If anyone has the inside track on financing for real estate deals, it would be Ram Perilall. But this New York mortgage broker — who also buys, rehabs and sells foreclosure properties — said he’s coming to the end of his rope in the current lending climate.
“The guidelines are very, very tight right now,” he said. “Some of the deals that I wanted to do I can’t do.”
Perilall said in the three years he’s been investing he’s often taken out 100 percent loans that rely on stated income and don’t require high credit scores. That allowed him to act quickly on deals without wading through time-consuming paperwork.
“I can’t buy anything right now because I can’t get 100 percent,” he said. “In the past it was very good. I had no problem.”
Perilall’s experience parallels what senior loan officers at 53 domestic banks and 20 foreign banks reported to the Federal Reserve Board in a survey conducted in July. While a relatively small percentage of the senior loan officers (14 percent) said their institutions had tightened lending standards for prime loans — also known as “A-paper” — during the previous three months, about 40 percent reported tighter standards for non-traditional loans and 56 percent reported tighter standards for subprime loans.
While the subprime tightening does not affect the purchase side of deals for most investors, the non-traditional category includes the types of loans that investors tend to rely on heavily for quick, short-term financing with minimal red tape. The non-traditional category is defined in the survey as including “adjustable rate mortgages with multiple payment options, interest-only mortgages and Alt-A products such as mortgages with limited income verification and mortgages secured by non-owner-occupied properties.”
Meanwhile, the tighter standards on subprime loans are shrinking the pool of potential buyers of homes that investors are trying to sell. Fayetteville, Ga., investor John Daniel said he’s been forced to take a break from his foreclosure flipping business because of decreased demand from buyers.
“I have taken a wait-and-see approach for the simple reason that I’m investing in foreclosures and the market is so soft that it is hard to turn around and sell the property after it’s fixed,” he said.
Money is plentiful
But in the midst of all the tightening, there is plenty of money available for well-researched real estate deals, according to Craig Hill, who runs the hard money loan business for The Norris Group, a real estate investing and training company in Southern California. Hard money loans like the ones Hill provides come from private lenders who don’t care as much about credit history and income documentation as they do about equity in the property being purchased.
“The overall tightening of money policies is pretty much affecting everyone. Fortunately the one loan I do is not affected at all,” he said, adding that he has been more conservative in the loans he approves in the last few months, not because of a lack of funding available but because of the lack of deals available. He expects that to change soon as foreclosing banks and homeowners in default realize they will need to cut prices drastically in order to successfully sell properties.
“For us by being conservative for six to nine months, it has allowed us to keep an enormous amount of money so when this thing breaks loose we’re going to have an enormous amount of funding available,” he said.
North Carolina foreclosure investor and trainer Larry Goins runs both a traditional lending business and hard money lending business, and he said most of the foreclosure investors he works with opt for the hard money loans.
“Most investors do because your traditional lender will not give you a loan on a property that needs five to 10 to 15 thousand in repairs done — which most foreclosures do,” he said.
The hard part of hard money
Of course, a hard money loan will cost more than a traditional loan. Both Hill and Goins said a typical interest rate is above 12 percent plus around four points, if not more. And the term of the loan is just 12 months.
“But the average life of a hard money loan is only 60 to 90 days,” Goins noted. “We do not have a prepayment penalty. We want you to pay it off so you can loan it to someone else.”
And Goins argues that the cost of a hard-money loan is significantly lower than some of the other financing options available to investors.
“If you think hard money is expensive, try a partner, it’s 50 percent. And it’s 50 percent no matter how long you keep,” he said.
Because hard money lenders work almost exclusively with investors, hard money loans can typically close in 10 to 15 days so that investors are positioned to act quickly when they find a good deal. But just because hard money lenders are able to close quickly doesn’t mean that they don’t carefully evaluate each deal before handing over the money.
“The hard money lender is almost like a protection for you. They’re not going to let you overpay for a property,” Goins said.
That protective function is something that Hill, the California hard money lender, also takes seriously. He said that 80 to 90 percent of the calls he takes involve him trying to talk investors out of an unwise deal.
“It’s surprising how many people don’t want to hear that,” he said. “When it’s an investment you need to be very realistic because it is your money that is on the line. … I think they are too anxious to be an investor and they’re not being patient enough.”
Of course if Hill doesn’t agree to give an investor a loan, the investor can often find another private lender who will. Hill believes the looser lending practices of some hard money lenders will lead to problems — both for those providing the capital for the loans and for the investors purchasing the properties.
“They were getting people to buy more, buy more, buy more with private money lending and those people are going to have problems,” he said. “They just didn’t see the signs coming and they continued to lend out money.”
While that easy lending worked out fine when the market was so hot that “you could just put a sticky note on the house and it would sell,” it is not advisable now, when home prices are down and inventories of homes for sale are up in many local markets. Hill began clamping down on his lending about nine months ago because The Norris Group research showed the market was in for a cool-down.
“Typically a lender like myself would lend 70 percent loan to value. In a market like this you’d lend 65 percent loan-to-value,” he said.
In addition to the lower LTV ratio, Hill also looks at investor credit scores and access to cash reserves. Goins said he considers a borrower’s overall ability to pay back a loan, not just the strict LTV number that some hard money lenders rely on solely. “We don’t want them to be stuck in a loan that they can’t get out of if they can’t sell,” he said. “We don’t want to set someone up to fail.”
Other financing options
North Carolina investor Craig Rhodes has purchased four foreclosure properties in the past two years using traditional financing from banks. He said the hard money option appeals to him because it would allow him to roll rehab costs into the loan and not pay for them out of his own pocket.
But hard money loans would also require him to find homes that are available at slightly deeper discounts than he has realized thus far. So to get rehab financing for his last deal he took out an ad in the local paper to asking for a $10,000 loan. He found a private lender willing to lend the money for a one-year term at 10 percent interest.
Real estate investor and author Lance Young, who has written a series of eBooks on buying foreclosure properties, prefers working with a local bank to get his financing. Over the 20 years that he’s been involved in real estate investing he’s developed a relationship with a local bank and now works directly with the vice president of the bank.
“If you’re going to require financing you want to find a good local lender, ideally with a small bank because they work more with a small business owner,” he said, noting that investors will usually receive priority treatment and lower rates because of their repeat business.
For real estate investors, financing is a necessary cost of doing business. Along with the after-repair value and cost of repairs, the cost of financing is a crucial part of determining whether a deal makes good financial sense. And as the cost of financing goes up, investors will need to build more margin into their deals to account for that added cost.
“Everybody wants to be an investor. But the most important thing I can tell you is do your homework. Do your due diligence,” Goins said.