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Negotiate With a Lender: Commercial Property Loan

Commercial Real Estate Loan

Questions With a Lender for a Commercial Property Loan

A piece of property is considered to be commercial property when it is five units and above.  This includes apartments, office, retail, warehouse, mixed use and flex space.  A completely different lender and lending guidelines apply to these properties.  It is critical to your success to make sure that you are working with a lender that specializes in commercial loans.

Ask a Lender These Questions:

“What do they have an appetite for?”  This means what they are lending on in regards to the categories that are mentioned above.

“What is the commercial loan based on, the loan to value or the debt coverage ratio?”  It can be one or the other or it can be both.

“What are the terms that you are offering on commercial loans?” It could be 70% LTV for 25 yrs at 5% and a balloon in 10 yrs.  Or it could be a debt coverage ratio of 1.25 for 25 yrs at 5%.  These are two different kinds of loans.

For example, let’s say that you have a property that brings in a NOI of $2000 a month and the bank uses a 1.25 DCR.  The way that you determine the DCR is that you take the Net Operating Income and divide that by the DCR rate.  So, in our example, we have a $2000 NOI and we divide that by 1.25.  That gives us $1600 a month for Principle and Interest.  If you subtract the monthly payment from the NOI you have $400 a month in cash flow.  To determine your annual cash flow, simply multiply by 12.  This property has $4800 in cash flow for the year.

“What is the minimum credit score for this commercial piece of real estate?”  Usually the bank requires a credit score around 725, but keep in mind that each lender is different.

“What is the debt to income ratio?” Currently lenders are doing approximately 50% maximum debt to income ratio.  That means you are allowed to spend 50% of your income towards debt.  Debt is principal and interest.  Because of Dodd/Frank there is the possibility that the debt to income ratio may be lowered to 43% in the future.  Keep in mind that every bank, savings and loan, & credit union has their own loan conditions.

The sixth question you want to ask if you are looking at a loan which is based on debt coverage ratio is “What does the bank require in terms of vacancy rates?”

“What does the bank require in terms of a cash reserve?” Cash reserve can be based on a percentage of the rent. Cash reserve can be based on a dollar amount per unit.  Cash reserves are for capital improvements over the investment period that you are analyzing.  These numbers take into account cash reserve, utilities, and so forth and reduce the amount of money that you are making and that is called net operating income.

“How much money do you need to set aside for management?”  This is a critical number in determining your Net Operating Income.

Net Operating Income is determined when you take the Gross Rents and subtract:

  • The vacancy factor
  • The taxes and insurance
  • The cash reserve
  • The utilities
  • The maintenance
  • The management
  • And any additional expenses

Once you have subtracted all of these expenses, you have the Net Operating Income.

Cash on Cash Return

The next thing that you want to evaluate is your cash on cash return.  Take the annual cash flow of $4800 from the example above and divide that by the initial investment to determine how much cash on cash return you are making for that piece of commercial real estate.

So what does the initial investment entail?  The investment entails your down payment.  So let’s look at the payment again $1600 P&I for 25 yrs at 5%.  By using a financial calculator you can determine that the loan amount is $298,050.  So if the property is selling for $372,563 for example, that would mean you had to put down $74,507 or your investment.

Therefore, a $4800 Cash Flow divided by $74,513 yields a 6.4% cash on cash return.  That means at the end of the year you are making 6.4% more than what you invested.  In commercial real estate, you are looking for how much cash flow you are getting as part of your financial return.

The financial plan is to get the $74,513 down payment to invest in commercial real estate.  There are several ways to get the down payment for a commercial property.

Acquiring a Down Payment

One way is to buy houses below market value, like a short sale or a foreclosure, and then sell them at market value for a profit. You will typically have to do multiple deals to generate a large enough down payment for the commercial property.  Once you have enough money, then buy the commercial piece of real estate.

Another way to do it would be to buy a house at a discount, then fix the house up, then sell the house at market value. You may have to do multiple deals to generate enough money for the down payment.

A third way to accumulate that $74,513 is to buy houses in markets that are appreciating, then rent those houses, hold them for a few years until the value increases by that $74,513, then 1031 exchange into a commercial piece of real estate. You don’t have to 1031 the property. You can just sell it, take the money, and move the money into a commercial piece of real estate.

