Distinguishing Investment And Home Financing
Your first real estate investment should be your own home. In fact, if you dont own your home, we advise you to put down this book and pick up a copy of Home Buying For Dummies by Eric Tyson and Ray Brown first. Owning your own home carries the least risk and the most potential tax benefits while bringing you up to speed on the basics of real estate investing and ownership.
After youve purchased a home, you should have a fairly good understanding of the mortgage loan application and approval process. However, real estate financing differs quite a bit when you take on the role of investor rather than homeowner. You and the lender take on more risk. As a result, you can expect to pay more for the privilege of borrowing money. In addition, your borrowing strategy is likely to change. In the following sections, we cover these differences in greater detail, so you know what to expect before diving in.
A Look At Commercial Lending By Asset Type
As weve mentioned above, financing options can be affected by the type of borrower and how the borrower plans to use the property.
Loan options can also be significantly affected by the type of property being financed.
Lets look at the differences and typical outlook for lending across different asset types in CRE.
Financing Real Estate Investments For Dummies
Your practical guide to scoring cash to fuel your real estateinvestments
Want to be a smart, successful real estate investor? Thisno-nonsense guide contains everything you must know to make theright choices about financing your investments from thevarious options available and the impact on cash flow to the taximplications and risk factors involved. You also get tried-and-truetips for surviving a down market and using current investments tofinance future ones.
- A crash course in real estate financing understandstandard terms and concepts, learn the various sources ofinvestment capital, and gather all essential facts and figures
Weigh your options decide which type of financing is bestfor your circumstances and incorporate it into your real estateinvesting plan
Finance residential properties evaluate residential loanprograms, navigate the loan application and processing, and handlethe closing
Invest in commercial properties know the differentproperty types, choose the one that meets your investment goals,and discover unique sources for financing
Tap into unconventional sources discover the pros andcons of “hard money,” capitalize on seller financing, partner toshare risk and equity, and invest on the cheap with no-money-downdeals
Open the book and find:
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Paying Cash With Borrowed Money
In the world of real estate, cash is king. The buyer who shows up with cash is in a significantly stronger position to purchase a property and negotiate an attractive price and terms than a buyer who shows up needing financing.
When we say cash is king, however, were not advising you to show up with a suitcase full of money. Were telling you to show up with preapproved financing a financial backer who can deliver the cash on closing day. In other words, although youre financing the purchase as explained throughout this book, youre still placing yourself in a position to offer cash.
Taking A Crash Course In Real Estate Investment Financing
In This Chapter
Gaining leverage with other peoples money
Grasping the difference between a home and investment property
Discovering vital sources of real estate investment capital
Getting ready to meet your lender
Are you eager to set out on the road to building wealth through real estate? Although we hate to hold you back, we do discourage you from moving forward without the proper preparation. Our advice doesnt necessarily mean, however, that you need to read the entire book from cover to cover before you purchase your first investment property.
Here, we provide a quick primer on real estate financing along with what you need to do to secure financing for your real estate investments. We also provide a generous supply of references to other chapters in the book where you can find more detailed information on specific topics. So without further ado, let the real estate financing primer begin.
Dont let negative economic and credit information dampen your desire to invest in real estate. The best time to purchase real estate is when prices are low. You can still find and secure financing you just may need to look and work a little harder and smarter to get it.
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Brushing Up On Basic Real Estate Financing Lingo
Throughout this book, we toss around some jargon common in the real estate and mortgage lending industries. To the average consumer, these terms may sound Greek, but we assure you that theyre part of the English language. In the following sections, we define the most common and often misunderstood of these terms.
Pointing Out Mortgage Concepts
When you take out a loan, the lender requires something of value to make sure it has something valuable to sell and recoup its investment if you default on the loan. This collateral is officially presented in the form of a mortgage or deed of trust depending on the jurisdiction:
Mortgage: A mortgage is a contract between the lender and borrower that gives the lender the right to foreclose on the property in the event that the borrower defaults on the loan.
Deed of trust: A deed of trust is a mortgage contract that places control of the deed in the hands of a third party a trustee. The trustee has the power to foreclose on the property in the event that the borrower defaults on the loan.
The mortgage market is large and complex, but it consists of two main divisions: a primary and a secondary mortgage market.
Primary: This is the market in which you do business. It consists of financial institutions that lend you money.
Secondary: This is the market where institutional lenders and Wall Street investors converge. The primary lenders who actually loan money to homeowners and investors turn around and sell the mortgages or deeds of trust to investors. This gives the lenders more money to make available to borrowers.
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Financing For General Commercial Buildings
Most types of commercial buildings share similar characteristics when it comes to financing, though some may differ.
