Real Estate Debt Financing 102

In this follow-up episode to Real Estate Debt Financing 101, the team discusses various ways to sort through your options when it comes to sourcing debt.

(Transcript below.)

Ben Shelley: [00:00:00] Welcome back to the Brick x Brick Podcast. Today's episode is part two on the topic of debt financing. If you haven't heard Part 1 I encourage you to listen back. Part two is focused on discussing different strategies for the types of financing we reviewed in the first episode. Enjoy.

 

John Errico: [00:00:28] So we have all the terms down and depending on how we edit this that could have taken five or thirty five minutes 45 minutes and we've only listed terms. It's important the definition section of contracts very long. So what I think we would be great to talk about is if you're an investor or homeowner and you want to actually buy an investment property or your own house to live in. How or what should I. Why would it make sense to get a different type of loan product or a different type of loan. And there are pros and cons and whatever we can just walk through some sort of common use cases that we do as property investors so I would say one major caveat is how these loan products are underwritten so how they're analyzed varies depending on the product and depending on the type of home that you want to get in general very high level. If you're going to get what we've been talking well maybe even before delve into that let's just dealing it out even further the different types of loans are going to be talking about. So we're talking about step one would be a conventional loan. So a conventional loan in the parlance of real estate would be let's say a residential conventional loan. So we're talking about a 30 year fixed mortgage that you put down a certain downpayment depending on the type of property you're buying. We can contrast that with say a government backed insured loan like an FHA loan which is different from a conventional loan in that it might determine there might be limitations on the type of property you can buy with it. There might be advantages to using it based on down payment. There might be different interest rates et cetera et cetera.

 

Ryan Goldfarb: [00:02:03] Just just real quick. John distinguish between these two well but conventional in the common marketplace refers to Fannie Freddie back loans which our government is somewhat government affiliates. Right. But FHA is kind of its own beast. So those are kind of separated out.

 

John Errico: [00:02:24] Great point. There are loans that you might get that appear to be conventional loans but are not necessarily backed by Fannie or Freddie. So those could be portfolio lenders that are banks that are lending money but are not necessarily complying or reselling their mortgages on a secondary market so don't necessarily have to comply with some of those some of the laws that a conventional mortgage would have to comply with. There's the hard money side which is essentially a type of private loan. It could be given by a bank or an individual or a quasi bank or something which generally also has different terms and a different purpose and a different rationale for obtaining it. So very high level we're talking about conventional loans. We're talking about FHA loans we're talking about portfolio lenders I don't want to classify commercial and virtual lenders before lenders hard money and then we could talk very end about private lenders a hard money lenders are kind of like private lenders but whatever.

 

Ryan Goldfarb: [00:03:22] And then on a real institutional side you also may have life companies insurance insurance companies. They do a fair amount of lending as well. And also CMBS lenders which are very much active or inactive depending on the state of the market.

 

John Errico: [00:03:39] So if you were to buy a property say you want to buy an investment property you could buy cash or you could attempt to get financing on it. So why don't we just say I'm a new investor. I want to buy a flip. What would I do.

 

Ryan Goldfarb: [00:03:53] You can start either from the beginning or from the end. So if you're starting to the beginning you're just thinking about what kinds of loans are available to me maybe Who do I know what have I used in the past. You know it's you're limited by what's in front of you I guess if you think about it from the end and you think about what your end goal is with that property. Then I think that's probably a more efficient way and arriving at the best option for you. So if you're looking at it from the end and working backwards you might say OK this is a flip and then you may ask yourself what kind of liberty is it is this. Am I buying a piece of raw land that I'm going to develop. Am I buying the house next door to me that just needs a fresh coat of paint. But I've known the owner for years and they just want to sell it. Am I buying a property that is bank owned has been vacant for five years and needs a renovation. That question is important because each one of those strategies is going to have a different timeline. So if you're buying the house next door that just needs a fresh coat of paint you could conceivably be ready to sell that in a month or three months or four months if you're buying. A vacant foreclosure. It might be more like six months or nine months. And by the time the new buyer gets into the home it it might be nine or 12 months. And then for a new construction project depending on where you live it could be 18 months. It could be two years it could be even longer than that. So if you're looking at one of these longer time horizons it would certainly not behoove you to explore hard money options for example that generally have a duration of twelve months.

