Real Estate 015: Finding a Lender to Finance your Rental Properties

Now that you have learned about the benefits of real estate, how to identify a market, analyze a deal, and applying different strategies, it's time to understanding the financing. As David Greene mentions in his book “Long-Distance Real Estate Investing”, there are a “core four” you need in your real estate team that is comprised of the deal finder, the property manager, the contractor, and the lender. Today we will be discussing the lender and their role in financing your deals.

Before you start looking for properties, it's important that you receive pre-approval from a potential lender to understand your buying power. This will also give you a leg up on the competition because it shows the seller you are a serious buyer who is capable of closing. In a hot market, a pre-approval is a minimum requirement to get your foot in the door and have your offer be reviewed.

When you are looking to build a relationship with a lender, you may come across direct lenders as well as mortgage brokers. In short, direct lenders are actual lenders such as banks and credit unions that will have in-house underwriting and review your documents themselves. On the other hand, mortgage brokers will connect you to different programs that they have build a network around and be an intermediary between you and the final lender from start to finish.

There are pros and cons to using direct vs a broker as a direct bank may have more flexibility in terms of removing some of their own underlays as well as the convenience of dealing with on shop when doing multiple loans across your portfolio. On the other hand, brokers are able to shop around rates with different banks and also become your advocate in terms of trying to get you the best deal possible. In addition, you may come across complex deals that the direct lender you have worked with in the past is unwilling to lend on. This is when the mortgage broker can speak with multiple banks in hopes to find a lender who will loan you the money.

Finding a lender will vary depending on where you want to invest as well as your asset class. For the purposes of this discussion, we will assume that we are seeking residential mortgages for 1-4 unit rental properties in the state of Missouri. As your lender needs to be licensed in the state in which your property is located, it may benefit you to find a national lender who has the license and knowledge to lend in most if not all 50 states. To find a lender, you can ask your investor network, Biggerpockets forums, and local real estate property managers and agents, you may notice names being repeated as lenders who have a high reputation for being investor friendly and closing deals are sought after.

Once you have identified the lender you would like to work with, it's important that you ask them good questions to ensure that you understand one of the core members of your core four. Remember that you do not have to “impress” them as they too are trying to earn your business. Some lenders do not like to work with investors, a quick interview is also a good way to measure how responsive the lender may be and also see if they are investor friendly.

When you are obtaining a Fannie Mae (conventional) mortgage, banks have to adhere to certain rules and regulations set by the government agency, however banks can have their own “overlays” and rules (e.g. maximum 4 properties per person vs 10), so it's important to be able to identify the differences between Fannie Mae’s requirements and the bank’s additional overlays. It may be disadvantageous for an investor to work with a bank with multiple overlays which restrict the investor from scaling their portfolio. Below are some basic questions you may want to ask your potential lender:

1. How many loans do they close per month (understand the bank’s volume and experience. A bank doing 35 loans a month may know how to navigate complex situations vs a bank doing 3 loans a month as they will have seen more unique cases).

2. What type of loan programs are available? (e.g. Owner Occupied, Non-Owner Occupied, VA, FHA, Conventional, Portfolio, Delayed-Refinance)

3. What states are you licensed to operate in?

4. What are your minimum and maximum loan amounts

5. What paperwork is required, Debt to Income (DTI), Debt Coverage Ratio requirements?

6. What are current interest rates for a FICO score of XXX?

7. What fees are involved (administration, closing costs, etc.)

8. What is your average time to close?

9. What is the maximum number of loans per person?

10. What are the reserve requirements per loan, do you help investors with planning for multiple loans?

The answer to these questions will vary from lender to lender and I would recommend you interview at least 5 lenders to understand the differences and similarities across the market. Once you have selected a lender you would like to work with, you will need to submit the paperwork required to get pre-approved. This will result in a hard inquiry and briefly lower your credit score, so make sure you are ready to purchase a home in the near future. Once you are pre-approved, you are ready to make an offer on a property.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Real Estate 014: To buy or rent, that is the question

For people who are looking to move, there is always the question that one asks themselves, “is it better to buy or rent?”. At the time of this writing, the US real estate market has seen close to 8-9 years of solid year over year appreciation. While no one has a crystal ball, history tells us that the real estate market goes up and down through different cycles that last as short as 6-7 years to as long as 10-12 years. Whether you are single, newlywed, or have a growing family, the decision to buy or rent can have multiple trickle effects to your financial situation and future trajectory. It is a very important decision. Many people see their friends buying their homes, market going up, and wonder if they need to buy now as well. Let's take a look at some of the pros and cons of buying a house vs renting as well as other factors to consider before making this decision.

Before you even jump into the idea of looking for a house to purchase or contacting a realtor for showings, you need to have your finances in order. This can include reviewing your credit score through your annual free checkup via the three major credit bureaus (Transunion, Equifax, Experian) or you can sign up for free services such as CreditKarma.com (I personally use this and love the ability to check my score through a “soft inquiry” that doesn’t negatively impact your score. ALthough the credit score you see on Credit Karma may end up being lower than what your mortgage lender actually sees when they pull your FICO score, in my experience, it has been very close (+/- 5 to 10 points).

