Creative Real Estate Financing Q&A
I was recently asked some great questions in my real estate community that I wanted to share with you all. I hope the answers help you in your real estate journey.
Q1: Hey Robert! What financing did you use on this acquisition?
A: I used commercial financing via a small credit union. It is essentially "hard money" for the purchase (up to 12 months term), then once the BRRRR is done it gets refinanced into long-term (20-year amortization, 5-year term) debt.
Q2: Great, thanks! This probably isn’t front of your mind, but what’s your plan as you draw closer to year 5?
A: Most likely just refinance with the same lender, but I might not own those properties in 5 years, might sell them at the 5-year mark, might refinance with a different lender, might pay them off, etc.
Want feedback?
Do you have a deal you’re considering? Do you want me to take a look at it for you and provide feedback? Did you complete an analysis of a property yourself and want some feedback on the analysis itself? You can submit your deals and analyses for me to review by emailing the details to robert@therobertleonard.com
Q3: More just to understand the pros and cons here, but have you thought through a worst-case scenario? I.e. The market drops significantly, and the value of the home is now worth less than the principal owed, as you approach the 5-year mark. Just curious how you’re thinking through it, as I know you err conservative with investing and 5-year term, imo, seems a bit risky. Thanks!
A: I definitely have given it quite a bit of thought, since not only do I have one of these loans currently, but I have three Please do continue asking these questions — they're great. I have thought this through a lot this time, but there is likely a time in the future where you have a question I haven't thought of or raise a point I hadn't considered.
It certainly is risky. I won't sugar coat that — it is risky. The absolute worst-case scenario is foreclosure. Part of the worst-case scenario includes: tenants not paying rent, not being able to refinance with ANY financial institution when the 5-year mark hits, the property being worth significantly less than the principal remaining, and me having no reserves. In this case, the loans would be due in full and I wouldn't be able to perform (meaning I couldn't pay them off in full). The bank would then likely start the foreclosure process.
However, I'm not too concerned with that actually happening. The biggest reason is that the bank has no incentive to actually foreclose. I keep significant reserves set aside to cover the mortgages if tenants stop paying. My business partner and I make enough money to cover the mortgages ourselves if we had to, but even if we both had no income, we have the reserves. If the bank got to a point where they had to foreclose because I couldn't pay the loan in full when it came due, that means I couldn't sell the property. If I couldn't sell the property, they likely couldn't sell the property either (or would have a really hard time). It's expensive for them to foreclose. They already own the loan, so it'd be much easier for them to just do another loan, especially if I had been a good borrower all along without missing any payments. I can't see a reason why they wouldn't lend to me again if I hadn't missed any payments for 5 years.
Also, with a 20-year term, the principal gets paid down quicker than a 30-year, so I'm not too concerned the property prices will be lower than the principal amount at the 5-year mark. I specifically invest in areas that focus on cash flow and not appreciation, which reduces the volatility of housing prices.
Q4: Great analysis my man, really love that answer. Thanks a ton for the completeness and walkthrough of your thought process. Definitely helps me think things through as I consider different ways to finance my first investment. I also bet you’re getting better interest rates on that when compared to a 30-year standard, conventional mortgage.
My last question for day: how many banks or lenders did you contact before settling for your current? And any tips for finding the right ones? I always hear small regional banks on BP, but wondering if there’s anything else to look for.
A: My pleasure. You mentioned, "Definitely helps me think things through as I consider different ways to finance my first investment." — Just to be clear, I probably would NOT do this on my first investment. I don't know that 100%, but I most likely wouldn't.
"I also bet you’re getting better interest rates on that when compared to a 30-year standard, conventional mortgage." — The rate is actually a bit higher on these types of loans because there is more risk for the lender and they're a lot more flexible. If you can, conventional, 30-year debt is almost always the way to go. What I used is a suboptimal alternative when 30-year conventional isn't an option.
I have used 5 different lenders in total in my real estate journey — every single one has come from a referral from a fellow investor or my agent. For the TX rentals, I used the referral from my agent — he gives me referrals for everyone to use (contractors, electricians, plumbers, lenders, insurance, etc.). This is the lender he uses, so I used them too. I talked to them first before blindly using them, but referrals are the best way, in my opinion.
What questions do you have about creative real estate financing or real estate in general?
All the best,
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