A fourth way would be to bring in investors for the $74,513 and then share the profit or make them an equity partner in that venture giving them a piece of the cash flow and/or appreciation and/or principal reduction and/or tax benefits.

Richard Maryanski and Erik Maryanski
Rich Dad Education Elite Trainers and Mentors

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Real Estate Financing

Real Estate Financing

Observations on Real Estate Financing

Here are some current observations on financing in today’s real estate market.  Since the economy is up and inventory is down, the prices are up in several markets.

I have noticed from information that I have gathered from students in the Creative Real Estate Financing class and from mentoring students, as well as from banks that we have talked to while mentoring, that the financing terms for real estate are finally loosening up.  Depending on the markets that you are in, here are some observations on financing for Owner and non-Owner occupied single family homes.

  1. The owner occupied LTV was 80%, now it is up to 90 and 95% in some cases.
  2. Banks are taking a 90% 1st and a 5% 2nd.
  3. We have not seen 2nds since 2007.
  4. FHA is still at 96.5% LTV, however, now they allowing the co-borrow to come in on the loan if you have a poor credit score or debt coverage ratio.
  5. Debt coverage ratio on Owner occupied was 30-45%. Now it is up to 50% ratio.
  6. For investment property on SFD, non-owner occupied max loans were 4. Now some places will allow 10 loans or higher.  This will allow you to buy more investment properties.

Jumbo loans were $417,000. In some places, it is as high as $728,000. Up until recently, jumbo loans required 20% down or higher.  Some lenders are offering 10% down and offering 5% interest only.  Again, we have not seen these types of loans since 2006.  This is a great time to be purchasing Single Family properties, with interest rates at 60 year lows and property appreciation increasing.  This is also an excellent time for a great ROI on properties.  Talk to several lenders, credit unions, and banks to see what kind of financing you can get for your project.

Richard Maryanski
Rich Dad Education Elite Trainer

Calculating Return on Investment

There is a lot of discussion today about, “What is a deal?”  A deal is not the same for everybody.  Some people are looking for cash flow properties and some people are looking for appreciation.  There are two ways that you can make money on a deal: cash flow and/or appreciation.  I would like to have a discussion about these two ways to make money.

How do I determine if this is a deal? In order to answer this, you need to factor in four things.  How much is needed for the initial investment?  What amount is needed to cover the down payment, the closing costs, the carrying costs and the repairs?  For example, if you have invested $50,000 for those four things, what would make this a deal?  It depends!  It depends on how much that property can make for you in the next 12 months from the two categories that I mentioned before, appreciation and or cash flow.

Cash flow is the money made from all the income generated by the property minus the expenses.  Typically cash flow is determined on an annual basis.  So if the cash flow on the property is $5,000 and you invested $50,000, then you are getting a 10% return on investment.  You determine the cash on cash return by taking the annual cash flow in this case $5,000 and dividing it by the initial cash investment of $50,000. $5,000/$50,000 is a 10% cash on cash return.

The next number we need to know is appreciation.  Appreciation is determined by the surrounding properties and the economic trends.  If the economy is strong then the supposition is that the area will continue to appreciate.   If the property increased in value by $5,000 based on properties in the area and strong economic conditions, then you can assume that the property will continue to increase in value by $5,000 a year.  Market appreciation is a result of supply and demand.

There are two types of growth: market appreciation, as discussed above and forced appreciation.  Forced appreciation is where you do something physically to the property to increase its value.  You may paint or fix up the property or add square footage or a bedroom or bathroom.  Once you have improved the property, then you will be able to sell it for current market value.

Back to determining if this is a deal.  Let say that the property has $5,000 in profit from cash flow, and $5000 in appreciation, this means that the property profit is a total of $10,000.  To determine the Return on Investment, you take the total profit from appreciation and cash flow and divide that by the initial investment.  In this case that is $10,000/$50,000 for a 20% return on investment.

Ultimately, you are the only one that can decide if the property is a good enough deal that you want to move forward on it.  Make sure that you consider all the expenses and run the numbers before you purchase a property.  It is too late to crunch the numbers after you have purchased the property.

Rick Maryanski
Rich Dad Education Elite Trainer and Mentor

Finding the Deal or Finding the Money

Which came first, the chicken or the egg? Well, there is a similar conundrum in real estate investing. Which one is more important: finding the deal or finding the money?

