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Commercial Property Leasing Tips

Major differences in commercial versus residential leases

When evaluating commercial investment property, it’s best to take into account the major importance the property’s leases play in determining overall value of any given property. Commercial leases differ in several key ways from residential leases, and greatly affect the market valuation based on these differences. Here are the key elements that differentiate them, and why they play such a major role in property value…

Viability of tenant

In commercial property investing, always consider the credit capacity of any prospective tenant. While this is important in residential property management as well, it is more crucial in commercial investments, where longer-term leases come into play. You’ll need to feel very assured that the tenant you’re installing on a long term agreement has the capacity to pay you regularly each month. With tenants that have little or no track record, you, as their landlord, will need to ask for some form of personal guarantee to back up their lease agreement.

Length of lease term

In residential real estate, a one year lease is pretty standard. Two years would be rarer. But in commercial property investing, terms usually start at three years, and can extend many years out in many cases. Additionally, lease options allow prospective tenants to renew at certain years in their overall lease contract. Sometimes rent bumps are included as part of the overall lease. Sand sometimes rent bump options are included. As a landlord, anything you can do to lock a tenant into as long a lease term as possible is most beneficial to your bottom line. You’ll also want to keep the number of renegotiation periods (in the guise of rent bump options) down to a minimum. Not only will this help you be able to count on a set revenue stream down the road, but you won’t have the need to renegotiate at a future date with the same tenant either.

This also has a major effect on the total valuation of your commercial property. The more long term leases you can lock tenants into, without options, the more “set” you property will be for the future – especially when it comes time to sell your investment. Any new prospective investor will look at all your leases, see how set in stone they are, and a market valuation based on non-negotiable terms will be much easier to arrive at. And remember, the less future negotiating that’s required, the less turn over, with all its concomitant time, energy and fees (like commissions and repair costs) associated with installing new tenants.

Lease arrangement factors

Most property investors in commercial real estate want to try to negotiate triple net (NNN) leases with prospective tenants. In a triple net lease, a base rent is negotiated, and tenants are required to pay for all operating expenses associated with their premises. These long term leases tend to also build in rent bump increases pegged to some inflation average. This helps the landlord avoid future negotiations with his tenants. As mentioned above, it also helps “set” the future market value of any given commercial property.

Allotments for options

Commercial tenants and landlords tend to be diametrically opposed on the key issue of allowances for renewal options. While tenants like them for the ability to reevaluate their expense and space needs every few years, landlords want to ensure that tenants stay in place as long as possible, with rent increases set in stone in terms of regular inflationary bumps. So commercial landlords tend to be very stingy with requests from prospective tenants for any form of lease term option. Keep in mind that this may not always be a good decision on the part of a commercial real estate investor.

While locking tenants in is great on one hand, it also can be damaging on the other, in the fact that a landlord must then live with his decisions for a very long time. If he wanted to change the make-up of his commercial building to attract a different class or type of business operation, he would not be able to do so if he had no options built in to the original lease with his tenant. This could also affect future valuation of his property if a landlord finds, down the road, that he is lagging behind in collecting current market rents. So sometimes, locking a set of tenants into no-option style leases can be ultimately damaging to a commercial property investor.

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Property Investing Safe Haven

Commercial property alternatives

It’s sometimes easy to get too staid as a property investor. If you’re used to residential investing, you tend to stick with it, thus placing most all of your real estate eggs in one basket. If you’ve been doing this for a while, you might want to consider a safer haven for part of your nest egg….commercial property. And by commercial property, it can run the gamut from office and retail space to more niche-oriented, but relatively safe property investments, such as medical office space, hospitals and nursing homes. The entire medical care industry is a safe bet for tenancy in the mid to long term periods.

Building your safety net

You’ll soon discover that locking up tenants for long term leases is a whole lot safer and more predictable, let alone less expensive to administer, than finding tenants each year for every one of your residential rental units. The time factor of not having to constantly be advertising, screening, doing financial and background checks, and dealing with a multitude of residential tenant emergency issues makes renting to commercial tenants a great boon as an alternative.

