting up a cash down payment of up to 30%
of the purchase price. Most sellers want to sell to a cash buyer in this
traditional way, and do not have sufficient motivation to want to enter
into a more creative, and perceptively more risky, deal.
From the investor's perspective however, this traditional approach has a
number of drawbacks:
- The investor has to endure a mortgage broker's application process and
credit check.
- The investor must tie up many thousands of dollars with the down payment
- an important consideration in a process that can take weeks to go from
application to closing.
- The investor may need to divulge personal or business income.
- The investor may have personal credit exposure and liability.
- When buying multi-unit residential, rental
income and ownership expenses enter the mix. (Note: These can and should
be carefully analyzed before applying for a loan. A more favorable
mortgage rate can be had if the investor also intends on becoming an
occupant. Be sure to get a referral for a mortgage broker who has a
reputation for following through in a timely manner.)
Personally, and for the reasons listed above, I prefer more creative ways
of financing investment properties. The goal of creative financing is
straightforward: Satisfy the seller's needs while minimizing the
investor's credit exposure and the hassles inherent in traditional
borrowing. There are many tactics an investor can employ that are
completely legal, moral and ethical.
* Next 37 17 investors only!
Some examples. . .
- Do an all cash deal The easiest deal - but not always the smartest -
is when the investor is an all cash buyer. In this case, you literally
pay 100% of the purchase price with your own cash. The advantage of
course, is that you can close very quickly and don't need to involve
lenders or partners of any kind. Credit scores, loan applications, income
disclosures, partnership agreements and all the inherent delays (usually
on the mortgage broker's side) are not part of the cash transaction.
That said, it is the rare investor who can, or wants to, put their cash
liquidity on the line. Readily available cash can be put to better use!
An all-cash buyer's source of funds might be from personal savings, or
more likely from equity drawn from other property already owned. It is
probably wisest to not liquidate for cash unless you have a truly sweet
deal in hand ... one that is certain to produce huge profits quickly.
- Make the seller your partner. By allowing the owner to participate in
your plan to create and extract equity from their property, you may need
less of your own money to put the deal together. (Partnering with the
seller begins by establishing a trusting relationship ... and honesty is
paramount to your success. NEVER lie or mislead anyone on your plan or
your intentions of the outcome ... let the seller know that you are
working with her for your mutual gain.)
Keep in mind that the seller is much more likely to work with you on a
creative deal if you are able to demonstrate the benefits to her of such
an agreement. Ideally she will hold a note for the entire purchase price
(the ideal "nothing down" tactic). Typically however, to get the deal
done you will need to offer a cash down payment, with her holding a note
for the balance. With this arrangement, your seller, in effect, becomes
your lender.
(See our next article, "Seller Financing - An Attractive Option
to Traditional Methods," for a more in-depth look at seller financing)
- Use OPM - Other People's Money. In general, I recommend borrowing as
much as possible from private investors whenever you can. Build
relationships within your investor group, and be aware of who has money to
lend, and what type of deal and terms they would be interested in. If you
borrow from a private party, and sufficient equity is available in the
target property, guarantee your private lender's loan by giving him a
mortgage, which will be paid off when the property is transferred to a new
buyer. Offer your private lender a fair return for his cash and his risk
... greed will not get the deal done. Remember, you are in this for the
gain of all parties.
- Borrow from a "hard money" lender. It's called "hard money" because
it's easy to borrow, but hard to pay back, due to the higher interest rate
and shorter terms. In this approach, the buyer/investor must have some
"skin in the game" - some of your own money or other collateral. Typical
hard money can be borrowed for 1-2 points up front and 18% interest.
A recent conversation with a local hard money lender revealed that the
investor will pay 4 points upon receipt of the loan, and make interest
only payments at 14% for a one year term, with principal due by the end of
the term. Some hard money lenders specialize in rehab loans. The rehab
lenders have a reputation for understanding and meeting the rehab/investor
needs. As you establish a relationship with a particular lender, borrowing
becomes easier.
These are just a few of the ideas involved in the financing of investment
properties. Whichever way you go, keep a few things in mind:
- Do not enter into any deal without being thoroughly prepared with all
the understanding, knowledge and proper forms necessary to enable your
investment transactions to end with winners on all sides.
- Keep in mind that each state has specific laws. Things you learn from a
nationally known guru will not be specific to your state. Always minimize
your legal risk by asking your attorney, "Is this legal?"
- Always be fair and honest.
George Riley is a regular contributor to ForeclosuresMass Monthly. He can
be contacted at Exit Realty Center at 781-297-9494, at Genesis Funding
Resources at 508-904-7086, by email at
george@genesisfr.com or
via his website online at: www.genesisfr.com.
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