Toe in the Water or Expanding your Portfolio

Finding the Money is Key

 

As CEO of KRS Holdings – a rental property management firm serving investors in Central Virginia – earlier this year I declared being bullish on the purchase of rental properties in 2016.

My experience and analysis of the Central Virginia rental property market supports my conclusion that 2016 presents a nearly perfect climate for rental property investors … one which may not prove repeatable for decades.

What elements make up this unique mix particularly in the Greater Richmond and Tidewater regions? Three in particular:

  • Low mortgage interest rates.

Mortgage interest rates are below immediate post-World War II levels.

  • Attraction of millennials.

Compared to other desirable areas, Central Virginia is an attractive residential destination based on affordable living, availability of jobs and quality of life … all magnets for Millennials.  

  • Upward trending of rents.

An increasing rent environment is likely to continue through 2016.

Click Here for the full article that lays out the details of the above three essentials … a perfect primer for what follows.

 

So, if this is the year for rental property investors to do well, how do you proceed with financing sources? That’s the subject of this article.

To save you some time, investors that intend to make their purchases 100% from cash-on-hand (few though you may be!) need read no further. The following will address those residential rental property investors that choose the route of OPM … using other people’s money.

                 

Pre-Work – Know Thyself

Before getting underway with seeking financing, start with an assessment of what those OPM folks will look for. After the real estate bust several years ago, lenders are wary enough to make it tough to secure loans for investment properties. Here’s a checklist to start you thinking how to prepare and position yourself for greatest success.

  • Check your credit score, as it will have a significant if not the greatest impact on securing a loan and the terms of financing.  A score of 740 is usually considered the dividing line between paying more or less in interest and fees. Fees to buy down the rate to the level of 740+ borrowers can be as much as a quarter to full two points. Check your credit score for free at myBankrate.
  • What level of liquid reserves can you demonstrate that will pay for all personal and investment expenses? Ideally, that will be at least six months of cushion for all rental properties that you own, including the one for which you are seeking financing. Lenders want assurances that short-term vacancies won’t sink your ability to service the debt.
  • How much of a down payment are you prepared to make? Private mortgage insurance (PMI) does not cover residential rental properties. Anticipate that you will need at least 20% down to secure traditional financing … more may mean a better interest rate. Non-bank financing may well require in excess of this amount, often 30% or more.

Now let’s look at possible sources of financing – both traditional bank resources and alternatives that may be used as sole lenders or part of a mix of lenders.

Bank Financing

The good news is that rates are at nearly historical lows and competition for quality borrowers is keen. That means that the cost of borrowing is attractive, plus competition has driven flexibility in mortgage terms. For example, it is common to find 7 – 10 year balloon loans as compared to the more traditional 3 – 5 year terms.

The less than good news is the days of fast-and-loose financing are over. Banks exercise much more scrutiny and require prospective borrowers to clearly show the viability of both the borrower and the property to service debt and repay the loan.

Start by determining a frame of reference of lender appetite for the type of loan you seek. Meet with two to three lenders and see what non-owner occupied loan programs they offer. Include a bank or two, plus a mortgage broker. Check online lenders as well. Lending requirements vary.  A bank may reject you while a mortgage broker may deliver just what you need.

Ideally, go to a community bank rather than a large regional or national institution. They are likely to have a better handle on the local market, are motivated to invest locally and may have more flexibility in their lending requirements.

                 

Private Lenders

Private lenders can include family and friends. Additionally, there are professional investors who you can find through Google and other online searches.

The professional investor category also includes private professional lending institutions. While they may have lending requirements more relaxed than traditional lenders, anticipate higher interest rates and more restrictive terms. That need not be a deterrent if your investment generates positive cash flow and appreciation potential. You may only need private funding for a short time before you are able to arrange conventional financing. On the plus side, the private lending process is generally faster than conventional mortgage financing.

Here are a couple of articles that will help you better understand these resources.

In this high tech, internet age a relatively new phenomenon is private loans via peer-to-peer lending sites. Two examples are Prosper.com https://www.prosper.com/landing  and LendingClub.com https://www.lendingclub.com/ . These sites connect investors with individual lenders. Generally, these lenders tend toward the conservative in their qualification requirements.

A discussion of private lenders must include hard money lenders that lend based on the value of the property … not on your credit score. Expect interest rates to be much higher than traditional mortgages, sometimes double, plus higher origination fees.

There’s much less red tape. Typically you can get funds within a couple days, and other than origination fees, perhaps with no appraisal costs.

An example of how some investors use hard money loans are house-flippers and those who spruce up a property and seek a traditional loan to pay off the hard money lender. Hard money can be beneficial for short term loans. Caution!  Many hard money investor/borrowers run into trouble when the short term loan runs out and repayment is due.

 

Owner financing

With qualifying for credit tightened, owner financing does not have the same less than positive connotation of years gone by. You will need to sell the owner on the idea of financing and your ability to perform according to the loan terms. Prepare your game plan ahead of time including anticipating answers to likely questions of skepticism.

 

Self-funding

This is not a likely avenue to attain 100% financing. However, it may contribute to the liquidity you need to obtain financing and feel confident that your investment is secure with a safety-net in the event of unanticipated vacancies or costly repairs. What might these sources be?

  • Cash-out refinance of your residence or another property you own.
  • Home equity line of credit.
  • Cash values of life insurance policies.
  • Self-directed investments from your IRA or 401K plan.
  • Credit cards.

Toe in the Water – The Two-Step Approach

For the budding landlord with limited means and credit history, a sensible way to begin is to buy a home that is a good choice for a rental property, but you live in it for 12 months to satisfy the requirements of an owner occupant. That gives you the best of financing choices including a minimum down payment.

At the end of a year or so, rent out this property and purchase another future rental candidate as an owner occupant. Your loan stays in place with the original terms. Then plan on repeating the process at intervals that fit your lifestyle. Great way to learn to be a landlord while you build a residential rental portfolio!

 

Summary

This is an excellent time for Central Virginia residential rental investors to initiate their first purchase or expand their existing portfolio of properties. And there is money out there to finance those efforts. The key thing is to be aware of the many sources for financing and don’t be afraid to think outside the box. There are traditional and not-so-traditional ways to acquire funding. Educate yourself, do your due diligence and prosper with your residential rentals nest egg.

 

 


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