Get Creative with Alternative Real Estate Financing – Video
Let’s talk about financing. When I got involved with B2R in September, I told the chairman of the company who’s also the chairman of invitation homes, the Blackstone Company that bought 43,000 houses. I told him that what investors needed was a consistent, dependable financing source that allowed scale.
Because when you look at Fannie and Freddie, now look, no one’s ever going to beat their rates because it’s stolen government money, and they can loan it out for 4% or whatever. Take all of it you can get, but at the end of the day, they penalize you for scale. The moment you get where you’re almost a great borrower, they say, we can’t give you any more money.
It’s probably the most counterintuitive thing the government actually does, because if you have five houses and one goes vacant, what’s your vacancy factor? 20%, great. If you have 10 houses, one goes vacant, what’s your vacancy factor? 10%. If you have 20, one goes vacant, 5%. It’s much more manageable to be scaled in this business.
Community banks. One of my problems with community banks is you can almost always get a better deal at community banks than you can with a large national lender like myself. But, the problem is, raise your hand if you live in California. Raise your hand if you would want to exercise this strategy outside of the state of California.
Okay, community banks won’t touch you, until you have a track record, until you have a local presence, until you may be able to meet someone like a Brian Scrone that could walk you into a local bank that he had a long track record with, but that’s not scalable. You can’t build your strategy based off of if and when you meet the right person.
Then, you have hard money lenders. Hard money is a great way to buy distressed property and stabilize it, it is not a great way to generate yields. We’ve got a guy right now, we’re doing a $1.2 million loan with that he’s been in 14% hard money for two years. Hard money lender loves him, I mean that hard money lender he’s like 50% LTV in these houses. The hard money lender is going to keep renewing him as often as he’ll write the checks but it’s not good for you as the investor for a yield.
Let’s talk about net cash flow, gross potential rent, less vacancy, right because houses go vacant. The National Association of Realtors say that the average rent house goes vacant every 1.8 years, so you’re going to have vacancy on your property.
Maintenance. I’ve never met a tenant that took care of a house, just the bottom line. I had this in a couple months ago, called me, they wanted a new carpet, they’ve been in the house for four years and they were willing to renew another two-year lease. I said well, Jennifer that’s great but why would I put new carpet in that house, it’s almost four years old.
She goes, “Well that’s normal wear and tear.” I said, “No sweetie, the house I live in I’ve been there for five years and I got a four-year old and a 13-year old and I don’t need new carpet.” That’s not normal wear and tear, but you’re going to have those things.
Operating expenses, property tax, insurance, property management. If you’re not a professional property manager, do not try to manage your own properties, you will fail miserably. When you really model in the yield, your yield will be higher by having someone that was competent, collected on time, collected fees and made sure that your rents were increased when they needed to be or that you had better retention whenever a market may be getting loose. I use property management on my entire portfolio.
The same thing with that goes with anything right. If you’re not a professional general contractor, don’t try to fix the houses yourself. I know it’s fun to go to Home Depot and buy the toilet paper holders and go put them in on the weekend, but you’re not good at it. Unless your time is worth $10 an hour. If your time is worth $10 an hour, then you should put your own toilet paper holders in. I doubt many of you are staying at sitting in this room right now because you make $10 bucks an hour. If you are well then you should probably do your own construction.
Then you have capital expenditures. Well, that gets you to the underwritten net operating income, then you have capital expenditures. Capital expenditures; roofs, central heating air. The capital expenditures are, we estimate on average, it’s about $450 a year if the property was in good condition when you bought it. That’s money that you may not spend every year, but after five years, you’re going to have spent about $500 a year just on capital expenditures.
A new roof, a new central heating air unit, plumbing system issue, just something like that. Houses have problems and we count that in. Then you get to your underwritten net cash flow. That’s the absolute most important thing, because even if you’re just looking at investing with cash and cash alone, you can actually make decent returns using this formula.
The beautiful thing about leverage is it allows you to spread your risk across multiple sites and that’s where you get into scale and that’s where you don’t become the– Okay, who’s ever heard the example of the tenant that calls at midnight with the toilet. Now, raise your hand if you actually own your own property and you’ve ever had a tenant call you at midnight with a toilet problem.
People don’t clog up the toilet, you’ve done too many Brian, you’re the property manager too. People don’t clog up a toilet at midnight and call you. They wait until 8:00 or 9:00 in the morning, say, “Oh, my kid dropped to a toy in there,” unless you’re into college kids and then that’s just a whole different model. They’re kind of proud, they clog up the toilet at midnight, right?
I want to talk about different limitations, GSEs, the Fannie, Freddie, Ellie loans, they’re going to cap you from 4 to 10, and it’s really hard to meet someone that’s actually qualified for 10 mortgages. Unless they just really have a smoking hot loan officer and I don’t mean like visually, I mean really good at what they do. It’s hard to get the 10. I mean, if you got a million bucks in the bank and an 820 FICO and you make a million bucks a year, you can probably get there.