 

John Errico: [00:05:33] Well it's actually interesting sort of analytical question because part of the type of loan that you might get is driven by the asset that like to Ryan's point like what you're doing with the actual thing that you're buying. And part of it is just driven by can you actually obtain it for that property. So there might be a loan like I would say it would be amazing to get say conventional financing for every flip that we would do. But assuming that we could also get you know renovation costs baked in. But that's just not obtainable for these types of projects.

 

Ryan Goldfarb: [00:06:03] The other the other question is what what will you or the quote unquote borrowing entity qualify for. So when one issue that I've run into in the past over the past few years is that I'm. Somewhat newly self-employed and generally most conventional lenders require two years of tax returns with quote unquote self-employed status in order to qualify for a loan for any one of their loans. No matter how good the deal is. So as much as I would have loved to take advantage of that in the past that just hasn't been an option for me. Though it may have been for Ben or for anyone else who could have qualified it.

 

John Errico: [00:06:42] Yeah maybe. So let's look at it this way. Let's look at two different common investment hypotheticals that an investor might face and talk about how the different options that we might take advantage of to finance them. So we could look at say a very run of the mill a fix and flip on buying a distressed property that has a lot of damage but it has a lot of value. When I sell it and I want to sell between six and nine months from now if I were to look at that we could automatically eliminate a couple of different types of financing for their property just because it's probably the case that a bank will not lend money for that property under a conventional loan or possibly an FHA type of loan. Maybe there's a caveat. If you're living there but.

 

Ryan Goldfarb: [00:07:31] And that that limitation may also be driven by the fact that if it's that good of a deal you're probably going to have to close it quickly which would be maybe in 30 days. And I would say it's generally not a good assumption to assume that your lender can close your conventional loan or FHA loan or even commercial loan that would otherwise that this property would otherwise qualify for within that time frame.

 

John Errico: [00:07:55] Right. So that teases out another important thing which is that just in order to buy the property. So if I'm if I'm buying a a flip. There are several reasons why I might not either want to be able to use conventional financing to do that. One reason Ryan mentioned is that banks generally when you are getting a conventional or an FHA type of mortgage require time to closing it and will often look at your personal assets as a means to underwrite or analyze whether or not they should give you this loan. That is contrasted significantly with the hard money loan or a private loan in which case banks will though be aware of your private finances will not use that as the basis necessarily to give you a loan and also are created. When I say banks it just mean lenders not necessarily a bank. These loan products is what is their standardized products are usually created to accommodate this type of activity. So they'll close within 10 days 15 days maybe three or four days if you have a relationship with a hard money lender in return for a different loan terms.

 

John Errico: [00:08:58] So a conventional loan would be say as we talked about before a 30 year fully amortizing loan where you put down maybe anywhere from three and a half to 25 percent down a hard money loan will be oftentimes an interest only loan that might be between six and 18 months will require probably some amount of downpayment maybe between 10 and 20 percent down possibly inclusive of renovation costs and we'll have an interest rate that's more like 9 10 11 or even higher percentage however will be able to get loans upfront with points of front points upfront meaning that you essentially are paying a percentage of the entire loan amount as a fee to the lender to initiate the loan.

 

John Errico: [00:09:40] However you can usually they usually will not care about so much your personal finances. So some of the things we talked about about debt to income are not so much considered with many hard money lenders again this isn't a standardized industry but may many hard money lenders don't care about that per say they do or may care about how much you anticipate selling the house for how much they believe you could sell the house for as it means to underwrite their product and they will close within a very short amount of time relative to conventional or FHA lenders.

 

Ben Shelley: [00:10:09] And it's probably worth noting that these specific areas of investment there are institutions and individuals who are specifically targeting these different types of investors and investments. So right there's a whole marketplace of hard money lending that you can go to if you're not qualified and that's a great point. If either the situation. Thank you. If either the situation doesn't allow for it because of either your finances et cetera or because for example you have a short closing timeline that you need.

 

Ryan Goldfarb: [00:10:37] And if I wasn't gonna knock my microphone over I would have gotten up and given you a physical pat on the back.