Although its widely accepted that owning your own home is part of the “American Dream”, there are alot of things that come along with owning your home. You have to ask yourself if you are ready to handle the extra costs and maintenance that comes with owning a home. Furthermore, look at other areas of your finances to determine if you can withstand any sudden life changes (e.g. new baby, loss of job, job relocation):

1. Do you have an emergency savings account with roughly six months of expenses?

2. Do you have any large student loans or credit card debt that may have variable interest?

3. Do you have down payment + closing costs saved for your new home?

4. Will your new mortgage be under 30% of your debt to income ratio? (DTI) - Lenders look at this as a metric to determine if the borrower’s capacity to repay the loan.

5. Does your job require you to move frequently? (e.g. state to state or military)
   

If you have answered “yes” to any of the above, there is a good chance you may need to wait a little longer before you decide to purchase and think hard about this move.

Assuming you have decided that renting is out of the question and you are ready to buy, let's consider some of the pros and cons of buying a house.

Advantages

1. Building Equity

By purchasing a house with “other people’s money” (e.g. bank or private lender), you are able to lock in a payment (typically fannie mae 30 year fixed rate mortgages) where you build equity as long as you are current on your loan. As the loan is being amortized over 30 years, the first 12-18 years will mostly be interest payments, however, you still will increase share of ownership compared to a lease situation. Furthermore, as your payments are fixed (unless you have variable interest mortgage), you are not impacted if your landlord wants to raise rents 5-10% each year over the next 10 years, or are you impacted if the landlord decides to sell and not renew your lease, in which case you are forced to move.

2. Tax Benefits

The US tax code allows us to deduct interest associated with your home’s mortgage as well as property taxes. Note: There may be other tax favorable treatments, but please consult your CPA to determine what fits your unique situation. Further, starting 2019 tax year, the standard deduction has increased to $12,000, meaning your the break even point on standard deductions vs itemized (tax benefits mentioned above) has gone higher. You need to evaluate the price point of the home, as well as possible tax advantage amounts before assuming one is more beneficial than the other

3. Appreciation

Generally speaking, US real estate has appreciated over a long period of time. However, there also have been multiple down turns that have had negative consequences to homeowners who wanted to sell. I personally consider appreciation to be icing on the cake, as speculation can be a very dangerous gamble from an investment standpoint.

4. Pride of ownership

As a homeowner, you have the freedom to do make updates to your home as you please (within laws/regulations, HOA guidelines, etc.). This means that there is no landlord to stop you from using nails to hang picture frames, paint the baby room purple, or have a vegetable garden in the back lawn. Furthermore, some view a home as a long-term situation compared to leasing, as such you may psychologically feel more attached to your house, neighborhood, and feel grounded.

5. Using Leverage (Bonus - Investor’s Perspective)

This last advantage has been mentioned less by potential buyers evaluating decisions as most new homebuyers do not think like an investor. However, as an investor myself, I like to purchase my primary residence as I know there are a couple different ways to make money.

In my neighborhood, I was renting a 2 bedroom apartment for close to $1,800 a month. However, after 1 year, I decided to purchase a 3 bedroom townhome which resulted in monthly expenses of $2,700 a month. When normalizing the tax benefits I would receive on this property, I was able to credit about $300 a month to the “buy” side ($2,700 - $300), making it a $1,800 vs $2,400 decision, with the difference being $600. I ended up renting out one of the bedrooms for $750 a month which actually made my decision to buy $150 cheaper per month. Furthermore, the price of the home increased $70,000 over two years when I received an appraisal for a HELOC (home equity line of credit). Using this HELOC, I purchased two additional rental properties that cash flowed $700 a month after all expenses - $200 HELOC payments = $500 additional cash flow, which further brought my “buy” side down to -$650/month. Looking back, this was a no brainer for me, and I would gladly make these decisions again as I am creating equity in my primary home and two rental properties, have tons of tax benefits, reduced my cost of living, and did this all using other people’s money. Note: Not all home purchases can result in my experience, in fact, if you buy too much of a house in coastal markets of LA, NY, SF, etc. then you will probably lose money most of the time vs leasing. However, if you buy slightly undervalued properties at the right time (historical low interest rates 2012-2015), then you have a good chance of success.

Disadvantages

1. Lack of Flexibility

Due to the costs associated with buying, maintaining, and selling a home, there are fixed costs that require you to wait, or season, before you will break even. For example, if you have purchased a home and 6 months down the road you need to sell, unless the home has appreciated 10% or more, closing costs (transactional + commissions, etc.) alone may put you in the red. If you are not sure that you will be staying in a certain location or job for 2 or more years, it may be best to rent until further notice.

2. Dealing with maintenance

As a renter, when there is a leaky pipe, or broken toilet, you call your landlord. Unless there was excessive damages caused by you, the landlord is responsible for wear and tear, as well as general upkeep of the home with due notice. Once you become a homeowner, that switch is flipped and you are responsible both financially and mentally dealing with the stress of the repair.

