By Sean Sutton Private money, a term often used for non-bank, non-agency loans, is one…
By Mario Navarrete
In today’s market, we’re finding more and more investors unable to get the same margins they’re used to on their fix and flip projects. One option they have is to branch out into new markets, but they’ve been faced with limited supply in primary markets and have had to consider secondary, if not tertiary markets. This unknown market leap is not only daunting, but it is also much different than finding another primary market to invest in. Your model changes, your cost changes, your yield changes and you most often have to change your team, all of which is not easy.
As such, we see many of those same investors, instead, come back to the markets they already know rather than seeking yield elsewhere. In their home markets, investors are now more open to holding onto flip projects as rental properties since yield averages are strong and the rents can sustain the property until a time comes to unload them at a more desirable margin.
The challenge for them then becomes how to approach this new method and be most effective in doing so coming out of an unprecedented time in our history. How does your finance strategy differ when you’re not coming into a familiar and somewhat large lump sum every 3-6 months on flip projects anymore? What loan options do investors have and what is seen as the best path for them when it comes to minimizing costs linked with a growing portfolio as well as the cost of capital associated with it? All of these questions and more are what I hope to provide clarity on when I speak with clients directly and I hope to shed a little light on them here.
The first thing to understand is that once you decide to accumulate rental properties, financing for these assets will require more of a down payment than you may be accustomed to. On flip projects, you might be able to get 80% to 90% of the cost financed (even 100% sometimes if you choose to work with certain hard money lenders and the associated rates that come with that). Whereas, rental properties generally max at 75% loan to value. Extrapolating that into a small portfolio of let’s say 5 to 10 properties worth a total of a million dollars (for simplicity’s sake here), means you’ll need to be ready to come to the table with about $250,000 in cash plus closing fees, reserves and carrying costs.
Thankfully, if you do not have this liquidity today or you’re waiting for some of your flip projects to sell, there are loan products like our Rental Aggregation Credit Line that can assist you in accumulating rentals over a year’s time versus one large transaction. This is a bridge product I will discuss in greater detail for a future blog. For now, let’s continue with the topic of financing your rentals long term and how.
There are generally three options to finance rental assets today and I will list them in order of most cost-effective. Agency loans such as the ones provided by Fannie Mae are first. They may have rates in the 3s and 4s if you meet all their requirements. Second is a CMBS product, like our Rental Portfolio Loan, which could have rates in the 4s and 5s for qualified borrowers. Lastly, you can find a basic single asset rental loan that resembles more of a sub-prime product having rates in the 6s and 7s, granted that you qualify.
The obvious thing to think is, “well I will just get all agency loans then.” Unfortunately, these loans are typically maxed out to an individual at 10 properties or based on other income limitations. This means once you have 10 of these loans in your name, it’s hard to obtain any more. If your goal is to get to 10 rentals and call it quits, then this is the best way to go. However, if you’re like the many clients we work with, accruing 10 rentals is just the tip of the iceberg.
Once you’ve maxed out your 10 “Fannie Mae’s”, the next, most cost-effective growth strategy is to wipe those loans from your personal liability to go get another 10. This can be achieved with a CMBS blanket loan, like our Rental Portfolio Loan, as they will deed all of these assets from your personal name into a business entity which clears your personal liability. You can then pretty much rinse and repeat. The caveat is that these CMBS loans do have restrictions such as location, borrower/sponsorship setup, liquidity and net worth requirements.
Granted, most of the time these items are a non-issue for us and the agency to CMBS method works well for our borrowers. However, if you happen to fall into that small bucket and cannot get a CMBS product for whatever reason, you then have the third option of the sub-prime loans. Yes, it costs more, but depending on your strategy and where you are buying, this may be your only route.
All said, it would be advisable to speak with your loan officer(s) first and devise a game plan that might work for you. The bright side is you have a wide array of financing options and lenders available! While growing a rental portfolio is not the easiest thing to get up and running, once you do, it’s an amazing position to be in. For those of you reading this who have already built your rental portfolio but were perhaps unaware of these options and their strategies, we can take a look at your financing in place now and provide guidance on how to best maneuver going forward. Either way, as investors grow their portfolios, there are many items such as this to consider when keeping costs as low as possible.
Things like property management, CapEx, Yield Maintenance and more are all very important components of rental investing. Feel free to reach out at your convenience and I’d be delighted to setup a time to chat and go over all of these items together.