Loans for Investors, past-present-future! Part Trois

Lee’s Notes: Third part of the series from Vena Jones-Cox.. Pretty good read.

The Future of Institutional Lending

   As badly as lenders have been hurt in the past 2 years by the stupid loans they made in the prior 5 years, the pendulum WILL swing back closer to center in the next year or 2. As banks unload their REOs (and realize that they’re missing out on a LOT of profits by not making loans to investors), we’ll see portfolio programs returning to more and more local banks.

   Because the secondary market is so slow to move, I believe that it will be a decade or more before the killer “4-loan rule” is reevaluated, but national non-conforming programs will also return over the medium term.

   The lending “crisis” will not soon be forgotten by lenders, though. I’ll be surprised to see a return to 100% investor loans in the next 20 years; down payment requirements will continue to be high for the foreseeable future; “stated income” and “no-doc” loans will be rare and expensive, so credit score requirements will stay high.

 

What You Should Do

   My crystal ball is no better that yours; I’m looking into the past rather than the future for my predictions. From 1989, when I bought my first investment property, through about 2000, investor loans looked like the description above, and lenders seemed very satisfied with the level of risk involved.

   What’s more important is that the loans we saw back then—and that we’ll see in another year or 2—were much less risky FOR THE INVESTOR than the no-doc, 100% loans of recent years. Having equity in a property, cash reserves, etc is good business for US, as well as the bank. So if you’re planning to have a successful, profitable real estate career, here’s your plan:

1.  Take care of your credit score. Almost all institutional loans are driven first by credit score. Pay your bills on time, don’t open too many lines of credit, don’t run your credit cards up to the maximum—in other words, live within your means and take care of your books

2.  Save or wholesale your way to some cash reserves. Between down payment requirements lender’s growing obsession with your cash, this “should do” has become a “must do”. And it’s good for you, anyway.

3.  Make an acquisition plan. Given the dearth of repair loans available and the extremely conservative appraisals we’re seeing today, it’s almost better to plan to BUY properties creatively, then REFINANCE them institutionally, if necessary. Your choices for purchase and repair money include private loans, subject to or owner-held mortgages, credit cards and lines of credit, or, of course, cash. Refinancing a finished, rented property is a whole lot easier than buying it in the first place. Plus, ONE set of loan costs rather than TWO adds $2,000-$5,000 to your bottom line.

4.  Make sure you’re evaluating income on “keepers” correctly. Most investors still use the completely incorrect “Rent – PITI = cash flow” formula when figuring their profits. In truth, the short term (1-10 year) cash flow on a COMPLETELY FIXED UP single family home is around Rent-20% of rent-PITI. In the longer term (20 years+), it’s more like Rent-40% of rent-PITI. If your DSCR does not meet the bank’s requirements, it makes absolutely no difference how much equity you have in a property; you will only be approved for a loan that lets it meet the coverage ratio the bank has decided is “safe”.

5.  TALK TO YOUR LOCAL BANKS ABOUT YOUR NEEDS. Forget the big multi-state, multi-branch banks; go to your local small S&Ls and discuss your business and the sort of financing that makes it work AND could make a lot of money for the lender. You’d be amazed at how many small local banks don’t really have the first clue how real estate investing works—I once had a VP of lending call me and say, “you’ve lost money on your real estate for the last 5 years. Why should we make you a loan?”. I spent an hour educating him about what “depreciation” means, and that it’s not a “real” loss before getting approved. Local banks still make money by taking in deposits and loaning them out, and they’re missing the boat by not catering—in a conservative way—to the people who are still buying properties (that’s us, of course). No, you won’t convince Joe Banker to open a new loan program for you today, but you’ll plant a seed in his mind. He’ll bring up the idea at the next board meeting. They’ll think about it for awhile, and eventually come up with the idea, all on their own, to go back into the investor market. And the rest of us will thank you for it.