Office buildings, for example

Consider the benefits of office buildings, where many leases with a wide range of tenants over multiple lease terms helps to increase their overall return on investment, relative to residential property. When one tenant in an office park leaves, the effect will be minimized on the overall performance of the building, compared with residential rental unit buildings, especially smaller multi-family dwellings with less units than apartment houses.

In addition, if you own commercial property, you’ll certainly be negotiating for longer-term leases than only one year. Typical commercial leases will range between three to five years on average. Some, a lot longer, depending upon how much remodeling work a business has to do prior to moving in. The more upfront costs they have to incur to get their store ready, the longer the lease they’ll be looking for, in order to help them amortize the total cost of their renovation in your building. On the other hand, a two year lease in residential property would be considered long. And then you have to spend the time replacing any tenant when they leave.

The upshot of the longer term leases in commercial property? Simple…you’ll be able to plan better, as well as realize a greater degree of security and consistency of cash flow by having longer-term tenants. The steadiness of the income stream is one of the chief advantages of commercial property over residential investments.

Other benefits of commercial property

There are several other key benefits of investing in commercial property relative to residential investing. Consider that commercial real estate offers a wonderful buffer against inflation. This is because most tenant leases, since they are mid-to-long term in nature, have bump-up increases in yearly rents. This acts as a hedge against inflation. This helps build in increased valuation for your commercial property over time. In addition, there tends to be less market volatility amongst commercial buildings. Especially ones that are at or near capacity for rentals. Relative to residential buildings, commercial property will show a much flatter growth line, with fewer sharp spikes or dips.

Lastly, commercial real estate offers the ability for certain tax breaks that may not be available for residential property. For example, if building or renovating in a central city a municipality may be offering commercial property owners certain tax-deferred tax breaks to spur construction in their city. This is just one type of tax benefit that may be available to commercial property owners relative to residential investors.

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The Property Diversification Dance

Diversification into commercial property

If you already have a major portion of your property investments tied up in residential real estate, it’s always a good idea to consider some form of property diversification. Like any asset class, diversifying can be a great way to help weather any downturns in a given sector of the market. With so many large fund investors (who acquired foreclosures by the thousands in the past few years) beginning to sell off a large portion of them on the market while prices have risen in the past year, looking at the commercial sector to invest in now makes good sense, since prices will surely stabilize in the residential arena due to the sell-off.

Office buildings

If you look at office space as just one sector of the commercial market, there are numerous advantages over residential buildings. Since offices tend to have a much greater number of tenants, there is a built-in diversity to the type of tenants you will have in place. In addition, their lease time frames will all be different, and the leases will, on average, be much longer than any residential lease could be. It’s usual to see five to ten year leases in commercial space. Compare that with the typical one year lease in residential property, and you’ll quickly see some of the advantages of not having to constantly be soliciting, screening and installing new tenants each year – per unit. And with a wide variety of tenants, if one leaves, it won’t affect your bottom line as adversely, or as quickly as in residential real estate. In addition, the types of companies you attract may be larger firms, with proven track records of doing business. So their singular lack of risk of default, or of their going out of business, will greatly aid your cash flow in the long run. Thus, commercial property can afford you a higher chance of bringing in consistent income streams.

REIT’s

As mentioned in prior articles here about Real Estate Investment Trusts (REIT’s), if you’re not looking to own “bricks and mortar” pieces of commercial property, then investing in REIT’s that specialize in the commercial building niche make sense for you. While some funds lean more towards retail space (large enclosed malls, strip malls and stand-alone shops), and others towards office buildings, most will invest in some combination of the two. Some may specialize in medical office space, others in warehouse buildings. But all will diversify within a particular set of commercial buildings. Still others will keep a mix of commercial and residential buildings, mostly apartment houses of varying sizes and locations.

More benefits of commercial investing

Besides the advantages listed above, consider the fact that commercial property makes a great hedge against inflation. Since commercial leases tend to include annual inflationary rent bumps in them, you don’t have to worry about your rent rolls not keeping up with inflation. In addition, your property values will increase over time due to these lease-inflation bumps. And finally, consider that historically, commercial property tends to have less volatility in market valuations than residential real estate.