3. Opportunity Cost

The difference in total cost of owning a home - leasing = financial opportunity cost. You may be better off using the difference to invest in the stock market, real estate, or other self improvement to get you that promotion or new job with better pay and benefits. Also, there are intangibles such as being able to easily relocate to other market, from LA → SF to work for a startup tech company or move from NY → Thailand to drastically lower your cost of living, be with family, or live a lifestyle by design. A mortgage will most likely be the biggest expense in your personal finances, so make sure that it doesn't become your golden handcuffs.

In conclusion, be sure you have adequately planned for any unforeseen expenses that come with home ownership - foreclosure can be a painful and detrimental to your financial health for many years. Furthermore, if you have big life changes ahead of you (e.g. marriage, new job, new child), remember to factor in how each of those events may change you stance in wanting to root yourself in a new home.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Real Estate 013: Pros and Cons of Section 8 Rentals

When placing a tenant in your newly rehabbed or purchased rental property, finding a suitable candidate may often depend on various factors such as neighborhood, schools, type of home (single family, duplex, bedroom/bath count), and time of year (winter vs spring). The US government has a housing assistance program called “Section 8” that is funded by the Federal government but administered by the local authorities. This may present an opportunity for real estate investors to tap into a different kind of pool of tenants. Potential candidates for Section 8 assistance must submit an application and become accepted into the program. Typically these spots are reserved for low income families, disabled persons, and/or senior citizens. As a landlord, you can legally choose to participate or not participate in the Section 8 program. As I have two Section 8 properties, I wanted to share with you my experience with the program and dispel some myths:

Advantages of Section 8

1. Tenant Pool

By choosing to accept Section 8 applicants, you are “widening the net” to include both market rate tenants and Section 8 applicants with vouchers. This will allow you to be more selective in your tenant placement and technically have more candidates that meet your pre-defined criteria.

2. Guaranteed Monthly Income & Higher Rent Rates

One of my favorite parts about participating in the Section 8 program is that a portion of the rents (70-80% average for my rentals) is being paid on the 1st of each month by the Government. As long as the tenants do not lose their voucher or you, as the landlord, do not fail multiple Section 8 inspections, you should be receiving these checks via ACH like clockwork.

Further, as the Government determines the appropriate rent range in a given market for the type of house (3 bedroom 1 bath $750-850 vs 4 bedroom 2 bath $900-1,050), the landlord is able to select the higher rate of the range as long as the tenant has the voucher to support the rent (3 bedroom vouchers vs 4 bedroom vouchers).

3. Lower Vacancy

Tenant turnover is one of the single biggest expense an investor faces. When your property sits vacant, it generates no income, but there are many fixed expenses such as the mortgage, taxes, and other fees that occur monthly. Based on conversations with other investors who have done Section 8 for 10+ years, if the Section 8 tenant is happy with the property and landlord, they will stay put for a longer time than their market rent counterparts who often move more frequently for their children’s schooling, new job opportunities, and to find a larger home/purchase their residence.

Disadvantages of Section 8

1. Section 8 Inspections

On an annual basis, you are required to undergo a Section 8 inspection with the housing authority’s designee. This may cause you to make some rehabs sooner than later if the inspector feels that updates need be made immediately. There is not cost involved for the landlord (other than your property manager potentially charging you for their time to meet the inspection and perform the updates).

My take: I personally feel that having an annual inspection at no charge is a benefit for real estate investors as it forces me to take a look at my property and ensure everything is up to code, there is an liability exposure, and preventive maintenance items are taken care of. As the inspector is not looking to make cosmetic improvements, but make sure the property is functionally sound, it serves as an additional line of defense.

2. Wider selection, but “rougher” tenants?

Generally speaking, it appears to be widely accepted by real estate investors that Section 8 tenants are rougher on the homes and cause more wear and tear on their properties. This idea stems from the fact that since they are receiving assistance, and not pouring all of their own hard earned cash into the rent, they have less skin in the game to care about what happens to the property.

My take: I think that regardless of market tenant, or Section 8, you still need to do your due diligence and be thorough in your tenant selection process. Contrarily, as tenants may lose their voucher if they cause excess damage than normal wear and tear, and as Government funding gets tighter, Section 8 tenants will think twice before “trashing a property” that they live in. I’ve had B class market rate tenants trash a unit, and also had C class Section 8 tenants who were very clean and left my property in great condition.

3. Dealing w/ a Government Agency

As this is a Government program, you will have to work with local authorities when issues arise and that may mean time lost. Some counties are notorious for not responding to an email for weeks and taking up to two or three months to setup a new tenant in the system for payout. However, all strategies have their pros and cons, risk and rewards. As for Section 8, after it has been initially setup, it has been on autopilot, and I have received the Government’s ACH and tenants money order every month without issues along with an addition $100-200 what I would have received with a market rent rate tenant.

In conclusion, I think there are different strokes for different folks and some may not see the benefit of working with Section 8 tenants. I personally feel like in the markets which I invest in have a great Section 8 tenant pool, with above market rents that will allow me to cash flow a minimum 5% higher with little to no additional risk. Furthermore, on a personal level, it gives me a sense of pride that I am providing a roof over the heads of those who need it most: senior citizens, disabled persons, and/or low-income families.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!