Archives for January 2015

Property Investment Basics: Mortgagee vs. Mortgagor

Understanding some basic property investing financing language

Novice real estate investors sometimes get caught up and lost over all the property investing jargon – especially when it comes to basic financing options. This article is a brief primer on some of the most often used terminology involved with the concept of the mortgagee vs. mortgagor relationship, as well as the two essential forms of loans investors encounter when investing in real estate…namely, conventional and commercial types of loans.

Welcome to property investing loans 101

Some of the most basic language you’ll need to understand are the difference between a mortgagor and a mortgagee. This is simple enough. A mortgagor is the borrower (and therefore, the buyer) of a piece of investment real estate. The borrower is putting up the property to be purchased as a security for the mortgage loan. And where would the mortgagor be without the mortgagee? The mortgagee is therefore the lender in any mortgage loan deal. So what is a mortgage lender? Lenders are comprised of companies that are licensed by their respective state to make real estate loans that can then be legally sold to investors.

Mortgage lien

The pledge of real estate as a security for the repayment of a debt is known as the mortgage lien. It can also be the document that creates the mortgage lien. It’s a charge on the property of a borrower (the mortgagor) that is the security instrument for the total debt obligation of the mortgage note. A great deal of mortgage law involves the mortgage title, which is evidence of the ownership of a piece of real estate by the mortgagor. Title companies are hired by prospective purchasers to research the chain of title of a property to ensure the seller is the only current owner of the real estate to be conveyed once it’s mortgaged. The title company then offers insurance to the borrower/buyer to ensure that they will now become the sole owner of the property.

Land contracts

Also known as a mortgage for land, installment contract or contract for deed, a land contract is a contract for the sale of a piece of real estate where the purchase price of the land is paid in installments by the purchaser. The purchaser will retain possession of the real estate, even though the title is kept by the seller until the final payment of the contract is completed, however long the contract stipulates. Mortgage law also defines an equitable mortgage as being the interest that’s held by a contract vendee involved in a land contract. This is comprised of the equitable right to obtain total ownership of the property when the legal title of the property is in another person’s name.

Conventional investment real estate mortgage loans

Most conventional investment property mortgage loans are standard income and asset verified loans. They can be comprised of conventional 30 year terms, or short-term adjustable rate mortgages (ARMs) with balloon payments – much like their counterpart products in the residential home buying mortgage market.

Most of these type of loans need a minimum of 30% down. So you’d be obtaining a loan of 70% of the purchase price. Your loan-to-value ratio (LTV) would therefore be 70%. When buying investment property, you’ll usually want to try to obtain the greatest return on investment (ROI). Leverage is one of the ways you can purchase multiple properties over time, and thereby maximize your ROI. Depending upon your credit rating, as well as the type of property you’re purchasing, the down payment required may be higher, and could go up to 50% – and therefore your LTV would be a low 50% as well. In addition, the points charged on the loan (pre-paid interest) are roughly twice as high as for a conventional home loan.

There are some lenders who still make no income verification, or no income and no asset verification type loans to investors (also known as NINAs). Due to the inherent extra risk of these loans (from the lender’s perspective), you can expect to pay more in the way of higher interest rates, as well as more points on these type mortgages.

Commercial investment property mortgage loans

When considering the purchase of 5-family or above rental buildings, or more typical commercial space (for example, office buildings, retail stores, warehouse buildings), you’ll have to move up to a commercial loan. Lenders have separate divisions which evaluate and then offer mortgages on these type of properties. Since commercial properties are much more specialized, their inherent risk needs to be evaluated as a niche within most banks’ lending divisions.

Banks tend to rely greatly on commercial building appraisers, who are akin to the Jedi knights of the appraisal industry. Unlike conventional residential mortgages, there will be more attention paid to your loan qualifications, as well as the existing income statement of the property you’re considering purchasing. Also expect rates and points to be higher than conventional rental real estate loans.

photos courtesy of kwcommercialsa.com, lgfcunewsworks.org, worldpropertychannel.com, allmandlaw.com, mediacenter.dw-world.de, ocdwellings.com

Property Investing Basics – The Right Of First Refusal

One more useful tool of the trade…

The right of first refusal (or ROFR) is another excellent tool a property investor can use to manage risk and rewards. As a seller of investment property, the first right of refusal allows you to get something extra in return for providing a legal option for the potential buyer. As a buyer, this first refusal option allows you to lock down a property at some point in the future…sometimes at an agreed upon price, sometimes at a price to be negotiated later. In either case for a buyer, this right of first refusal real estate essentially creates a monopoly for one – you. All your competition gets eliminated in the process…a nifty arrangement for any buyer.