Commercial style loans, there’s no limit to the number of properties, that’s going to be lender dependent. A lot of lenders have, like small community banks in Texas, they have loan limits versus property limits. Once they get to say, 2 million bucks, they’re not allowed to give anyone borrower more than a certain amount of money, and then you’ve got to go find another bank, and you’ve got to go find another bank, or you got to get two banks to work together and it’s difficult to scale.
Loan structure. I feel like the GSEs are way behind on this, because who’s ever closed on a Fannie or Freddie mortgage? Who’s ever closed on a non-owner occupied Fannie or Freddie mortgage? Here’s the fun thing about those, the loan docs are almost identical to like an FHA mortgage, but then there’s an addendum on the back that says notwithstanding the foregoing, you may rent the property out, it’s pretty simple. These loans are going to be multiple properties per loan, and most likely they’re going to be cross collateralized.
The thing that I love about that is then as a borrower, as an operator of a business, I really don’t have one check to write every month. I really only have one amortization schedule to keep up with, I really only have one interest calculation and tabulation for the year to keep up with.
Borrower. Another counterintuitive thing that Fannie and Freddie do that I just find ridiculous is they tell you, yes, we’ll let you buy rental property, but you have to do it in your own personal name. Liability wise, it’s ridiculous.
Whereas, a commercial lender like myself, we’re going to make you put it in a corporate entity. I do not loan money to individuals, I only loan money to corporate entities. Because, if you own rental property, they’re not in a corporate entity, I mean, just be careful.
Underwriting. These are heavily underwritten on your own debt to income ratio, whereas a commercial mortgage on rental property is going to be underwritten on what’s called the debt service coverage ratio. You’ll see this term more and more and more, the DSCR is nothing more than the debt to income of the property.
If you’re asking for $1,000 a month mortgage payment from me, I’m going to make sure that the property is underwritten net cash flow from the previous slide is at least $1,200. I’m going to look at your financials last, because at the end of the day, if you’re a good operator, which if you have five or more houses, the assumption is you can be a good operator. It’s more important to me that the properties can pay me back than you can pay me back with your doctor job or your lawyer job or your whatever you do for a living job or your pension if you’re retired.
To me, if you get in trouble, I can step in and use what’s called an assignment of rents provision. If you’re fairly new, and you don’t have the experience, we’re going to require you to get a property manager. Then I can call your property manager say, “Hey,” I’m not going to pick on Jose but I just saw your name first. “Jose got a little behind Jason, here’s the form. You’re going to need to start sending the surplus cash flow to me.”
Then we’re going to erase any indebtedness to us. We’re going to pay your monthly bills for you and send you what’s left. It’s called cash management. It’s never in place until you get behind or there’s an event of default. The beautiful thing for me is that keeps me from ever having to foreclose on you unless you go commit fraud and willfully act in a bad manner, I can place cash management, collect the funds and it’s called a waterfall and you get what’s left.
Ideally we never get to that point, but it’s one thing that I actually like as a lender because it allows me to step in for a couple months and help you manage your portfolio if you get a little behind.
Cash out financing, it’s a little crazy there, with us we don’t care about cash out. Here’s the way it works and I’ll go ahead and cover this.In the first 90 days, we’re not going to let you pull cash out above your basis. It’s actually a 75% loan to cost in the first 90 days of owning it.
Because at the end of the day, even if you get the smoking hot deal like we at home investors do all the time, I don’t think it’s a solid business philosophy to be operating and planning around borrowed money. The first 90 days, it’s a 75% loan to cost. We count your purchase, your rehab into your cost basis and your closing costs from when you purchased it. From day 91 through day 365, it’s 90% loan to cost. Really and truly for the first year, we want you to have at least 10% skin in the game.
We know that that’s going to really lower our default risk, because what we don’t want to do is what Bloomberg says we’re doing, we do not want to create Subprime 2.0. We do not want to start, “Stated income, stated assets, yes we we’ll give you 75% cash out, you don’t have to have any money in the game.” After day 366, you can pull out as much cash as you would like up to 75% loan to value and that’s because we figure if you’ve operated the asset for 12 months, there’s a lot less risk in that by letting you reap some profit.
Pricing, I think that, what are the GSEs pricing out right now anyone who knows? 5%? Yes that’s inching up. Right now our pricing is around 5.5% – 6%. It depends on the LTV you’re asking for. We have priced out a couple of deals recently around 6.5%, but those were a little bit more risky portfolios; high crime rates, high vacancy rates, things we felt like needed to be priced into the deal. For now, of course the stolen money, I mean the government money, has the advantage there.
Then minimum properties, I think they have the advantage there. They can do one by one. With us, you have to have at least five houses, because again, it’s about operating risk. I know that you’re going to be a much more solid borrower if you have five houses to spread your risk across instead of just one. If you have one and it goes vacant, it’s pretty easy to figure out that vacancy factor.