 

Ryan Goldfarb: [00:10:41] So yeah. That's a great point.

 

Ryan Goldfarb: [00:10:43] And it also highlights the importance of having the right contacts within your network because our hard money lenders for example make it far easier for us to say yeah we will really buy this in 10 days at this number. If you're willing to accept that and oftentimes you're dealing with a distressed seller for any number of reasons. That's the ultimate selling point for them because it's more important for them to get their money in 10 days than to wait 45 days and get an extra 15 percent.

 

John Errico: [00:11:12] So the reason why when you see fixed and flips usually the to the extent that they're purchased with debt and sometimes the purchase with cash. But the reason why they're often purchased with debt would be a because a conventional finance conventional bank can't fund the loan can't essentially underwrite and go through the process and the amount of time that is required for you to buy it be because the person buying it you may not have the the credit or the debt to income ratio or other assets that a conventional lender might require and C would be the bank itself might just not want to make this type of loan. They might not be interested in making a loan or a property that maybe has substantial damage or whatever you might have issues with the appraisal essentially.

 

Ryan Goldfarb: [00:11:58] One thing to keep in mind with these hard money loans is that they will generally lend a percentage based on what the appraised value is minus renovations or After renovations rather. So in order to qualify for one of these loans they're essentially screening the deal for you and saying OK your numbers are like there's enough of a delta in there there's enough margin for us to expect that this makes sense for you as a flip to the point where at the end of this project you will be able to pay us back. Based on the value that you've created through this renovation. So to understand the numbers a little bit. A lender's requirements might be that they will lend no more than 75 percent of the appraised value which might be in this case let's say it's two hundred thousand dollar appraised value after repairs. That means the market value of this property. When you're done with your renovation is two hundred thousand dollars. If you're buying this property and let's say it's reasonable to assume that you can do this with fifty thousand dollars in renovations. So if you back into kind of your maximum offer price on this property you're going to arrive at one hundred thousand dollars. The way to arrive at that is saying 75 percent of the two hundred thousand dollar market value is one hundred fifty thousand dollars. I know that I have to put 50 thousand dollars into the project to get it to that point so I can offer no more than 150 minus the 50 which is a hundred thousand dollars. So based on those numbers you'll see that there's a margin and there are fifty thousand dollars and at first glance you'll say wow I'm gonna make fifty thousand dollars on this project. But as we've discussed in the past that is certainly not the case embedded in that fifty thousand dollars is both your profit margin and all of your additional expenses. So that's your holding costs for the six months that you have to hold onto the property before it's done or nine months or whatever it may may end up being your mortgage payments your taxes your insurance it's your closing costs on the back end your closing costs on the front end the lender is generally not going to take those into account but there are those in class when you require it and then when you sell a grant programs commissions transfer taxetc.

 

Ben Shelley: [00:14:17] Partners for disposition or foreclose you got legal fees legal costs relation fees rise also processing fees title and insurance again substantial.

 

Ryan Goldfarb: [00:14:28] So you know based on those numbers you might at first glance I think your margins 50 grand. But the reality is it's probably closer to like 20 which depending on your circumstances and your arrangement might be might be a good deal you might be a realtor too and that's your that's your way to continue building a pipeline and to feed the beast so to speak.

 

John Errico: [00:14:50] But I think that's so yeah to Harken it back to the terms that we discussed before. If you're talking about a hard money load in this context your I don't know in what order we did the terms but your loan length is generally going to be I would say very commonly twelve months but could be between six months and 24 months.

 

Ryan Goldfarb: [00:15:07] And it could be and it could be 12 months with a three month extension not shorter term multiple of those for a price.

 

John Errico: [00:15:13] Your your interest rate or your EPR is going to be probably in the high single or low double digits.

 

John Errico: [00:15:21] So you're looking at I don't know 8 percent 9 percent at the very low end up to 15 20 percent at the very very high end. Is this a before you might have to pay points upfront which are a percentage of the total loan amount as a fee to begin the process which some people I think don't consider as a cost but can be very significant. So even one or two points can be thousands and thousands of dollars that you have to pay either as wrapped into the loan or upfront.

