How to Get a Loan for Real Estate Property Investments
Investments in real estate involves the purchasing, ownership, management, rental and sale of all types of real estate properties for a profit.
Most real estate investors normally use a variety of appraisal techniques to determine the value of properties prior to purchase, and when an investment property has been located, and preliminary investigation and verification of the condition and status of the property completed (due diligence), the investor will have to negotiate a sale price and terms with the seller, then execute a contract for the sale.
Most investors employ real estate agents and real estate attorneys to assist with the acquisition process, since it can get quite complex, and improperly executed transactions can be very costly. Real estate investors rarely pay cash for the entire amount of the buying price of a property.
A large portion of the buying price is usually financed using some sort of financial instrument or debt, such as a mortgage loan collateralized by the property itself. The percentage amount of the buying price financed by debt is normally referred to as leverage, while the amount financed by the investor's own capital, through cash or other asset transfers, is referred to as equity.
The ratio of leverage to total appraised value (LTV) is the mathematical measure of the risk an investor is willing to take by using leverage to finance the buying of a property. Real estate investors usually seek to decrease their equity requirements and increase their leverage, so that their return on investment (ROI) is maximized.
Most lenders and other financial institutions usually have minimum equity requirements for real estate investments they are being asked to finance, typically on the order of 20% of appraised value. Investors seeking low equity requirements may explore alternate financing arrangements as part of the purchase of a property, and if the property requires substantial repair, traditional lenders like banks will often not lend on a property and the investor may be required to borrow from a private lender by making use of a short term bridge loan like a hard money loan.
Hard money loans are short-term loans where the hard money lender charges a much higher interest rate due to the higher risk nature of the loan. Hard money loans are usually at a much lower loan-to-value ratio than most conventional mortgages.
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Where can you find loans for real estate investing?
Lenders have different programs and in order to get your loan request approved, you should compare several lenders and their offers to find a loan program that works for your particular situation. Loan costs, terms and rates will normally vary, so make sure to get several loan estimates to compare in order to find the best deal available.
Financing using cash payments
Hard money loans financing
Hard money lenders comprise of by private businesses and individuals who provide short-term, high interest loans for real estate investors, which does not conform to traditional bank standards of creditworthiness.
Hard money loans charge fees and much higher interest rates which often times double the amount of a traditional mortgage. All hard money lenders have different requirements, and as a real estate investor, you need to be fully aware of what you are getting yourself into when considering hard money loans to finance your real estate investment.
Private money lender financing
The financing terms will usually be agreed upon upfront, with a specified payback period ranging anywhere from six months to a year. These loans are most common when an investor is certain they can raise the value of a particular property over a short period of time through renovations. You should understand that private money should only be used when you have a clearly defined exit strategy.
Self-directed IRA accounts financing
Both the buyer and seller can often enjoy a faster transaction process and avoid many costs and fees associated with the closing process. In addition, the property owner can sell the promissory note if they no longer want to manage their own owner financing.
Peer-to-Peer loan financing
Loans for real estate development can be taken from banks, wealthy individual investors, or investment companies. To apply and qualify for real estate financing from any source whether local within your country or international, you need to be well prepared. The basic process to follow include:
Prove your credibility
To secure funding, you must demonstrate that you are able to accomplish the goals of your project. To do this, you will likely need relevant development experience and a track record of successful development projects. You can also team up with a partner who already has a strong track record of real estate development success.
Without a good record or a partner with a good record, your chances of securing a large loan from any source will be greatly reduced. However, you may still be eligible to get a small loan amount for an individual rental property or small commercial property.
Always plan for multiple locations
Loans usually take time to be processed and could result in the property you wanted to buy being sold to another buyer. In order to get a loan, you will need to show that you have a good plan in place that will most likely result in a good return on investment (ROI). Plan on working with multiple lenders and not just your preferred lender, and have a backup plan should the process take much longer than you normally expect.
Research and prepare development cost estimates
Do your due diligence and research and create a detailed cost analysis of the projects you are planning to invest in. Make sure the selling price is comparable to other properties listed for sale in the local area.
Prepare estimates for all the costs associated with the development of the property and look at the material, labor, and overhead costs in addition to the fees for permits and associated costs. Once you have your estimates, add a 10 – 15% buffer on top as a contingency item.
Create a proposal pitch
Always be ready to present your project to lenders by providing the financial highlights in a good way, and be prepared to outline all the details. Make sure you can answer every question a lender may ask, and be ready to get more information to them if and when they ask for it.
Since the lending industry is highly regulated, always be prepared to provide extensive documentation to substantiate your background and financial history.