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Commercial Property Investment Comeback

Where’s the smart money going?

Savvy property investors remain wary of the current housing rebound. This is mainly due to heavy institutional investing in rental residential properties over the past couple of years, which have acted to buoy up the previously moribund housing arena. And with almost one-quarter of all recent home purchases being gobbled up by said institutional investors, where should the average property investor be searching for high returns these days?

Clearly, this new housing marketplace, especially in previously hard-hit areas like Miami, Phoenix, Las Vegas and parts of southern California, continues to show such marked gains as to make the underlying economic factors for new-buy positive cash flows untenable, due to the rapid increase in property valuations. Simply put, in many markets, there are no bargains to be found right now where the metrics make sense, and that will throw off enough positive cash flow to yield even a modest Return On Investment (ROI).

The current trend away from residential rentals

Large investment firms have already begun to stop their residential buys due to this inflation in market values, and smaller investors naturally are shunted to the sidelines when the cash flows make no particular sense for them, at least in the short term. In fact, many large institutional investors may already be starting to unload some of the foreclosures they previously bought (and are now weaker-performing residential properties), but nevertheless have soared in valuations since they were bought over the past two years. They are now selling them and re-investing their profits. And where are they reinvesting, you might ask?

Commercial property as prime reinvestment arena

Large commercial investment companies, such as Simon Property Group, are doing much more buying and development of new retail outlet malls across the world of late. They are creating new mall centers, purchasing existing ones, as well as creating mergers with other commercial institutions to meet the expected need for more retailers world-wide over the next several years. Smaller investors have the ability to buy in with shares of these large commercial companies, as well as investing on a small scale locally, in their own local communities, by sticking with local commercial retail space buildings to meet the expected demand for new retail space.

Technology sector investing

Another area smaller investors should consider is commercial data center building investment. Technology growth continues to expand in the real estate sector of late. And new data center investment is way up to meet the demand. One particular technology real estate company is CyrusOne, which specializes in the creation of new data centers world-wide. The current expansion in the data industry continues to fuel the need for more construction of facilities to house these huge data centers.

So smaller investors should look to the potential returns from investment in these companies that specialize in data building investments as another way of bypassing the current dearth of high-ROI producing residential investments. With the housing industry making a sketchy comeback, and underlying metrics in the housing arena being very suspect, it’s time to consider commercial real estate alternatives in the interim.

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Commercial Real Estate Investing In Rebound Mode

Europe helps shape current investing patterns

Just as the U.S. residential property investment picture has been transforming itself over the last year, with valuation gains occurring in most areas of the country, so too commercial real estate investing has been on the rebound as well. While not growing at the same pace, it is still seen as extremely attractive, especially to foreign investors. This is mainly due to its relative stability over the past year, as returns on commercial properties such as offices, retail space and warehouses continue to increase steadily.

Poised for a rebound

While not producing stellar returns, the commercial U.S. market is poised to rebound strongly this year. The reduced vacancy rates overall, as well as the perception that the commercial real estate investing arena is less risky and is not considered overpriced at this time, have led foreign investment firms to plow billions into the commercial property sector in this country. It is expected that commercial values will rise throughout the remainder of this year, making it an attractive time for investors before prices rise due to this increased demand.

Increased competition from abroad

Naturally, individual investors, as well as U.S. investment companies, have to contend with increased competition for the most desirable commercial properties because of the increase in overseas investing here. Compared with other countries, commercial real estate investing has increased at a much faster rate in the U.S. over the last six months. While investment increased by six percent in Europe and 15 percent in Asia in the second half of last year, it grew by almost twenty percent here in this country, according to DTZ, a London-based commercial real estate brokerage.

Safety in the U.S. commercial property market

They also report that investment in a single country is a safer way to place investor funds rather than spreading their capital pool over many different nations. Of course, Europe’s current financial woes have played a big part in the overall increase in shifting investment funds to the U.S. Despite all our political stalemate woes over controlling the U.S. budget, foreign investors are still quite concerned over all the volatility in their home countries in Europe, and still see the U.S. as much more stable and stronger economically. With their shift in investment patterns, individual investors should be aware of the way this increased demand will place upward pressure on price valuations for the entire commercial real estate investing segment in the U.S. over the next six months.