 

Ryan Goldfarb: [00:15:49] In addition to maybe a legal lender legal review fee title insurance like your personal closing costs and then on top of that lender Title Insurance lender legal and maybe an appraisal or inspection amount.

 

Ben Shelley: [00:16:04] And worth noting that you're paying interest on the totality of what is being loaned. So that's that's both the principal and sometimes.

 

John Errico: [00:16:10] Yeah. So you're paying interest on debt depending on your arranged with the hard money lender you could be paying interest on the amount that you're actually obtained. Or you could be paying interest on the amount that you actually anticipated needing. So the difference is that you might say buy a house that costs one hundred thousand dollars and you loan one hundred thousand dollars but you know that it is cost fifty thousand dollars renovated so you actually want to get a hundred and fifty thousand dollars if you put say 10 percent down of that total amount you might be lending either one hundred thirty five. So yeah you're lending a hundred thirty five. But to actually buy the property you only need a hundred thousand dollars so you might be paying interest either on the amount that you lent the amount that you needed to purchase the property which could be a hundred thousand dollars or the amount that you need to purchase and renovate the property which could be hundred thirty five thousand dollars.

 

John Errico: [00:16:59] You might have actually received thirty five thousand dollars until one two three six months into the project.

 

Ben Shelley: [00:17:04] Would you say it's more common for hard money lenders to incorporate renovation costs as part of what you're paying your interest as in not what you need in the moment but what you ask for what you're approved for use in totality.

 

Ryan Goldfarb: [00:17:16] Usually it's done based on the loan amount less commonly it's done based on the amount that you draw. But that's obviously advantageous especially if you have a significant renovation budget. Right.

 

Ryan Goldfarb: [00:17:26] As we're learning on a few projects so yeah. So why don't we. Why do we move to the buy and hold.

 

John Errico: [00:17:31] Read universe which is has different considerations other perhaps might have similar strategies depending on the project. So if I buy a 2-family home and I want to buy it for cash flow I would say your options for buying a 2-family home are probably a bit broader than your options for buying a fix and flip. So you could consider hard money.

 

Ryan Goldfarb: [00:17:52] You could consider conventional lending you could consider FHA lending the one the one caveat I would add is that it's also going to depend on the condition.

 

John Errico: [00:18:01] Yeah so the way that I I guess I could maybe conceive of buying a home a multifamily home as like a hierarchy. There's kind of an order of preference and maybe my order of preference might be different from your order of preference but I would say if I had the option to do it I would probably say buy home with FHA financing as the number one option. If it's possible because I'd be able to put very little down and own a home essentially. So with an FHA loan on a multifamily home said 2-family I could put down three and a half percent of the purchase price. Pay some additional fees for FHA appraisals or whatever might be and then move into the home with only putting down very little the disadvantages to that would be it could take a very long time for that loan to close and if the property requires repairs I might not be able to I might not be able to obtain an FHA loan. There is an FHA 203k loan but I might not be able to obtain a straight FHA loan. I also would have to live in the property which is maybe the biggest catch you had. FHA loans are generally available only to primary resident owners owner occupants and for many reasons a sell ever home might not find that as an attractive offer because they know that it will take a very long time to close the property and one additional caveat is that I need to make sure that I have sufficient credit and income and debts to qualify for the loan. So we're talking here in the world of it's essentially a loan product created for you as a primary homeowner to live at home. But you could use it for investment purposes and I've bought homes with an FHA loan. The living in it. But in my mind thinking I'm going to use this as a as a real estate investment long term. I guess the second thing in my my hierarchy would be to buy a home with conventional financing so conventional. Well I don't know if that's thing.

 

Ryan Goldfarb: [00:19:54] Well I actually would look at it a little bit differently. Yes and different hierarchies. Yeah I mean in a perfect world for sure I would love to be able to buy an investment property that hits my investment criteria while putting three and a half percent down even if I to live there for six months or a year whatever the requirement is.

 

Ben Shelley: [00:20:14] But I think most people do you think most people don't qualify them for that FHA more so than let's say your average conventional life.

 

John Errico: [00:20:21] It's the property that the underwriting for a person is probably more lenient but the underwriting for property is more difficult to read.