ROFR = financial benefit gained

In the case of a seller offering the right of refusal, some financial benefit usually accompanies the largesse of providing right of first refusal language in a formal agreement. Many times, it is a tenant who wants to take advantage of the prospect of a “rent-to-buy” scenario. I have done this on occasion with tenants for my single family houses. A fixed purchase price is arrived at between the parties, and incorporated into their lease as a first right of refusal real estate option. The tenant then has the right to purchase the property at the pre-negotiated price. They are usually given a set time window in which to exercise this ROFR option. At the end of that window, if they have not exercised their option, or if they have turned it down, then the seller has the right to place the property on the open market for sale.

Above market rents as option fee

In this scenario, the seller may be able to receive a higher rent from the tenant for their “buying” of the legal option. In addition, many times a portion of the increased (above market) rent can be applied towards the purchase price as part of their (already paid in) down payment on the property. Another point of negotiation between the parties may be the percentage of rent that will be applied to the down payment. If they choose not to exercise the option, the buyer effectively “loses” the amount they have been paying for rent that is greater than the “normal” market rent for the property.

Buying time to secure financing

If the property investor is the potential buyer of a piece of rental property, a right of first refusal gives them time to secure financing for the property, over and above a normal sixty to ninety days. Usually, a property investor buyer will need to pay some sort of ROFR option fee for this privilege. As mentioned above, this legal option effectively eliminates any competition for the property. Therefore, it has some value attached to it. And that option fee is a negotiated amount between buyer and seller.

The importance of the written agreement

All right of first refusal language should be written by an experienced real estate attorney. Language must be very specific to cover many possible scenarios. The stronger the language, the less chance the transaction can end up in court somewhere down the road. There are many variations and conditions that an attorney will make sure are clarified prior to the parties signing the agreement. As an example, there will traditionally be a limited amount of time in which the transaction must close once an option is exercised. Also, the ROFR option may be transferrable to another party (known as assignment). Again, all conditions need to be negotiated prior to the agreement being fully executed. Overall for the real estate investor, right of first refusal makes for another useful tool in their property investing arsenal.

photos courtesy of landthink.com, thompsonburton.com, pittsburghlegalbacktalk.com, jayfalone.com, robertgsarmiento.org

Commercial Leases And The Estoppel Certificate

Why the need for an estoppel certificate?

Simply put, the estoppel certificate is an instrument of assurance. The assurance is that what a landlord says about his lessees is true. When a landlord puts his commercial building on the market for sale, part of the due diligence a buyer will require involves obtaining estoppel certificates from each and every tenant of the landlord for his particular building. While this is rarely done in residential real estate, getting a tenant estoppel form properly filled out and signed is imperative in commercial real estate..

Traditionally, a standard commercial lease will include the right of the investment property owner to obtain this signed landlord waiver from his tenants. These fully executed documents, known in estoppel real estate parlance as estoppel certificates, provide a potential buyer of the seller’s property with honest data about the leases they have in place with the current landlord.

Due diligence

The landlord waiver form is then used as part of the overall due diligence by the buyer. And many times, their lender will want to review these estoppel certificates prior to extending a mortgage to the buyer. They help the lender feel comfortable about the rental amounts and terms that are in place with the seller’s building. Usually, the lender’s underwriting department will perform the review of the documents to ensure accuracy before a loan will be granted. Unlike residential real estate, commercial property rental leases are usually for much longer periods of time. However, like in residential investment property sales, these lease assignments are critical to the new owner when a building is sold.

Provisions of the estoppel letter

The estoppel certificate (also known as the estoppel letter) is traditionally filled out upon the request of the landlord. In effect, the tenant certifies that their current rental agreement and its provisions are honest and truthful. Items usually found as part of the estoppel certificate include the veracity of the lease, when it began and when it ends, what security deposits are being held by the landlord, whether the tenant has assigned the lease to another party at the time of the estoppel letter, and whether the tenant has pre-paid any rent over and above his existing monthly rent.