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Fiscal Cliff Notes

The Genie prognosticates…

In the aftermath of the Presidential election, so much has been commented about on television and written about in articles throughout the world about the proverbial fiscal cliff we’re about to hit here in this country. And property investors need to develop alternate plans as a means of grappling with this uncertainty. You’ll want to be prepared with several real estate investment strategies in place as we approach the end of this year.

At the time of this writing, it appears to be a 50-50 coin toss as to which way Congress is going to go regarding avoiding the fiscal cliff. With all the rhetoric coming out of Washington post-election about how conciliatory each side is going to be, it’s hard to take both parties seriously, and hard to believe that some compromise will come to fruition.

So my gut feel is some form of agreement will not occur by January 1st. It is possible all involved will come to an agreement on a further extension of time beyond January 1st for a short period to allow for more discussion on the matter, but buying time only prolongs the pain. We live in a time of extremes in Congress, when both political parties here in this country seem unable or unwilling to reach agreements. The concept of compromise is all but gone. This has been demonstrated numerous times over the past several years. So with recent history at our backs, it’s hard not to be pessimistic about a solution be worked out by the end of the year.

The sequestration effect

Without a new deal struck, and sequestration taking effect, property investors need to create a proper plan for this horrible eventuality. In this scenario, let’s see what will happen to your property investments in the short-term and long-term, then determine some proper real estate investment strategies moving forward.

Sequestration calls for deep cuts in government spending to all sectors, most noticeably in defense spending. These cuts will take place over the next ten years. Job creation will be severely affected, and so the overall drag on the economy will be a major hit.

World-wide repercussions

In addition, there will be repercussions seen across the world as Europe still struggles to climb out of its recession, and China is just starting one of their own. The psychological effect on the entire U.S. economy will be severe over the next year should sequestration occur. People, afraid for their jobs and having very little job safety, combined with little job creation in this country, will ratchet up saving for the proverbial rainy day. That means they will stop buying frivolous goods and services.

Effects on residential and commercial markets

With that, the small brief expansion of the economy that we saw this year will come to a grinding halt. The residential real estate market slowdown (and any appreciation that occurred over the past year) will come to a halt. Commercial property will also be adversely affected – probably more so than residential markets, as businesses struggle to either stay put, or end up contracting.

With very little expansion by the business sector, office vacancy rates will increase. So too vacancy rates in retail outlets, shopping centers and malls. Look for overall contraction in the commercial real estate investment market over the next year if sequestration occurs.

However, residential rental real estate, at least for property investors, should remain strong. House prices will at best struggle to stay level, and they will most probably contract somewhat as the sequestration puts an overall drag on the economy. However, as we’ve seen over the last several years, as the economy got worse, rental property cash flows went up.

Increased rentals

The reason was simple: buyers sat on the sidelines, preferring to rent instead of purchase. The increased demand for rentals increased the average rents in almost all areas of the United States over the last two years. This trend would absolutely continue with sequestration, as the economy continued to contract. So if you’re already holding rental property, you would want to continue holding it for the short term. You could expect cash flows to increase in the likelihood of this scenario.

In addition, if sequestration does take effect, property investing for the mid-to long-term will require more patience and fortitude. For one, you’ll definitely want to plan for longer-term acquisitions and hold onto your existing properties longer. You will not be able to rely on property appreciation to provide much in the way of returns on investment. Instead you’ll look for cash flow (and strictly cash flow) on your properties. In addition, flipping properties will be much more difficult as more people stay on the sidelines because they lack jobs or are fearful of losing their jobs.

If a compromise is reached

But what if Congress is able to reach some sort of compromise by the end of the year? What will the overall economic landscape look like then, how will it affect the property investor, and what real estate investment strategies should youy implement in this case? Well, for one, financial markets love stability. So if a deal is struck, even one with higher tax rates, Wall Street will invariably fall in line, calm down and stabilize as markets become less volatile. This will then have a ripple effect going overseas as European markets are subdued by the lack of volatility in the US market.

