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Financing Part 1 – The Topic on Every Investor's Mind

With the way sales prices have dropped in most markets across the United States, people have realized that this is an unprecedented time of great bargains. When the media reports about sales prices dropping, it comes across to the average person as “the sky is falling.” As a real estate investor, you should recognize this time as an opportunity that you may never see again in your lifetime. This is the time when generational wealth is created.

Everything in real estate runs in cycles, and the current cycle is no different. Historically, when you see periods of time when prices dropped really low, or interest rates were really high, people thought that real estate investing was unwise. There were years in the 1980s when interest rates were very high (13-18%), yet investors still made money during that time. In fact, they made more money than they did before because the uneducated people did not know how to take advantage of the opportunity. Why? Because their primary method of investing (getting a loan) was no longer feasible.

Today is no different. Traditional financing in today’s market is also difficult. Lenders have placed a lot of restrictions on getting a loan and that makes it hard for investors to adjust. With all of the foreclosed loans that have happened in the last several years, lender’s appetite for risk has decreased and so the rules have become very tight.

Every problem (if you can solve it) becomes an opportunity. The biggest problem facing real estate investors today, is financing. During this article, we will address several ways for you to solve this problem. When you understand how to overcome the financing aspect of real estate, then you can easily capitalize on one of the greatest buying times that has ever existed.

What are my options?

The options for real estate investors are the same as they always were. The truth is that most people only focused on one way of acquiring properties. Here are a few of your options:

1. Traditional Financing
2. Asset Based Loans
3. Seller Financing/Lease Options
4. Debt Partner
5. Equity Partner

We will review the first two options in this article and handle the other three on the second part. Let’s review how these options can help you with your goals to get out of the Rat Race.

Traditional Financing

Although it may seem contradictory to list this as an option, it is still something to consider. Think about this for a moment:

What is the largest obstacle when trying to obtain a loan from a bank? There are many possible answers, but at the root of it the largest problem is that the loan is based on your financial profile. They are looking at your credit, your income, your debt, and your financial statement. It is ironic that people that own their own businesses and have plenty of assets have a hard time getting a loan because they do not have a work history. The current rules for lending are not written to accommodate those people.

However, what would happen if the loan were made based on the performance of the property rather than the individual? There are still loans like this being written today. The banks will loan money based on the property’s performance and they will not require the loan to be personally guaranteed by the individual. They are called commercial loans.

Commercial loans are for properties that have commercial zoning, or they are five units or more. In some cases, going after a slightly larger deal has benefits, especially where financing is concerned. The lending guidelines for these kinds of properties are much easier to meet than residential loans. As difficult as it may seem, it is often easier to buy a large commercial building than it is to buy a three-bedroom home.

The opportunity on commercial properties is also at an all time high. There is an impending wave of foreclosures on commercial properties coming. Richard Parkus, at Deutsche Bank, estimates that the cumulative commercial real estate charge-offs in the U.S. will be in the range of 10% of the banking system’s $1 trillion in core commercial real estate loans by the end of 2012. That is roughly $100 billion dollars worth of bad loans that will be coming. This opportunity will be enormous for those that know how to do it.

Asset-Based Loans

An asset-based loan is where the loan is made based on the value of the property rather than the financial profile of the individual. Some people call these kinds of loans asset-based loans and others call them hard-money loans. Even though the terms are different, the concept is the same.

Since the lender is more concerned about the value of the property, they will usually do a very limited check of your financial profile. They may pull your credit, but that is about all they will do on you personally.

The value of the property is the number-one thing that an asset-based lender will look at. They do not want to over-finance the property and so they usually will only lend up to 65% of the value of the property. If the property needs repairs, they will also include that money into the loan as long as it does not surpass 65% of the value.

For people looking to get into a property with no down payment, a hard-money loan is an option, as long as you are buying the property at a significant discount of its true value. Many investors also wonder how to cover the cost of renovating a property and this is a potential solution for the repairs as well.

When you are interviewing asset-based lenders, there are several questions you want to ask them:
• Do they lend based on the before repair value or the after repair value?
• What is their maximum loan to value (LTV)?
• How many points do they charge (fees for doing the loan)?
• What is their normal loan term?
• What interest rate do they charge?

These questions will give you an insight into how they work and if it will be a solution for your deal. You always want to find a lender that will loan based on the after repair value (ARV) as it will be much easier to find deals that meet that criteria.

Hard-money lenders are very easy to find. A simple search in Google will help you find many in your area that you can talk to. Do a search for “(your state or city) hard money lender” and you will find plenty of results. Then it is just a matter of talking to them to find out what their lending criteria is, since each lender is different.

These two valuable ways to finance deals in today’s market are just the tip of the iceberg when it comes to financing. Check out the article next month when we discuss creative financing and raising capital from partners. These techniques are things that every investor must know to be successful in today’s real estate market. Now is the time to create generational wealth for you and your family.

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