Office Building Financing
Most asset types have fairly consistent financing rates across the country.
Office building financing rates, however, vary widely by state, with the highest rates in areas with high demand and limited asset availability.
Financing requirements for office buildings are generally typical of commercial real estate financing requirements across the board, but medical office buildings have slightly relaxed requirements.
Due to the stability of the market segment, they typically have high occupancy rates and loyal tenants.
The DSCR for medical office buildings is slightly lower, often starting at 1.20 and their purchase may require only 10% down.
Higher DSCR ratios than normal may be required for hotel loans, as hotels typically have a volatile cash flow due to their lack of long-term tenant leases.
Also, most hotel lenders prefer to stay between 55-60% percent LTV.
Hotels with recognizable names or affiliations tend to get better rates and terms and larger appraisal values than similar, unflagged hotels.
Regardless of flagged status, a hotels management is vital to its financing.
Whether borrowers are running the operation themselves or using a management company will play a factor in the financing.
Special-Use Property Financing
Maximizing Your Potential With Other Peoples Money
Other peoples money is money that you borrow from other people to finance your investments. OPM isnt much of a secret. Assuming you own a home, you probably used OPM to buy it. You may have put down 5 to 10 percent of your own money as a down payment and then borrowed the rest.
Dealing with a major credit crunch
The mortgage meltdown, foreclosure epidemic, and global financial crisis that all came to a head in 2008 led many real estate investors to believe that credit had all but dried up. Banks were failing left and right, and the United States was forced to step in with more than $1 trillion in economic rescue funds to keep cash flowing to individuals and businesses that needed credit. Surely, real estate investors would be the last on the list for cheap and easy credit.
Actually, the credit crunch didnt put real estate investors out of business. In fact, in many cases, it made conditions better for investors:
When the bubble burst, properties became much more affordable. Investors could buy better properties for less money.
As millions of people worked through foreclosure, demand for rental properties soared.
A credit crunch doesnt mean that financing disappears it just means that you probably need to look for it in some unusual places. Even FHA has investor financing with 25 percent down and a lot of foreclosures theyre willing to deal on. Throughout this book, we show you how to tap into these markets credit crunch and all.
Identifying Types Of Lenders
The moneymen and -women you deal with when securing financing for purchasing investment property play various roles in the process. You need to know whom youre working with:
Commercial lenders: Theyre financial institutions rather than individuals. They include banks, credit unions, mutual savings banks, savings and loan associations, and stock savings banks.
Private lenders: A private lender is any individual who loans money outside the channels of institutional lending. This person can be a friend or relative, such as your Aunt Mabel, or an investor. Real estate investors often rely on private lenders for access to investment capital when banks and other financial institutions turn them down.
Mortgage banker: Mortgage bankers are financial institutions that directly fund home loans and either service those loans themselves or sell the mortgages to investors and contract out the servicing of the loans.
Servicer: The servicer is the institution contracted or appointed to collect the monthly payments from the borrower. They have to account for all payments and disbursements and provide yearly statements showing all transactions within a mortgage account to the borrower.
Mortgage broker: Mortgage brokers are licensed by the state to assist borrowers in finding mortgage lenders, comparing loan programs, applying for mortgage loans, and securing financing for purchasing real estate. They act as the eyes and ears for many different mortgage lenders.
Commercial Real Estate Financing
Commercial real estate lending is a highly complex topic.
Investors seeking financing to purchase income-producing property, business owners looking to build or buy space to house their business, and developers in need of a loan for an upcoming project all need to understand the many aspects of commercial real estate financing.
Lets start with the basics.
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About Commercial Real Estate Financing
Regardless of the reason a borrower is seeking a commercial real estate loan, financing the purchase of a commercial asset differs from procuring financing for a personal residential loan in several ways.
These differences depend both on the type of financing needed and how the borrowed funds are going to be used.
Grasping Different Loan Types
Throughout this book, we introduce you to various types of loans for financing the purchase of real estate, including conforming and nonconforming loans, jumbo loans, and hard money loans. In the following list, we define the most common loan types and toss in some additional information that you may find useful.
Conforming loan: A conforming loan is one that meets the criteria set forth by Fannie Mae or Freddie Mac the organizations that purchase the loans and then package them up to sell on Wall Street. In general, to qualify for a conforming loan, the borrower must
Show sufficient income to cover monthly payments.
Have enough cash for a down payment and reserves.
Have a good credit history.
For additional details about conforming loans and current criteria, visit the Fannie Mae Web site at www.efanniemae.com.
Nonconforming loans: These include everything else outside the Fannie/Freddie box. Sometimes referred to in the market as subprime or even exotic loans, theyre bought by other financial companies or investment banks and packaged to be sold to Wall Street investors. When the subprime market suffers, as it did starting in 2008, far fewer of these types of securities make it to market.