How to pre-qualify for the best real estate loan financing
If you are a qualified borrower, you can usually find a lender for your real estate investments. However, you do not want just any type of loan, but you want the best investment property loan you could possibly get.
In order to do just that, you need to be the most attractive applicant possible in the eyes of lenders. Below are some suggestions to help you find the best loan for your next investment property.
Work on your personal credit score
Whether you are applying for a mortgage for your investment property or a commercial asset-based loan, you can be sure that lenders will generally check your credit score from all major credit bureaus and use that credit score to determine your loan eligibility, your down payment requirements, and your interest rates.
You can get an investment property mortgage with a credit score in the low-to-mid 600s. However, you may be asked to put more money down than you want to, and your interest rate might be significantly above average.
A credit score of 740 or higher will generally qualify you for a lender’s best terms and rates, so working on your credit score can be an extremely smart move. Your credit score is a good place to start with different investment property lenders and loan programs having varying credit score requirements.
Provide your income and employment documentation
Some asset-based lenders do not care about your personal income or employment history when you apply for an investment property loan. However, a majority of lenders do offer better loan terms, and will most likely consider your income and employment situation when making loan approval decisions.
If you are applying for a bank loan, you cannot have a debt-to-income ratio of more than 45%, including the expected payment on your new loan. You can include 3/4 of the property’s expected rental income for qualification purposes, but you will still need to be able to document your other sources of income.
Before you begin looking for a loan, it is a good idea to have all of your income documentation including your last tax returns. It is also good to have a contact number for your employer’s HR personnel who can verify how long you have been at your job.
Pay down some of your outstanding debts
Debt reduction can boost your qualifications for any type of loan and improve your debt-to-income ratio. Even if you are already within your lender’s limit, a lower debt to income ratio can help you get better loan terms.
In addition, reducing your debts can help raise your credit score. The amounts of money you owe on your various credit accounts usually make up 30% of your credit score, hence, a substantial debt reduction could have a big impact on your personal score.
The lower your monthly debt obligations are as a percentage of your pre-tax income, the stronger your loan application will be.
Your assets and cash reserves
Most lenders want borrowers to have a certain amount of cash reserves. This is usually as a certain number of months' worth of mortgage payments, including taxes and insurance. Lenders have different guidelines, but do not expect to get investment property financing without at least 3 months' worth of cash reserves. Some lenders may prefer that you have at least six months' or more, before considering your loan application.
Make sure your investment property will generate adequate cash flow
Most asset-based lenders offer loans based on the property, meaning the cash flow from the property needs to be more than sufficiently cover your mortgage payments, including taxes and insurance. Always make sure your target real estate investment property will generate enough cash flow. The debt service coverage ratio (DSCR), is the property’s expected income divided by your monthly expenses.
Apply for financing with as many lenders as you possibly can
The most common mistake when trying to look for funding is to apply for loan from just one lender and accept whatever terms they may be offering. You do not have to worry about too many loan applications hurting your credit score, since as long as all of your applications take place within a two-week window, they will often count as a single inquiry for credit-scoring purposes. Make sure to apply to at least a number of lenders before making a decision.
Different types of lenders consider different things when making lending decisions. Real estate properties usually represent a generally higher risk level to most lenders, and before trying to get property financing, you should make yourself attractive to most lenders.
You need to have at least 20% down to finance an investment property, though some lenders may require 25%, 30%, or even more.
The first thing you need to do before applying for a real estate development loan is to check with local lenders. You may be surprised at how willing some small local banks and credit unions are to finance your investment properties. Some of these institutions have an excellent knowledge of their local markets and you should not overlook them.
You also need to get your documentation in order before you start making loan applications. Besides having a signed purchase agreement, prepare your recent tax returns, contact information for your employer, and other documents. The less time it takes for you to get everything in your lender's hands, the better it will be for you.
You also need to be very open and responsive throughout the whole loan application and approval process, especially if you have a tight closing time frame. If your lender has a question for you, it is important to respond as quickly as possible.
Real estate investment financing is complicated and it is important to know the practical options and best practices for navigating the process. There is no one-size-fits-all way to finance real estate investments, so weigh all the pros and cons of each financing available, to find the best that suits your needs.
How to lower your real estate project costs
No matter where you get funding for your project from, your profits will always be higher if you can lower your project costs. Keeping your development costs low will usually result in a much better profit for you and any potential equity investors in the project.
Even if you do not reach your income goals, lowering the overall costs of a project will help you achieve your main objectives. It is easier to secure funding for lower cost projects as a percentage of projected value upon completion, than for relatively higher cost projects.