 

Ryan Goldfarb: [00:20:31] But what I would say is I would rather a better investment even if I had to use a more onerous financing strategy than to buy a lesser quality investment and only do it because I have the ability to obtain an FHA mortgage through it or for that property. That's that's not to say that you can't make a good investment. Either way I think there are certain properties that lend themselves extremely well to doing to obtaining or acquiring through FHA financing. But I'd rather if I can buy a 2-family if I'm looking at two 2-family right next door to each other one of them needs to sell superfast and maybe needs a little bit of work but they're offering it at two hundred grand if you can close it close on it in 14 days or you can buy the one next door for two ninety that's ready to go and the sellers in less of a rush but they know they're asking a little bit of a premium and so they're more receptive to an owner occupant buying it with FHA financing. Depending on how much work it needs and whatever my personal financial situation is at the time I may prefer to buy the one next door and forego the opportunity to use FHA financing because the deal itself maybe you make more it makes more sense for my investing thesis.

 

John Errico: [00:21:44] Yeah. So I think I mean it's kind of a difficult even general topics to discuss because it's so dependent on the particular asset.

 

Ben Shelley: [00:21:54] I would like to look at it through your guide size.

 

Ryan Goldfarb: [00:21:57] I think that's the most well I look at I look at all of these finance financing options as just another tool in the tool belt and there are different projects that are going to that are going to make a lot more sense for different financing strategies.

 

Ben Shelley: [00:22:09] Well say something you just said Ryan too is is interesting to note which is that from a buy side perspective to keep in mind that also the way you finance your property can have an effect on how the deal proceeds because certain sellers will be more in climbing. Naturally you're more inclined to take a cash offeretc. And as you go down and put less down it becomes more tenuous for that seller to proceed with with your offer. Yeah.

 

Ben Shelley: [00:22:32] Yeah. So I would say I've just SEO my own life as an example. I have I've purchased several properties or purchased a property with an FHA loan. That was the very first property that I bought. I lived in it as a multifamily proper 2-family property and it was a great success because I was able to live in one unit and rent the other unit ultimately move to the basement rent out both units essentially all the other investment properties that I purchased for buying whole purposes I've bought with I don't use that word commercial loan because I may be a little confusing but I've bought from banks that are portfolio lenders so like nonconforming non not conventional loans but that have terms that are comparable to conventional loan to conforming loans. To explain the reason why I've done that it might be important to tease out the difference between a conventional lender and a portfolio lender. A portfolio lender is generally going to be in this world of real estate finance like a local bank or your credit union or a savings bank or something like that that is interested in getting your business for whatever reason but is not either eligible or interested in reselling that loan. They want to continue servicing the loan for the life of the loan and they have enough liquidity and other advantages to continue servicing the loan for however long you have it. So the advantage with going a bank like that is that they could offer interest rates in terms that are very similar to conventional loans. They can offer a 30 year fixed loan at say whatever the prevailing rate is like 5 percent for 4.5 percent. However their standards as to your credit or your debt to income or whatever aren't governed by essentially federal regulations but by their own perception of your credit worthiness. So in my case in New Jersey I've been lending I've been buying homes in an LLC quite frequently and I don't usually want to transfer the home after I buy it. So for various reasons you may not want to buy a home in your own name and transfer it into an LLC with with a mortgage one being because the due on sale clause if your mortgage could be triggered and another being that your name is on the property records anyways you're sort of defeating the purpose. But having said all that if you want to get a in New Jersey if you want to purchase a property in the name of an LLC you are generally not going to be able to get a conventional lender to do that you're going to have to find a portfolio lender. So I've used portfolio lenders to do that but have offered me terms that are identical to a conventional conforming lender. So those are like I said before a 30 year fixed prevailing rate usually there's an underwriting process about my personal credit so they do look at my credit score and my whatever but if my credit score is above or below a certain number they may or may not disqualify me as it would in the world of conventional financing if my debt to income is a certain thing. It may or may not disqualify me depending on the banks discretion.

 

Ryan Goldfarb: [00:25:24] In that world, it's generally more asset based than then borrower based so that's they may have certain thresholds that you need to eclipse with respect to credit score or net worth or debt to income. But so long as you are above that threshold it's it's generally driven by whether or not the property itself is a good investment amidst that criteria.

