Your Biggest Partner in Real Estate Investments
Published on: Friday, December 18th, 2015
Your Biggest Partner in Real Estate Investments
Most real estate investors use financing to buy investment properties. This allows the investor to control more property using less of their money. If you have used a loan to buy investment property before, then you have taken on an investment partner. You just might not have thought of them in those terms. In most transactions, it is the biggest investment partner you will have. It is also the partner that requires the smallest return on their investment. But, they also provide the majority of your funds. Who is this investment partner I speak of? It is the bank.
Whether you know it or not, when you finance investment real estate you have just taken on an investment partner. It’s not the traditional partner that you think of – you know, the partner who expects a return on their investment plus a percentage of the profits when you sell. This partner will give you the majority of the purchase price. They don’t ask for any of the upside in the cash flow or appreciation. They just want a set interest rate and for you to pay them back over time. The interest rate they want is even much lower than private partners.
Banks will be the least expensive real estate investment partner you ever have. With this in mind, there are some things you need to know when you approach a bank about financing (partnering with you) on your next real estate investment.
Loan to Value – Loan to Value, or LTV, refers to how much of the purchase price the bank will lend you. For most commercial transactions 75%-80% LTV is the maximum that a bank will loan you on your purchase. That means, if you buy a property for $1 million, the bank will lend you up to $800,000 (80% of the purchase price) and you will need only $200,000 out of your pocket to close.
Term – Term refers to how long the bank is willing to loan the money to you. In residential homes that you live in you can often get up to a 30-year fixed term. This means your payment will be locked in for 30 years until the loan is paid off. In commercial loans, the term is usually much shorter. 3, 5, 7, and 10 year terms are the most common. These shorter terms force you to either refinance or pay off the loan at the end of the initial term.
Rate – This is the interest rate that the lender is going to charge you for their investment dollars. This is usually quoted at an annual rate and then calculated into your loan payment each month. This can be fixed over the term, meaning it stays the same,or, it can be variable, which means it adjusts during the term of the loan.
Amortization Period – The amortization period refers to the number of years it will take you to repay the loan if you make payments each and every month. A typical amortization period for investment property transactions would be 20 to 30 years. Most banks will give you 25 years on newer investment real estate or multifamily properties. However, on older properties it’s more common to have a shorter amortization period such as 20 years. The shorter the amortization period, the faster you will pay off your loan. However, your monthly payment will be higher as well, which can affect cash flow.
Recourse – When you get financing from a bank it will either be recourse or non-recourse. This is the security that the bank puts on your loan in case you default on your obligations. In the case of a recourse loan, if you default the bank can take the property and also come after the person who signed on the loan for any monies owned. With a non-recourse loan, the bank cannot come after you personally if you default on your obligations. Instead, their only recourse is to take back the property. Non-recourse loans are preferred, but are harder to get unless you have a very strong performing property and take a much lower loan to value loan.
Closing Costs – Closing costs are the costs associated with receiving the financing from the bank. They can range from a percentage fee charged for taking out the loan called “points,” to appraisal or legal fees. These are the fees the bank charges to give you the loan, and will vary widely depending on the financing or lending institution you are working with.
If you take out financing on your real estate investment properties, then you have taken on your biggest partner. They will bring the highest percentage of money needed to buy your investment property. They cost less than private partners for their money. They will also tell you up front what type of return they require. And, best of all, they do not ask to participate in the upside of the investment. By thinking of them as a partner and understanding the basic terms they use in lending you their money, you will have an easier time securing the money you need to close your next investment.