In the short term, things may get jumpy in the first quarter of the new year if an agreement is reached, but for the remainder of 2013 however, things should settle down and remain pretty much as they were this past year. That means: slow growth overall. Especially in residential real estate, and certainly in commercial real estate niche markets.

Increasing market valuations

Overall market values should slowly creep up over the course of the next year given this compromise scenario, and you can look for greater returns on your investment when you look to sell. Keep in mind that the rental market will soon be peaking as the economy stabilizes. So the best thing to do in a compromise scenario is try to quickly acquire more rental property before prices spike next year. Also, assuming the fiscal cliff is averted by the end of the year, look to possibly sell off some of your poor performing investment properties by mid-next year.

Mid to long term planning

In addition, mid-to long-term planning for property investors should include thinking about how to weed out poor performing properties and at the same time acquire better properties (even though appreciation will make it more expensive for you to do so). With the fiscal cliff averted, it will signal not just more stability in the financial markets, as well as an improvement in the overall U.S. economy, but an overall optimism from U.S. residents over what Congress and the president can accomplish together. This feeling of stability should translate into a very positive psychological feeling for most home buyers in this country. More home buyers will come off the sidelines over the next several years as this feeling pervades the economy. Look for appreciation to continue in the mid-to long-term (5 to 10 years).

Plan for both scenarios

So whether sequestration or compromise occurs, property investors will need to plan now for one of the two scenarios occuring, by creating several real estate investment strategies. With sequestration, make preparations for quick acquisitions and then the holding of rental property for the long-term. In the case of a compromise being worked out and disaster being averted by the end of this year, look to sell off some of your weaker properties and then acquire better properties for long-term growth next year. Also in this positive scenario, if you’re a property flipper, expect a very hot economy over the next few years. Either way, you’ll want to properly prepare as any good property investor should.

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The State Of The Current Commercial Real Estate Investing Market

And the survey says…

Commercial property’s steady recovery should continue well into 2013. This conclusion is part of a recent survey by financial services giant Jones Lang LaSalle. Their survey is an analysis comprised of responses from almost 500 real estate development pros.

Spurred by the Fed’s actions to pump money into the U.S. economy, as well as keeping interest rates low, thus making it easier for lenders to offer mortgages, commercial property investors have been taking advantage of the looser credit available, to invest in many forms of commercial real estate over this past year.

Signs of a healthier economy

Commercial tenants overall have been fiscally healthier, yielding less vacancy rates for property holders. In addition, growth is expected next year by companies who rent space, and both tenancy rates as well as overall rents will be on the increase, supporting a truly growing commercial real estate investing sector.

While there is still a preference for commercial property investors to buy in prime locations in large U.S. cities, secondary markets are also showing signs of increase as well. These markets include smaller cities, as well as suburban markets. And they are projected to continue increasing in popularity amongst investors in the coming year as well.

The most popular segments

In terms of types of commercial sector demand, the most popular by far has been multifamily housing. Forty-three percent of survey respondents felt this was their number one choice of investment. This includes not just multifamily houses, but apartment buildings as well. Due to the overall growth in the residential housing market this past year, tenancy rates have been on the rise, while vacancy rates have shrunk. Overall, this type of commercial real estate investing vehicle is now considered extremely stable and low risk.

The next greatest sector is the office building market. Twenty-seven percent of respondents felt this sector was their best bet for profits. However, office rental success was pegged largely to area. That is, for example, higher growth industries, like technology, were experiencing greater demand in Silicon Valley. So choosing the right area to invest was more important for continued growth here.

Industrial property investment ranked third among all sectors (at 14%), while retail came in fourth (at 12 %). Lastly, the hotel sector was seen as the most volatile of all markets, as hotel chains experience high debt ratios amid increased competition and a tighter marketplace.

Future concerns

The main factor most respondents of the survey were concerned about for the future remained the overall state of the U.S. economy. They were also concerned with the lack of job growth domestically, as well as the European debt crisis. All three elements could adversely affect the commercial real estaste investing market in the coming year.

