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   ARTICLE   |   From Scotsman Guide Residential Edition   |   January 2018

Always Search for the Best Option

Hard money, traditional mortgages and crowdfunding offer different choices for real estate investors

Always Search for the Best Option

Real estate investors have more options for financing than ever before. Although most fix-and-flippers use cash to purchase and renovate their investment properties, many use conventional mortgages and hard money loans. Some investors have even turned to a new form of lending that has emerged over the past five years — crowdfunding — which is gaining traction in the residential real estate investment space.

Mortgage originators who want to capture a portion of this residential investment market, should search high and low to learn all they can about the various loan products and platforms investors use. Armed with the benefits and drawbacks associated with hard money loans, traditional mortgages and crowdfunding, originators can better advise their investor clients.

The supply of distressed housing has dwindled in the past few years, but rising housing prices have kept interest in residential property investment high. And, with low-cost property opportunities diminishing, real estate investors appear to be more willing to seek out various types of financing to purchase and renovate higher-priced properties.

More than 53,000 single-family homes and condos were flipped nationwide in the second quarter of 2017 alone for a home-flipping rate of 5.6 percent of second-quarter home sales, according to Attom Data Solutions. The estimated total dollar volume of financing for homes flipped in second-quarter 2017 was $4.4 billion, the highest level since third-quarter 2007, nearly a 10-year high.

Although cash has always been king in the real estate investment market, for many real estate entrepreneurs, access to financing is extremely important. More than 35 percent of homes flipped in second-quarter 2017 were purchased with financing, according to Attom. That’s the highest level since third-quarter 2008, or a nearly nine-year high.

Hard money

Despite rising awareness and acceptance of hard money loans thanks to popular home- renovation TV shows such as HGTV’s “Flip or Flop,” short-term hard money loans haven’t really changed all that much over the years. These private-lender offerings still provide several key benefits for fix-and-flippers that mortgage originators should bring to the attention of their real estate investor clients.

First of all, hard money lenders are knowledgeable. Many specialize in the single-family and residential real estate market and are geographically focused, so their knowledge of the local market and their understanding of a real estate investor’s needs in that particular market is generally strong.

Second, they lend based on an asset’s value and not an individual’s credit score or credit history. That means a credit “ding,” such as a past bankruptcy or a less-than-perfect credit score, won’t hurt an investor client’s chances of getting funding if the hard money lender the originator works with determines the property being purchased is a good risk.

Short-term hard money loans haven’t really changed all that much over the years.

Last, but probably most important, hard money lenders are fast. They can often provide funding in just a handful of days instead of the six weeks it takes, on average, to close a traditional mortgage loan because of the significant amount of time it takes to gather documents, delve into a borrower’s credit history and maintain compliance with regulations. Speed is key for real estate investors who often are competing to buy a property and must move quickly or risk losing deals.

Although hard money has clear benefits, it also has a few potential drawbacks that originators should be prepared to explain to their investor clients — especially those new to flipping or who have not used financing previously.

First, because of higher risk, hard money loans have significantly higher interest rates than traditional mortgages. In addition, hard money lenders only offer short-term financing, which may be as short as a few months and often not longer than a year. Investors who need financing for a longer period will have to look for other options.

Finally, hard money lenders generally require a downpayment of 25 percent to 35 percent. Some may loan up to 100 percent of the existing value of the property, but not on the expected renovated value.

The traditional route

Although short-term, hard money loans are used more often by fix-and-flippers, traditional loans backed by Fannie Mae or Freddie Mac, such as a 15-year or even 30-year fixed-rate mortgages, offer a good solution for investor borrowers who can qualify and aren’t in a hurry. This type of financing also is useful for clients who are looking to fix-and-hold a property for use as a rental.

There are several benefits to a traditional mortgage loan for real estate investors:

  • Borrowers with good credit ratings often will get interest rates that are lower than hard money loans.
  • Longer loan terms and adjustable-rate mortgages are available, which can reduce monthly payments.
  • Investors with high credit scores (720 or higher) can finance up to 75 percent of the purchase price on up to 10 properties (with certain restrictions) under Fannie Mae guidelines. (Freddie Mac limits investors to four property purchases.)
  • Cash-out refinancing options also are available on investor-owned properties through lenders that sell loans to the government- sponsored enterprises.

Certainly, the main benefit of going the traditional route is lower cost, but there are two key negatives that often preclude real estate investors from pursuing a traditional mortgage loan: time and credit checks. Originators should be aware of these issues to help guide their clients to the best products.

Real estate crowdfunding has a value proposition that appeals to many property investors.

Most banks and nonbank mortgage lenders who make conventional loans can take several months to close the loan. For a real estate investor, that time frame could be the death of a deal. Most investors need to be nimble and able to act quickly, especially in today’s highly competitive housing market.

In addition, with traditional lending, borrowers obtain financing based on the strength of their personal incomes and financial records, not on the value of the asset or the cash-flow potential of the property being purchased. As a result, the best interest rates will only be available to those clients with the finest credit and the ability to show consistent wages from W-2 earnings. Many real estate investors are self-employed and do not have a W-2 to submit to the bank making the loan.

Alternative lending

It’s been interesting to see how the housing and financial crisis has impacted the mortgage industry over the past decade. Although there has been untold attention on all the new mortgage regulations designed to protect consumers, there also has been innovative disruption in the lending market.

The crisis — and the resulting tight credit markets that gripped the nation afterward — created just the right impetus for a host of creative startups to fill the lending void and find new ways to finance housing for real estate property investors. Originators who do not follow these trends run the risk of being left behind as the real estate debt-based portion of the crowdfunding industry helps fill the void with technology-based, online options for borrowers and new outlets for investors wanting to diversify their portfolios.

A joint study by the University of Cambridge and the University of Chicago suggests that the alternative lending sector, which includes crowdfunding, “hit a stride” in 2016 and has plenty of room for growth. Total market volume in 2016 for alternative financing in the U.S., Canada, Latin America the Caribbean was $35.2 billion, up 23 percent versus 2015. Real estate crowdfunding accounted for just 2.3 percent of the alternative lending market in 2015, but its volume rose by 70 percent in 2016.

Real estate crowdfunding has a value proposition that appeals to many property investors. For one thing, many online crowdfunding platforms offer a national footprint that makes them very accessible. Plus, like hard money lenders, debt-based crowdfunding can provide quick lending decisions in days, not weeks.

Crowdfunding platforms don’t require the borrower to raise funds from “the crowd.” Instead, the crowdfunder takes a first-lien position on the loan and offers it out to accredited investors (the crowd) only after it’s been fully funded.

The sophisticated technology used by crowdfunding platforms to determine if it makes sense to lend to a particular applicant also benefits the “crowd” of investors. Some innovative tools even allow investors to easily obtain greater access to transactions that meet their specific predetermined investing criteria.

It should be noted that not all real estate debt-based crowdfunders are alike. Originators who are looking to build a lasting relationship with real estate investors that goes beyond a single deal should do their homework so they can advise clients when asked about the pros and cons of these platforms. The same goes for the hard money and traditional mortgage lenders they work with to finance their clients’ purchases.

•  •  •

Real estate investors have more options than ever for financing their deals, but hard money, traditional mortgages and alternative lending products all have their pros and cons. Depending on each deal’s parameters, one product may make more sense than others. Good mortgage originators always look for the best options for their borrowers because they know that making clients happy is what brings them — and their friends and family — back for the next deal.


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