 

John Errico: [00:25:42] And then there is leeway so that these banks will have they might have they certainly have their own standards but if you don't meet those standards you might be able to negotiate some some means to make the loan happen even if you don't meet the standards as opposed to a conventional lender where if you don't meet the standards you just tell me the standards because they the standards are set by federal regulations. So if you don't meet the standards that can't resell the loan and they're just not going to they're just not gonna accept it. So it would sometimes it could sometimes make sense to produce a property a multifamily property with hard money. In fact we're doing that right now. And the reasons why it would make sense to do that or what Ryan mentioned a few minutes ago which is that a you need to buy the property in a very short amount of time because it's such a great deal and or b the property is in such a bad condition that you can't possibly get lending from any other institution or whatever and or see you yourself don't have the personal financial you know credit debt to income whatever might be to qualify for a conventional loan or whatever other type of loan product you're looking for.

 

John Errico: [00:26:46] So in that case you're almost treating it like a a fix and flip it cept the flip part the cell part is going to be you refinancing that property into a conventional or otherwise more typical loan product.

 

Ryan Goldfarb: [00:26:58] Yeah another. This is actually just reminding me of a strategy that I haven't really employed in the past but that is an interesting thought experiment for the purposes of buying property. There are obviously advantages to you as a buyer for utilizing different financing strategies. And there are advantages for the seller as to why they might have a preference for one or the other. I think we've done this in the past but I don't know if it's ever been successful. I know of people who just like to make offers with multiple options embedded in the offer. So they'll say if you if you want a 21 day closing here's our number. If you're willing to go to extend this out 60 days will we're willing to pay an extra six thousand dollars or something like that. And that's generally just a way of quantifying the difference between the two different financing strategies how much it's going to cost you either upfront or over the duration of that. Something else we hadn't really touched on that is maybe a little bit more common in lower cost markets but there's something called delayed financing which is generally generally entails acquiring the property with cash and then obtaining financing after closing. So you buy the property for one hundred thousand dollars because you have the cash sitting around and then you approach a lender to refinance out as soon as you close. There are certain a lot of banks have limitations against it because they don't. They might have quote unquote seasoning requirements but there are some lenders who will do something like that they may just they just may have a little bit more restrictive terms they might not go as high leverage or they'll no limit you to a percentage of cost. You'll see you'll be limited your leverage will be determined on a loan to cost basis rather than on a loan to value basis. So if you paid one hundred thousand dollars for the property even if the bank praises it at two hundred thousand dollars they might still only lend you 70 percent loan to cost which is seventy thousand dollars instead of 70 percent loan to value which is a hundred forty thousand dollars.

 

Ben Shelley: [00:28:57] Yeah I mean I think as John always alludes to both in person and on on the show there are so many creative ways to finance your deals. And so I think you know one of the things obviously the theme of this episode is to look at all your bevy of options and identify what's the best strategy for you. But I mean for example I guess you could probably approach your seller to do like a seller financing and say you want one half million dollars let me pay five hundred thousand dollars in cash and you take a million dollar note and we'll set up some sort of amortization structure for sure you know for a year. You know the rest of your retirement. I think that's particularly good for sellers who are a little bit older.

 

Ryan Goldfarb: [00:29:31] And it's also often used as a bridge that you might say hey I I know this property is going to need a little bit of work and might take nine months to do it instead of going and getting bridge financing and then ultimately refinancing into a more permanent loan. You may just say hey seller will you take will you offer this seller financing. Give me two years or whatever knowing that you're going to probably refinance around the year one mark.

 

John Errico: [00:29:53] Yeah. And it brings up a good point which we can touch on very very briefly at the end which is the world of truly private financing which I would say hard money is a subset of or a type of. But as Ben alluded to a seller financing if you're if you're talking about somebody maybe even a friend of yours who wants to invest in real estate you can structure a lot of times people ask me like well you know how do I do it or like how do I get money from my friends or whoever to buy property. And there's no really satisfactory answer because you can structure financing and debt in this way in every way. We've talked about this before a little bit with very high level like financing for deals. But in terms of the interest rates are all the definitions we talked about earlier. All of those things are totally up in the air and there's it's unsatisfying to hear this but there really is no market for these things. It's really what you and the person that you're investing with want to offer. So you can you can ask. So you're investor you can ask your investor friends what are the sort of deals that you give your friends. But I've done that before and I've been amazed slash appalled at the types of deals that other people have have struck with people in the investment world and it's very common for a smaller properties that to be the case. Nobody knows what the market is. There's no commonly understood market interest rate for private money deal at all. I mean there's a hard money interest rate but that may or may not have relevance towards what you know your best friend is going to lend you to buy your property. So that's a whole other topic. I think they were getting into.