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The New REIT-Offs

The wave of the future

Real estate investors should be aware that many non-traditional commercial property holding companies are utilizing recent IRS rulings, and are taking advantage of raising cash through conversion of their holdings into Real Estate Investment Trusts (REITs). By doing so, these companies not only take full advantage of capital market leverage, but they also save on taxes as well. REITs are not subject to federal income tax, because they must distribute at least 90 percent of their taxable earnings to shareholders as dividends. With these devlopments, there is now much greater choice afforded real estate investors among the list of REIT vehicles available for investment.

The non-traditional REIT conversion trend

REIT conversions are being created across a number of industries. Chief among them include prisons, data centers, cell towers and outdoor advertising billboards. This increase in REITs affords much more diversity for the property investor to consider, much more than traditional REITs that invest mostly in retail shopping centers and office buildings, for example. Of course, real estate investors win when they are provided with an ever-increasing array of investment vehicles to invest in.

REITs are required to invest at least 75 percent of their assets in real estate, and need to earn at least 75 percent of their gross income from rents, or from interest on mortgages. They sell shares of stock in their companies to raise equity for further development purchases, since most of their earnings are required to be given back to shareholders in the form of dividends.

Federal tax exemption

Companies that specialize in non-traditional commercial real estate have been jumping on the bandwagon this year, converting to REIT status, then being publicly traded, in order to take advantage of the federal tax exemption. It also provides these firms with the ability for greater growth by accessing more capital quickly. In addition, by taking advantage of this federal tax loophole, these newly converted REITs garner a major bump in valuation overall, simply because of the cost savings of no federal taxes.

With existing bank money market rates hovering in the three quarters of one percent range, property investors are constantly looking for much greater returns in a stable environment. With REIT returns running in the three and a half percent range this year on average, they are increasingly becoming an investment vehicle of choice for many real estate investors.

Close to an all-time high

It’s interesting to note that REITs now rank third amongst purchasers of real estate in the United States over the first half of this year, with acquisitions of $12.2 billion, according to research compiled by Real Capital Analytics Inc. This data shows that REITs rank just behind private buyers (at $40 billion) and institutional investors (at about $30 billion). In addition, REITs in the United States should come close to an all-time high for raising capital by the end of this year. Right now, they are running about 22 percent higher from last year, having raised over $41 billion through the first three quarters of the year.

Conversion risk versus reward

All this flurry of REIT conversions for existing, non-traditional commercial real estate companies does not come without costs and risks, of course. The conversion process is quite time consuming and expensive, utilizing a great deal of a company’s resources and capital in the short run. Also, once converted, REITs are subject to the vagaries of any new changes in U.S. tax laws that could adversely affect them down the road. But for now, this wave of conversion activity remains strong. And the great upshot is that real estate investors are offered a much greater choice of REIT vehicles in which to invest.

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Commercial Investment Opportunities – Part 1

Some basics of commercial property investments

Buying commercial property

Most property investors will tend to stick with investing in types of properties they know best, and feel most comfortable managing – usually residential real estate. But for those who are looking for greater profits at a quicker pace, then commercial property should be considered as well. Most investors will not be as well versed or comfortable with commercial property, so there is definitely more specialization required when investing in it. In addition, the absolute dollar amounts required (as well as financed) tend to be much greater than with residential property investing. With more risk comes more potential for return.

Unlike houses, commercial properties almost uniformly derive their value from rental income, not so much from general market appreciation. The greater the rental income, the greater the value of the commercial property. If you can purchase a building where rents are low, then manage to increase the rent-roll on the property, you can increase the overall value of the building. In addition, the quality of the leases you have with tenants in a commercial property will help determine its value. Poor tenants (read: poor paying) with very short leases will yield a less valuable property compared with a building that’s locked up with very strong tenants on long-term leases, with rent escalation clauses built into those leases.

Types of commercial investments

Commercial property investment runs the gamut from small apartment buildings to large-scale ones, small office buildings to large high rises, as well as office parks, shopping centers, strip malls, and many types of industrial buildings, including warehouses, manufacturing buildings and industrial parks.