Some investors will say that the deal is more important and others will say that the money is more important. Many investors feel that in order to be successful, they have to possess the skills to do both—the deal and the money—really well. Luckily for them, that is a myth and not the truth. In order to be successful in real estate investing, they only have to do one of two things really well. They either need to be really good at:

  1. Finding the deal or
  2. Finding the money

If you have a great deal, you can find people that have money because they will be attracted to the opportunity. If you can find money, then you can also use the money to get the deals coming to you. If people know that you have the means to put together a deal, they will bring opportunities to you, so it works both ways. If you have either the deal or the money, the other half of what is needed will be attracted like a moth to a flame.

Let’s review each of these aspects.

Finding the Deal

To be successful at finding the deal, you will want to put several strategies at work simultaneously to help you consistently locate great investment properties.

First of all, find a real estate agent that can supply you with potential opportunities. Let the agent know what kinds of investments you are looking for (rental properties, rehab properties, commercial, etc.) so they know what types of deals to bring to you. If you have a deal that is profitable, the money will come to the deal because it is an opportunity for another investor to make a profit.

When you are working with an agent, you will likely submit many offers or letters of intent to secure a deal. You need to know that it is part of the process so that you can set the right expectation with the agent.

Another way to get consistent deals is through advertising. Motivated sellers are always looking for a way to sell their property. If they see a sign, a billboard, a flyer in the mail, a letter, or are referred by someone, you can solve their problem and score a great deal in the process.

One of the keys to successful advertising is to be consistent. Many sellers do not respond the first time they see an ad because it is a timing issue. If a seller is losing a home due to foreclosure, they may be in denial for quite some time before they realize that they need help. There are similar circumstances with probate properties, job transfers, divorces and so on. The important part is that you never know when the timing is right. In order to get the best results, it is important to plan on having an advertising budget each month and stick to it.

Monitor the results of your advertising. When people call you, ask them how they found out about you. This is one of the easiest ways to gauge what is working and what is not. That also helps you identify where you should spend your money in the future as you advertise.

If you have the money but need the deal, another option is to work with wholesalers in the area. A wholesaler will constantly find deals and assign the contracts to other investors because they do not have the money to put the entire deal together. If you find a good wholesaler, this can be a constant source of potential deals and they are doing all of the leg work for you.

Let the wholesaler know what you are looking for in a deal and what you have the ability to fund. With that kind of information, they can use their resources to find the right scenario for you and it takes a lot of the burden off of you. This is another case of how people who have money set the rules and people do their best to match those rules.

With this combination of strategies, finding potential investments will be much easier and it will give you a place to put the money that you have located.

Finding the Money

What happens if you find great deals but you do not have the money? Well, use these strategies to help you with the other half of the puzzle.

If you cannot find the money, the simplest solution is to assign the contract as a wholesaler. This means that you sell your contract to another buyer (usually another investor) and they step in and use their resources to fund the deal. You would make an assignment fee for putting the deal together, and you are free to move on to the next deal.

Wholesaling is a common way for many investors to get started as it is a way for them to begin investing without having the capital resources to do it.

Another common method is for people to use creative financing as an option for putting the deal together. This includes lease options, seller financing, and many other options. The whole point here is that you can structure an alternate method for the deal to work where the money needed will be little or nothing at all. With these strategies, you can potentially bypass the need for having funding.

You can also use partners for funding a deal. The whole point is that you put up the deal, they put up the money, and you split the profits. Now, there are specific rules you must comply with when it comes to raising capital from others and they are too detailed to include within this article. However, the principle is that you can always raise the money. No one said that the money had to come from your bank account.

When you privately fund deals like this using other people’s money, you remove a lot of the barriers and limitations that many investors feel that they have. There are many people that have money that would like a better return than what they can find through traditional sources. If you can provide them with an opportunity that they cannot get elsewhere and they believe in your ability to deliver, then this can be a viable opportunity.

Summary

The purpose of this article is to show you that there are many roads that lead to success as a real estate investor. The training offered by Rich Dad Education will show you how to use each of these various methods to achieve success. If there is a specific path that interests you, enroll in the appropriate class and get all of the necessary information.

You can use your personality, your skill set, and your talents to be successful as a real estate investor. Get really good at finding either the deal or finding the money. When you have one half of the puzzle solved, the other half tends to work itself out.

Hard Money Loans

A common mistake for many real estate investors is that they focus on only one way of putting together a transaction. There are many different strategies and many different financing options. Knowing when to use each technique will make you a better investor.