Conventional loans: These loans are outside the sphere of the government. In other words, theyre not FHA- or VA-secured loans and arent underwritten by any government agency.
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Brushing Up On Important Legal Lingo
Even though real estate deals are generally classified as financial, they involve plenty of legalities, especially in relation to who owns the property or has a stake in it. Although real estaterelated legal terms can fill an entire dictionary, you should have a working knowledge of the following three:
Deed: A deed is a legal document that grants rights to a property. Whenever you purchase a property, whoever is handling the closing must file the deed with the countys register of deeds to make the transfer of ownership official. As the official owner, you have the right to borrow against the property and transfer your rights of ownership.
Be careful signing any deed, especially a quitclaim deed . Real estate con artists often use the quitclaim deed to hijack property from unwary owners. They may hide a single page quitclaim deed in a stack of papers, fooling the owner into signing the document without knowing what theyre signing. Then, they run down to the register of deeds and file the deed, making themselves the new owners, so they can take out bogus loans against the property.
Who gets first dibs?
In the event of a foreclosure, certain liens take precedence over others, meaning that when the property is sold at auction, certain lien holders are paid off first:
Tax lien: The proceeds from the foreclosure sale pay off any unpaid property taxes first.
Construction liens: If money still remains, it goes to the next lien holders in order of precedence.
Commercial Real Estate Investing For Dummies
Make real estate part of your investing strategy Commercial Real Estate Investing For Dummies
Yes, there is a fun and easy way to break into commercial real estate, and this is it. This comprehensive handbook has it all. You’ll learn how to find great properties, size up sellers, finance your investments, protect your assets, and increase your property’s value. You’ll discover the upsides and downsides of the various types of investments, learn the five biggest myths of commercial real estate investment, find out how to recession-proof your investment portfolio, and more. Discover how to:
- Get leads on commercial property investments
- Determine what a property is worth
- Find the right financing for you
- Handle inspections and fix problems
- Make big money in land development
- Manage your properties or hire a pro
- Exploit the tax advantages of commercial real estate
- Find out what offer a seller really-really wants
- Perform due diligence before you make a deal
- Raise capital by forming partnerships
Investing in commercial property can make you rich in any economy. Get Commercial Real Estate For Dummies, and find out how.
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Qualifying For Commercial Real Estate Financing
Commercial real estate loans typically require more scrutiny than residential mortgages.
When evaluating commercial real estate loan applications, lenders will consider several factors.
Depending on the lender and the type of financing, these can include available collateral, borrower creditworthiness, and certain financial ratios dependent on characteristics of the property in question.
Borrowers may need to provide several years of financial statements and income tax returns.
Lenders may also want to see financial statements indicating cash flow for the property to be financed.
Most residential mortgages are made to individual borrowers, but commercial real estate loans are often made to business entities instead.
If the entity itself doesnt yet have any financial track record or credit rating, the lender may require the principals of the business entity to guarantee the loan.
In commercial real estate lending, required minimum individual FICO scores typically range from 550 to 700, depending on lender and loan type.
Minimum business credit scores vary depending on those factors, as well as on which credit scale and credit reporting bureau the lender is using.
Because private mortgage insurance isnt available for commercial real estate loans, commercial lenders must typically rely on the property itself as collateral, in case the borrower defaults on the loan.
3. Debt-Service Coverage Ratio
Paying A Premium For Riskier Investment Loans
When you invest in your own home, you literally have a vested interest in making payments if you dont, you lose the roof over your head. On the flip side, if you lose an investment property, it may be painful, but its never that serious, and lenders are well aware of the difference. For them, investment loans are riskier propositions. To mitigate the risk, they generally
Require a larger down payment.
Demand a larger loan-to-value ratio. earlier in this chapter.)
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Pumping Up Your Purchasing Power With Borrowed Money
If you have any reservations about borrowing money to buy real estate, you need to overcome those reservations by developing a better understanding of leverage using borrowed money to buy more and better properties, thus improving your chances of earning bigger profits.
In the following sections, we show you why the goal of owning a property free and clear isnt such a smart move, reveal the secret of leveraging the power of borrowed money, and explain how you can offer
cash for properties even when financing the purchase.
Although we encourage investors to borrow money to increase their leverage, keep in mind that borrowing money can carry significant risks. As an investor, you can take action to minimize the risks by carefully evaluating your real estate market and properties under consideration, overestimating costs, underestimating profits, developing realistic backup plans, and so on however you can never completely eliminate the risk. You have to decide for yourself what an acceptable level of risk is.