With each successive commercial property type, the level of sophistication and specialization for that particular form is required. In may ways, relative to residential property investments, commercial properties require much less estimating and speculation, and therefore risk is actually lessened because as is the norm, actual income statements can be analyzed from existing, performing properties. That’s not usually the case with residential rentals, where the investor needs to make guesstimates as to market rents for vacant units, as well as for many expense items, such as fuel and electrical consumption. With commercial, past performance of a building will dictate it’s market value.

In addition, the high cost of most commercial property will be out of financial reach for an individual investor. However, investors can pool their financial resources (and credit lines) to form investing groups. Also, investing is Real Estate Investment Trusts (REIT’s) is also very popular. These are usually publicly traded funds that, like any stock-type of investment, you’d be simply investing in without having a say in the management of their respective property portfolios.

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Types of Investment Property Loans

Conventional investment property loans

Most conventional investment property mortgages are standard income and asset verified loans. They can be conventional 30 year terms, or short-term adjustable rate mortgages (ARMs) with balloon payments.

These loans usually require a minimum of 30% down in most instances. In that case, 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 (also known as cranking) 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 today who will make no income verification, or no income and no asset verification type loans to investors. 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 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 need to obtain a commercial loan. Lenders have separate divisions to evaluate and extend credit on these type properties. Since commercial properties are much more specialized, their inherent risk need to be evaluated as a niche within most banks.

Lenders will rely very heavily on the expertise of commercial appraisers, who themselves are sort of like the Jedi knights of the appraisal industry. Unlike conventional residential mortgages, expect much heavier scrutiny of your assets and income, as well as the existing income statement of the property you’re considering purchasing. Also expect rates and points to be higher than standard residential loans.

FHA 203K (fixer-uppers)

If you know you’ll be living in a multi-family rental building, then you can consider an FHA 203K type of mortgage. If you won’t be living there, this type of loan will not be allowed.

If you find a 2 to 4 family rental property that needs a ton of work, and you’d like to finance the renovation costs as part of the first mortgage (rather than self-financing the improvements, or trying to obtain a second mortgage after the work is completed), you can consider an FHA 203K type loan.

Before the mortgage can be approved by the lender, your contractor will need to have all the improvements, their time frame and his payment schedule approved by the bank. (You can also choose to make the payments to the contractor directly, and then you’ll be reimbursed by the bank – also known as a draw.)

These loans can be structured in a step fashion. In the first step, you receive the funds to close on the property. In the next step, some funds are released to your contractor when he begins the renovation work. Funds are then released to him in succeeding steps based on the intervals of work completed on the project, until it is completed.

This type of loan is great for leveraging all the necessary improvements needed on a run-down multi-family property. It also helps increase your ROI on this owner-occupied type of investment.

Home equity lines

Use the equity in your home to create a credit line for further property investments. This is a great way to finance investment property. The costs for loan acquisition are typically low for home equity loans, especially compared with conventional mortgages. And you can structure the loan as a revolving credit line. So when you sell a property, you can pay off the credit line. Then you can take it out again when you’re ready to purchase the next house. And home equity lines typically allow for interest only payments during their first 10 years. This will help increase your cash flow on your investment properties, as your monthly costs, relative to standard mortgages, will be much lower, since you’re not paying back any principal in monthly installments. Rather, you’ll be paying the principal off when you repay the credit line when you sell off any given property.

Seller financing

Always ask a seller of a property you’re considering making an offer on if they will extend some form of seller financing. Most will usually say no, but it never hurts to ask. Even if they won’t (or can’t) extend you a first mortgage, try to obtain a second mortgage. Again, always ask if it‘s possible.

Hard money loans

When you’ve exhausted all other avenues of property investment loans, crunch the numbers to see if hard money lenders will make a deal workable. Usually used if you have poor credit, or poor cash reserves, as their name implies, you’ll pay for the privilege of doing business with hard money lenders. Their investment mortgage rates are usually at least double conventional mortgage loan rates. And their points charged (pre-paid interest) can be triple or quadruple conventional points charged.

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