Tenant Liability

The main purpose of the estoppel certificate is to protect the seller of the building. It basically places the onus on each tenant that their existing lease is correct. This makes the leases fully verifiable for purposes of the new owner, as well as their lender. Most estoppel forms create an out for a tenant’s liability here – many times they will say that the tenant is certifying the lease “to the best of tenant’s knowledge.” You can check out such verbiage by looking at the California Association of Realtors commercial lease agreement as just one example (http://www.car.org/legal/standard-forms/) . The tenant estoppel form is an important landlord waiver when it comes time to place his commercial investment property on the market for sale. Ultimately, it makes a sale much easier for the seller.

photos courtesy of campbellpropertymanagement.com, oc.hughesmarino.com, realogicinc.com, www.snipview.com

Financing 2015 Tips For Property Renovations

Some additional creative financing tips

While there are some obvious and creative ways to finance any property investment renovation project, consider these tried and true options as we head into this new year. Any form of financing that offers using other people’s money (OPM) to create a deferred form of payment for you as a property investor, is a great way of creating more leverage as you upgrade and improve your investment property. Adding market value with financing leverage is an excellent way of increasing your overall return on investment (ROI) for any rental property.

When first acquiring an investment property, try using an FHA loan. Most FHA loans require owner-occupancy. And this can be accomplished if you plan on purchasing a multi-family home, and plan on living in one of the units as an owner-occupying landlord. Chase Mortgage, for example, offers FHA loans as part of their mortgage portfolio. To see if you qualify for any type of mortgage, try using a home loan calculator provided by the lender. Or use one of the mortgage calculators included here, on our site, specifically for property investors.

FHA 203K loans

If you don’t plan on becoming an owner-occupied landlord, consider a Homestyle Renovation Loan, also known as the FHA 203K renovation loan. This style of mortgage can be taken out when you want to expressly bundle all the fix-up costs on a prospective investment property , and roll them into the entire mortgage on the property when you first buy it. The Homestyle Renovation Loan is offered through Fannie Mae (FNMA), and allows investors to roll their renovation expenses dire4dtly into the overall mortgage loan on the property. And you don’t need to live on site either.

The increased use of leverage using this particular mortgage product is excellent for property investing. Save your cash funds, and utilize the lenders money to finance expensive renovation costs that will invariably boost the marketability and market value of any investment property –whether you intend it as a hold ‘em rental property or a flipping opportunity. In addition, this will open up the use of your personal capital for other projects that may come up in the near future. The 203K loan can be used on any house, multi-family (under 5 units), townhome or condo renovation project. And more importantly, it can utilized no matter the existing condition of the property. Mortgages of this variety carry loan to value ratios in the fifty to seventy-five percent range, all depending on the property.

Property leverage advantages

This type of loan is great news for investors who really want to leverage properties. Instead of sinking a great deal of your available cash into renovation costs, you can now wrap a large portion of those renovation costs into the mortgage. This frees up your other capital for purchasing other investment properties. It’s also a great way of saving your untapped capital for emergencies that may crop up – emergencies that will require quick infusions of your own funds on any given investment property you acquire.This Fannie Mae Homestyle Renovation loan can be used to purchase basically any house, condo or townhome, or multifamily property. And the property can be in any condition, and loans will typically carry loan to value ratios in the 50 to 75% range, depending on the property.

Use building supply store credit

Another tip for financing investment property renovations is to use building supply store credit. Consider obtaining as large a credit line as possible when opening a Home Depot credit card, for example. Lowes is another great building supply store to open a credit line with as well. Many times these stores offer great discounts or zero percent financing for extended periods when utilizing their store based credit cards on purchases made in their stores. I have used each for whole kitchen remodels, and they are great sources of other people’s money. Besides that, you can also take advantage of kitchen and bath design services for any remodeling/renovation project. And there is no cost to use their service. Finally, these home building supply chains offer deep discounts on appliances for your renovations. And if you’re trying to outfit new kitchens on a multifamily property, and need to purchase multiple sets of appliances, these stores will offer tremendous savings for bulk buys on appliances as well.

photos courtesy of ml-explode.com, shouldersofgiantmidgets.blogspot.com, kwcommercialsa.com, infrawindow.com