Each strategy and technique is effective when used correctly. Hard money loans are a very common financing option for investors, but they also have their time and place.

What is a hard money loan?

The easiest way to explain a hard money loan is that it is private financing. Hard money lenders are people that have access to a pool of money that they loan out on real estate. This pool is usually the result of a group of investors pooling their money together to finance real estate. They are investing in the financing behind the property rather than the property itself.

Since this is private financing, a hard money lender is going to charge higher interest rates for the money. These loans usually charge credit card type interest (10-18%). Because of the high interest, this is not a long-term financing option. Most investors use these loans for short-term financing.

If the loans have such high interest rates, why would you want to use this method? Keep in mind that most loan programs have their place and time. You are not going to use this financing option to finance every deal you do, but it is just another option. When it comes to creatively financing a deal, having multiple options is what it is all about.

Just because the loan is a high interest loan doesn’t mean that this isn’t useful. If you are going to turn around and resell the property, then the interest rate is not a primary factor in whether you’ll do the deal or not. The return on your money is far more important than the interest rate. You are not going to have the loan long enough for the high interest to make a large impact. As long as your profit is still in the deal, it makes sense to use the hard money loan.

If you are going to be using a longer term exit strategy like holding the property as a rental, you might use hard money to get into the deal, and then refinance the property with a traditional loan. Someone might do this if they are unable to get a traditional lender to finance the purchase.

Hard money loans are short-term loans. The majority of hard money loans will be 6-24 months in length. This will give you enough time to do what you need to with the property to make the deal work.

The reason that it is called hard money isn’t because it is difficult to obtain. It is called hard money primarily for three reasons:

  1. The higher interest rates can make the loan more costly than other types of financing. Even though it is high interest, the other benefits will help outweigh this problem.
  2. It is difficult to buy the property at a price that will qualify for hard money. Most hard money lenders do not want to exceed 65-70% of the ARV (After Repair Value). The hard money lender will determine what the property would be worth in its best condition, and they will finance up to 70% of that figure.
  3. The lender is going to give the loan based on the value of the asset (the property) rather than the financial strength of the borrower. The lender is going to be more concerned about the deal than they will be about you as a borrower.

However, there are great benefits for using hard money loans.

  • Fast turnaround time. It usually takes a traditional lender 30-45 days to complete a loan. Hard money lenders can do a loan in a much shorter period of time. Most of them can do it within 2-3 weeks and some can even do it in a matter of a few days depending on the resources they have available. If you need to come up with money quickly for a deal, you will want to keep this in mind.
  • Hard money lenders will finance 100% under certain circumstances. Most hard money lenders are not willing to finance more than 65% of the After Repair Value (ARV). If your purchase price is less than 65% of the ARV, then they could finance 100% depending on the lender. This could be another solution for getting into a property for as little down as possible.
  • Most hard money lenders will also include repair costs into the loan. If the purchase price plus the repairs is less than 70% of the ARV, they will include the repair costs into the loan. Since most traditional lenders will not include the repair costs into the loan, this is a great option if you are planning on rehabbing the property.

Here is a quick example of how this could work:

Purchase Price: $87,500

Value of Property After Repairs (ARV): $150,000

Cost of Repairs: $10,000

Since the lender would be willing to finance up to 65% of the ARV, they would loan $97,500 as their maximum loan. This $97,500 would cover the $87,500 purchase price as well as the $10,000 needed for the repairs. In this type of situation, you could finance 100% and have the necessary money for repairs. This could be a very attractive deal.

How do you find a hard money lender? There are quite a few ways that you can do this:

  1. Ask your traditional lender. Many lenders already have these connections set up. This is another way for the traditional lender to finance their clients if their traditional loan programs will not work.
  2. Real estate investment clubs. These investment clubs are a great way to network with other people. Hard moneylenders frequently go to these investment clubs as it is a way for them to get additional contacts and business. You might also want to ask some of the other investors in the club for additional referrals.
  3. Internet. The Internet is another great tool for finding hard money lenders.  Search for “hard money lenders” or “private financing” or even “rehab loans.” You can add the city or state name to find something local.

Hard money loans are just another solution for you to finance a property. You will not use hard money loans on every deal that you do, but if you are going to be flipping the property and it needs some rehab, then this is a great option to keep in mind.

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