 

Ryan Goldfarb: [00:31:24] But to to that point the reason why a lot of these requirements and restrictions are in place for these institutional lenders or for these bigger banks or for Fannie Freddie at large is because they don't have any way of understanding you or understanding the deal without looking into these metrics and all of this is a way of. It's all it's all a means of risk mitigation. So if they can say on average if we only lend to people with a 720 credit score with a DTI below 47 percent. And we don't lend more than 70 percent on the purchase price generally across the board. These will be pretty safe lending opportunities. But your friend may look and say Hey John I know exactly what you've been doing for the last five years I've seen every property that you've bought. I know you as a person maybe we've done business in another capacity before your bank might want six like your bank might be offering you 6 percent but your friend they have a ton of money. He may want some real estate exposure and he may say I'll do it for five and I'll go a little higher on the leverage or whatever and it's ultimately it's an opportunity to create a win win situation when you truly understand everyone's needs. Because these banks have very different needs than what your investor friend may have and you have a very different need than the vast majority of investors who these loans are otherwise targeted towards.

 

John Errico: [00:32:44] Yeah it's a great point and I think it gets to to sort of a problem with the industry that we've talked about quite frequently and why now. I think with in particular the past like five to 10 years there's been a lot more institutional ish private lenders out there. So I think that for a long time hard money lenders were almost like seen as a like a subclass of human like they're just like the like loan shark you know like kind of sell your soul to get a property.

 

John Errico: [00:33:13] And now we're seeing hard money lenders that are venture backed that have billions of dollars in valuation that are advertised to me every time I watch a video on YouTube.

 

Ryan Goldfarb: [00:33:22] You know that sort of thing because they're listening and because John watches a lot of the noise I wonder gosh it's scary actually.

 

John Errico: [00:33:31] But so because of what Ryan indicated about the status of the market of conventional lenders reselling their loans and the regulatory environment that frankly has has come up post the last financial crisis the housing market crash there really are sometimes gaps in the market for investors that can only be filled by private financing either by like your buddy or by some of these companies that are coming up that offer private financing although look like big companies now. So there's a market opportunity in my opinion or in many people's opinion to offer different loan products that may be not in the world of conventional financing that we've been talking about in this episode.

 

Ryan Goldfarb: [00:34:13] For sure. I have a few other things that came to mind while we were discussing that I just want to highlight real quick.

 

Ryan Goldfarb: [00:34:19] Maybe as an annex or as an appendix footnote well known as a footnote it came in right at the right I was just a buyer of close it's a place yes right.

 

Ryan Goldfarb: [00:34:29] Right. The first is seasoning. John discusses a little bit before and I think I mentioned it too but there are one thing you may run into when you're looking to execute on a BRRRR strategy is that certain lenders will have seasoning requirements so they won't loan on something until you've owned it for a certain period of time and it's quote unquote seasoned. So that might be six months or nine months and they really just don't want to get too ahead of themselves with constantly you know having someone who's constantly recycling loans and it's another just another means of protection for these lenders.

 

John Errico: [00:35:04] And also your seasoning in the context of money that you're using for a down payment which is another.

 

John Errico: [00:35:09] Sometimes people say there's a seasoning requirement for cash used to close in a loan so that prefigured a slight point but is an important one. Usually with a conventional or even FHA loan or any loan that's not a private loan they're usually limitations on where you get the downpayment money for and it usually can't be lent. So again usually there's a seasoning requirement for money in your bank account. So if you just got a check for fifty thousand dollars in your bank account it either has to be because you transfer it from another bank account or maybe got a gift but it can't be because you got a loan from your friend in general right.

