When it comes to this chaotic economic environment generally what’s a good bargain for you is not necessarily a great one for the lender. Let me explain how things work today.
Let’s say you look at this vacant apartment building and after doing your math the potential Cap. Rate is at 15%. Awesome, you think! The lender should be able to see its potential so there should be no problem securing financing. Well, not quite! The first thing the lender thinks about is risk. What if you default on the loan and they get stuck with a vacant property that generates no returns? A lender’s willingness to invest in your deal will be based on the “What if’s” that are thoroughly analyzed.
So, let’s get this straight, what’s feasible and what’s not. Unless you and the transaction qualify for HUD financing there are no conforming programs with low rates. Don’t be in hurry to apply for a HUD loan if you’re buying for example a $500K distressed property. HUD financing is for sure a different breed. But let’s stick with your great deal on this apartment building. After you spend weeks looking for the best program with the lowest rates and points you realize there is no such thing. But, you tell yourself, this is a great deal that can be stabilized in so many months! Yes, I know and I have faith in you, but lenders don’t think that way.
So, how do you then get the financing? I am sure you’ve heard of hard money lenders. Oh no, it sounds so awful! You’ve heard before that those are the sharks that make lots of money by charging high interest rates and high points. Well, yes, they charge higher rates and higher fees to compensate for the higher risk. If you encounter difficulties and default in two months then your problem becomes their problem. Again, a reminder that any investment return is based on risk, the higher the risk the higher the returns and vice versa. And for them a vacant property that yet has to be rehabilitated and leased out is a high risk.
Knowing this you’ll then want to determine whether hard money financing is worth it or not for your deal. Here are a few tips for you.
1. Your initial investment is at roughly about 50% more or less of the acquisition cost. Acquisition cost includes the purchase price, the cost to rehab, and the closing costs.
2. Hard money lenders are in it for a short period of time. You won’t get long-term loans with them, typically 6 months to a year. That means you must stabilize the property within that time frame.
3. You won’t get financing without a solid Exit Strategy. If you just tell them you’ll sell the property that is not considered a solid strategy, unless you can prove a future sale with a P&S agreement from a qualified non-related buyer, a substantial deposit, and the ability of the qualified buyer to purchase your property.
4. What’s considered a feasible Exit Strategy is your and your building’s ability to qualify for future permanent financing.
5. If you’ve never owned an apartment building in the past it’s very realistic to say that you won’t get the financing unless you can prove you’ve had extensive experience in the field. Or if you partner with someone who has the experience of ownership, that may be another way.
6. If you’re trying to borrow the down payment from another source that’s a “no, no”. You must prove it’s your own capital you’re investing.
7. If you’re using all your money for this transaction and you’re left with a dollar in your bank account it’s another concern. You must prove you have enough reserves to continue with the project just in case the preliminary estimates have been under-estimated.
8. And finally, you must be well equipped to prove yourself and the potential of your deal. I’ll teach you how to build your credibility with the lender in a future post.
Yes, effort on your part is expected into such a transaction but if the outcome looks bright it may be worth it. I wish you luck and prosperity! And don’t forget to visit my site to learn more about how I may be able to help you with your potential deal.