Unless you have a lot of experience with high-value real estate projects, you are not likely to get high leverage for your project, and neither would you want it. Debt repayment is the hardest financial challenge you have to face during a development project.
Most banks are highly regulated and will take the property from you in a foreclosure action if you fail to pay them on time. Having a disciplined approach to development can help you to build successful real estate projects.
What can you do to lower your real estate construction costs?
Location will normally determine the cost of buildings, land, labor, and supplies. Find locations with more favorable costs and look for potential projects in a location with a more favorable cost structure.
Land prices increase with demand, such as when they are located in a crowded city or near a desirable location like a beach or a significant landmark. The same project can have a different cost depending entirely on the location of the property.
Due to varied market standards, differences in regulations, and availability of certain inputs, your costs will never be the same in two entirely different locations.
Do not apply cost data from different locations to your estimates. Get to know the market standard prices for all the costs of your project so you can be sure to keep to your original budget.
Vendors and Contractors
Working with the right vendors and sub-contractors makes a big difference in cutting costs. Some contractors may have higher pricing while others might charge less but fail to perform, costing you more money down the line as you fix their construction mistakes and project delays.
Look into the history and capabilities of each sub-contractor you plan to work with before signing any contracts. Due diligence is very important if you want to work with people who can get the job done right.
Unless you understand every building regulation in the area you are considering developing, you need expert advice from architects, engineers, and similar professionals to make sure you are doing things in the right way from the start.
Look for contractors that are licensed, insured, and who have a track record of getting work done on time. Always be on the lookout for how many satisfied customers they have for similar projects.
Ask about maximum price guarantees and get quotes from multiple trustworthy contractors. If possible, speak to other real estate developers in the area to ask about their costs for developing similar real estate projects.
Size of the project
Small projects are generally lower cost projects, and unless you are planning an ultra-luxury development with a very high cost per foot to develop, reducing a project’s size may not be your preferred option since zoning regulations may permit you to build larger scale.
The highest and best use of a piece of land or redevelopment project may not always be to maximize the scale of the project simply because local regulations permit it.
Take time to evaluate the local market and demand for the kind of building you are developing, and be sure to scale your project to meet that particular demand. You may be better off building a smaller project that ends up being fully occupied, than a larger project that has a high vacancy rate.
The longer a property stays in development stage, the higher the carrying costs will be. You cannot rush a project to completion, but you should create a realistic timeline and follow-up consistently to make sure things are going on as scheduled.
Carrying costs include interest on any loans taken out on the project, property taxes, insurance, utilities, and other related operating expenses, and the cost of paying your investors returns on their investment.
You cannot do much to reduce your carrying costs, but you can reduce the amount of time it takes to get the project completed. Try focusing on buildings or properties that do not need as much work, only need renovations, and that have ongoing income while you complete your business plan.
Any full construction projects will usually take much longer and will include higher carrying costs over the full timeline, in addition to having no ongoing operating income until leased up.
Throughout the pre-development process, you need to plan every step of the project as thoroughly as possible. If you do not budget, it does not mean it will not cost anything.
Failing to budget for something or not budgeting the right cost in your development plan can result in substantially higher costs as you strive to arrange for something unexpected.
Know what costs to put in your estimates, what to plan for in development, and what to expect on site. Think about things that could realistically happen, not just your best-case scenario.
If something goes wrong, you should be ready for it and have a plan of action, or else it might heavily affect your costs – hence the need for a contingency line item in your original budgeting to cover unexpected cost overruns.
Financing real estate investments can be quite tricky. There are many types of lenders that offer loans and financing on real estate properties, and the requirements to finance an investment property can be significantly different than they are for a primary residence.
It is not hard to find financing for your real estate investment. However, to find the best possible loan for your investment will requires a bit more work on your part since real estate development projects, usually require some sort of external financing.
It is upon you to choose how to finance your project, how to manage the costs and expenses of your projects, and how many properties can you buy. If you have a good credit score, and your debt to income ratios is better, you can easily get financing for your real estate investments.
Any time is a very good time to buy property, but you must educate yourself on rental property ownership, do your due diligence, and do not think everything is going to be easy and hassle-free, since investing in real estate is hard work.
Hopefully the hard work you do and issues you have to handle over the years will just be distant memories when you retire with a nice rental property income stream. If you have a down payment of 20% or more and a good credit score, it is not too hard to find financing for a real estate project.
However, finding the best possible international real estate financing and loan can make a huge difference in your future cash flow, as well as your long-term equity. Take the time to make yourself the best applicant you can be and make sure to take advantage of all of your options.
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