Loan-to-value ratio | InvestingInProperties.com

Quick Property Investment Tips

Advice for the beginner investor

Novice property investors should be cognizant of these quick and simple property investment tips. They will keep you pointed in the right direction. Always refer back to them when you hit a snag in the process… (It also makes sense to try to memorize them, and recall them as you begin searching for new investments to acquire.) In this way, you too, can become a savvy, experienced property investor.

Purchase for retention

Make sure you always purchase rental properties for retention purposes. The longer you hold, the better equipped you’ll be to take advantage of long term appreciation in the property. You’ll also concurrently be writing down any mortgage note you’re paying off, thus increasing your equity valuation in the property. If you make a plan for purchasing a property at set intervals (for example, every couple of years – or yearly, even better), then you’ll be able to slowly accumulate a portfolio of properties (your “stable”) that will continue to throw off ever-increasing amounts of cash flow, as well as capital appreciation.

The power of leverage

Make sure you take advantage of leverage, when possible. While making all cash offers on properties may be advantageous to netting the best price on any one property, it is not advantageous to utilizing other people’s money to grow your investments through the concept of leverage. If you can obtain a mortgage, by all means do so. The greater the loan to value ratio the lender will allow, the better. Just make sure you don’t overextend yourself, and that you’ve double-checked your expense numbers properly. You want to ensure you have a comfortable positive cash flow on any property you’re thinking of acquiring.

Beware the bargain basement

While the concept of “stealing” a house in an auction or other competitive bid situation sounds really appealing, always be wary of the cost of a “steal.” Finding a great bargain in a poor location is like finding fool’s gold: you’ll end up paying for it down the road. Long term difficulties with obtaining market rent, high vacancy rates, and terrible capital appreciation tend to make that “steal” a steal for the seller! So be very, very careful when a deal feels too god to be true. It probably is.

The location axiom

Naturally, more desirable neighborhoods will yield greater upside potential in terms of capital appreciation. This does not mean buying a property in a rundown area is bad. Just be aware that a cheaper price for a lesser neighborhood will require you to understand the vagaries of dealing with the neighborhood…which will probably be run down in five or ten years, or whenever you will be selling the property. Keep your sights set realistically. If a bad neighborhood is all you can afford, make sure you don’t expect much from the property n terms of its capital appreciation over time. Or, at the very least, buy in a changing neighborhood – one that’s experiencing the start of some gentrification. (Hint: let the changing face of local stores be your guide here.)

Cash flow is great, but…

Make sure you always keep an eye on the capital appreciation rate in any given area you’re searching in. It’s the holding and growth of the marketplace of houses surrounding your building that will add value to your property in the long run. Be very mindful of this fact. Your year-to-year cash flow is obviously important to paying the bills and allowing yourself a profit on a regular basis. But it’s when you are ready to sell the building that most of your profit should be made…

Create an individualized investment strategy, and stick to it

Critical to this concept is that you’ll need discipline. In addition, you’ll need a plan. And most importantly, you can’t have discipline and a plan without also being scrupulously devoted to research and numbers-crunching for any potential property you are looking at. Simple math errors, not doing total due diligence on a property, accepting seller information only – these are like death to a property investor. You cannot tolerate mathematical mistakes. If you know this is not your strong point, then enlist the aid of a partner – or at the very least, seek the outside help of a trusted, math-oriented friend. Either way, this is the simplest way to mess up. So don’t.

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Unlocking Hard Money For Investment Property Loans

Using hard money lenders

Hard money loans are basically a form of short-term borrowing available to property investors. They are like bridge loans, in that they are designed to get in and out of very quickly. Hard money loans are typically used by those in dire financial straits, like borrowers facing foreclosure or bankruptcy. But property investors utilize their services as well – and with good reason. Simply put, hard money loans are a much better alternative to all cash deals.

Private investors

The average hard money investment property loan is supplied with capital put up by private investors – usually as a pool of money that is used to drive much greater profits for its investors. This private capital is traditionally unregulated, which gives the hard money industry a kind of “Wild, Wild West” feel to it’s practices and reputation. Pejoratively, many consider hard money lenders as sharks feeding off the misery of those in bad financial straits. As a property investor, you will certainly need to approach any hard money investment property loan with a great deal of caution and foresight prior to signing on the dotted line.

Who hard money is designed for…

That said, if you do not have excellent credit, or if you’re self-employed with much income written off, or if you are investing money from a self-directed IRA, then it may be difficult for you to obtain conventional mortgage financing. You could pay all cash for your next property acquisition. But hard money lenders allow you the ability to utilize leverage – even in the short term.

Think of hard money lending as a local train on the real estate train line. Conventional bank loans are quite onerous to qualify for, but they offer the best rates and terms for property investors. They are like the express trains on the line. Hard money investment property loans are like local trains in that you will need to continually be stopping off at more points along the route. Points where you need to pay off your existing short term loan’s balloon payment by taking out another short-term loan to supercede it.

Is this more costly, time consuming and fear-provoking? Absolutely. But, hey – you’re a property investor. You should be used to living with debt and risk – and be comfortable with it. Your safety is knowing there are always going to be hard money lenders out there with their private funds to ensure you make it through to your next “stop” on the line.

Leverage ability

While paying all cash for a property is the “safe” way of investing, it provides no way to leverage your financial strength. Assuming you could not obtain conventional financing, hard money lenders offer the next best alternative to all cash deals. While your cash flow will be severely impacted because of the relatively exorbitant interest payments on hard money loans, even a small positive cash flow will yield great leverage over several years of making timely payments on the loan. Remember, besides the cash you put up on the property as your down payment, you will be paying off the principal on your hard money loan each month – thereby helping to increase your return on investment (ROI). Over several years, a small positive cash flow will yield much greater ROI’s than an all cash purchase would.

Costs for hard money investment property loans

If you’re going swimming amongst the sharks, your protective shark cage is knowledge. You need to know ahead of time that typical hard money loans carry interest rates that can run anywhere between 12 and 18 percent. Balloon payment are de rigeur, and these mortgages usually come due within 1 to 3 years. In all but rare instances, hard money lenders require being in the first mortgage position, so they can get their money out first if you default.

In addition, typical loan-to-value (LTV) ratios on hard money investment property loans range between 50% to 65%. And this LTV is based upon the “quick sale” market value of the property…that is – what the property will fetch today – not three months from now after you’ve fixed it up. Another potentially scary cost to take into account are points (up front interest charges). Typically, they can run anywhere between 4 to 8 percent of the total mortgage amount.

Not for the faint of heart

As a borrower, the hard money loan is definitely not for the faint of heart. You should already be comfortable taking on more debt, especially of the short term variety. You should also be well aware of the consequences in case of default.

The hard money lender takes on the increased risk of borrowers with less-than-stellar credit. For this, they are able to charge exorbitant interest rates, with onerous terms, and even more Draconian conditions if the borrower defaults.

A mature, responsible investment property investor/borrower should not be scared off by the terms of a hard money loan. They realize they can use the leverage to their advantage to help grow their real estate holdings. And they enter into hard money investment property loans with eyes wide open.

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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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