 

Ryan Goldfarb: [00:35:42] And you can't just throw some salt and pepper on there to season it.

 

Ben Shelley: [00:35:45] Oh no. Nice was just about we get it.

 

John Errico: [00:35:49] That's so many laughs. It's crazy just crazy. I was an editor. Actually the whole room I mean I was worried about the structural integrity of the building standing ovations. Crazy. Well I stood. Moving on. There was a body. It's just a. I was in here. It was in silence.

 

Ryan Goldfarb: [00:36:04] The next thing is interest rate risk. This is I think only really applicable to commercial loans. I've never heard of this in a in a residential mortgage context. But if you're looking at commercial financing and you're obtaining an adjustable rate loan or a floating rate loan you may see that your lender requires some form of interest rate protection which can be in the form of an interest rate swap or an interest rate cap. The mechanics of each of these are a little bit different but they functionally serve the same purpose. It's to it's to offer you some type of protection against a crazy spike in interest rates and it keeps your interest rate payments. Those still variable a little bit more predictable so they generally they they wouldn't exceed a third a certain threshold up or down predictably variable rate. Next one was John also mentioned this with his some of his rental properties but it's not uncommon for investors to run into the issue where their lender will not loan to an LLC. It's just best to vet this upfront and to ask and I think this is actually a good lesson across the board but if you have any concerns about any one of the points that we've discussed today just ask your lender because it's a lot easier to figure out a way around it. At the very beginning they may just put you in a different product entirely but it's a very it's a lot easier to deal with it at the beginning than to try to deal with an issue when it comes up two months down the road or 45 days down the road when you're already in underwriting or when you've gotten your commitment and then you're looking to close.

 

John Errico: [00:37:45] And it reminds me of one other issue that I've run into which is that you might actually be disqualified from getting a loan at all because you have too many loans just in general.

 

John Errico: [00:37:54] So there is there is a Fannie Freddie guideline where you can only have X number of loans that's it doesn't matter what your debt to income ratio is.

 

Ryan Goldfarb: [00:38:01] About anywhere between like four in 10 per person.

 

John Errico: [00:38:04] Right. And again with a portfolio lender you might not have the limitation in with a private lender you probably won't have the limitation either.

 

Ryan Goldfarb: [00:38:12] There are also sometimes you may you may see some escrow requirements for things like taxes or insurance on larger properties you may also have escrow requirements for replacement reserves. It's usually something that can be negotiated but sometimes there's a hard stop on these things.

 

John Errico: [00:38:29] That's another thing. There are definitely in the world of again like Fannie and Freddie compliant loans. You will often find reserve requirements for certain types of loan requirements and you'll have to keep reserves for your other property SEO and eight other properties the bank might say. OK. We need to have 15 thousand dollars per property in a liquid account which can be a lot.

 

Ryan Goldfarb: [00:38:50] And that's actually that could be what's called a covenant a loan covenant which is actually the last point that I had written down but a loan covenant is an obligation that you agree to maintain throughout the life of the loan as a as a condition of that loan and a failure under your covenants may trigger it may trigger some type of action that could be default. It could be some kind of renegotiation you may have a covenant that says your group this is more relevant for commercial property but you may have covenant to maintain a certain level of occupancy through for the property and if not you may have to pay the loan down a little bit or they may hold back some kind of retainer or some money in escrow. It can be any number of things and when you're in the money on the commercial lending side that's when you'll see covenants that are a little bit more unique and tailored to that specific deal and the specific risk profile of that deal.

 

John Errico: [00:39:49] And in the residential world you could argue that you have a covenant for primary resident type properties that you have to intend to live in the property for a certain amount of time.

 

Ryan Goldfarb: [00:39:57] Yes. I just got lawyered up legally.

 

Ben Shelley: [00:40:00] Well more than in any episode I think we have ever created. I would very much recommend listeners. Go back to the beginning of this episode with pen and paper in hand take notes make sure you fully understand these concepts. If you don't look them up or feel free to reach out to us on our socials and I appreciate you listening. Guys thanks so much for your time and expertise as always. For the folks listening at home make sure you subscribe to us wherever you get your podcasts. You can find us on the brick by brick. That's brick X brick Facebook and Instagram. Thanks so much for listening.