Should I invest in SFH using commercial lending?

19 Replies

Hi All!

I am looking to close on my first deal in the next 2-3 months and could use some advice about how to continue to build my portfolio from there. 

Situation:

*I don't qualify for a conventional mortgage because I'm am an independent contractor with only 6mo of history *no co-borrower at the moment *100k available, good credit score, and weak income/W2 history 

1st deal criteria: *Fayetteville, NC market* CASH purchase and reno, SFH for 50-70k, complete a 10-20k reno, for an expected ARV of 100-130K, rent $800-1000 (~1.2%)

Question:

Should I use commercial lending (long term, fixed) to pull my cash out of the deal so I can continue to grow my portfolio? The lenders I have spoken with say that rates would be around 6.5%, which would make it difficult to find residential deals that would have strong cashflow after the refinance. I would also only be able to do one deal every six months with this strategy. (If I want to get money back before six months I could only get up to 80% of the purchase price)

I am very new to RE and the world of creative financing. I would greatly appreciate any and all advice or suggestions of a different angle to approach growing my portfolio.

Thanks! 

Additional context if interested: My goal is to create a portfolio with $1500 monthly CF in 2 years. I could refinance the commercial loans in a year and a half when I qualify for conventional mortgages (bring CF up to ~$200/door).  But I would still not reach my goal if I can only buy 2 properties a year.

@Rachel Smith what is your commercial lender going to use for income that a residential lender wouldn't use? 

Also, terms matter here. 6.5% is not bad for commercial but it can't be 30year fixed. so you have an increase in debt service from the shorter amortization as well. Neither of these are bad, just consider them. 80% LTV is good though.

Have you acually spoken to lenders about your financing criteria or are you assuming you can't use your income to qualify?

also obviously your numbers need to be dialed in. 50-70k is a big spread for a 100k house and a 10-20k rehab. On the high side you could be at 90% LTV based no yuor spread.

don't worry so much about speed. Speed and debt, and being at this point in the market cycle, leads to unnecessary risk. Real estate is a LONG PLAY, you'll naturally go faster as you get better but rushing in the beginning (before you've even done your first deal) is the cause of pain for most fallen investors. rentals are a long game, treat them as such. 

@Rachel Smith Talk to an experienced residential mortgage lender to confirm your qualifying status. There are a lot of programs out there that might work. @Alexander Felice Commercial loans do not use DTI to qualify for a N/O/O SFR (1-4 unit) mortgage, so that shouldn't be an issue. Rates start around 6.5% for a 30 year fixed, but obviously, many factors go into the pricing.

Originally posted by @Heather Easterbrook :

@Rachel Smith Talk to an experienced residential mortgage lender to confirm your qualifying status. There are a lot of programs out there that might work. @Alexander Felice Commercial loans do not use DTI to qualify for a N/O/O SFR (1-4 unit) mortgage, so that shouldn't be an issue. Rates start around 6.5% for a 30 year fixed, but obviously, many factors go into the pricing.

I didn't say comm lenders do use DTI, though it's not correct that they don't use it either.

 if OP can get a 30year fixed on 6.5% in house underwriting on such a small loan then my advice would be to lock it down as soon as possible as most banks wouldn't bother. 

Also Rachel, Lumbee guaranty bank has a branch in Fayetteville and local and might do this type of loan. I have some loans with Coastal Credit union which also might be able to help. 

@Alexander Felice thank you for your detailed response!

I was under the impression from speaking to the commercial broker that the main criteria for commercial lending in my situation would be the DSCR, and then I would qualify as a guarantor based on credit score, and funds available to cover at least 6 months of expenses. Though I will be sure to confirm this since you have brought it to my attention.

I have spoken to a few different lenders so far and they all have identified the fact that I haven’t been an independent contractor for at least two years as a disqualifying factor (for conventional mortgages).

It is interesting timing that you mention Lumbee Guarantee. Just earlier today, a lender I was speaking with referred me to that bank and put me in touch with one of their bankers. I will be sure to keep what you have said in mind when I speak with him tomorrow!

Thank you for pointing out the range in my criteria numbers. I should have clarified that they were all contingent of ideally being 70% LTV.

  • A 60k house with 15k reno would require an ARV of 110k
  • A 70k house with 20k reno would require an ARV of 130k to be considered and so on

Do you have any suggestions of where I should narrow my focus from there?

And thank you for the reminder that is the long game. I have been acquiring knowledge for a while now and am very excited to finally get some skin in the game. But you’re completely right, the worst thing I could do is rush and make a mistake that sets me back.

@Rachel Smith look into portfolio loans with local banks. Different banks will have different products. My last BRRRR was 45 days close to close. I have 3 more BRRRRs going on right now. If you want to do conventional then you'll have to wait 6 months, otherwise plenty of options to speed things up.

@Rachel Smith you can get commercial loans on residential property, but they are different in 2 main ways, that @Alexander Felice has mentioned, amortization and interest rate. Interest rates are higher and amortization is almost always 15-25 years, with the vast majority being 15 or 20. The other thing to be aware of is balloon payments as most commercial loans have a 5,7 or 10 year balloon.

As you grow your portfolio you’ll likely have conventional and commercial loans.

Since commercial loans are more expensive, make sure you get something In return, typically speed and ease to close.

@Rachel Smith Based on the information you provided, it would seem to me that a commercial loan may work best if the coverage ratios work out. Commercial lenders look at rent vs. PITI, vacancy, capex, and PM (in general). If the rent is over a certain percentage of that, say 120%, it meets the underwriting requirements. Again, this is a general example. Your personal income usually doesn't matter. Some smaller banks may be more flexible on the coverage ratio and look your personal income if that is a positive factor, with you personally guaranteeing the loan. At least that is what I see in Minnesota. And I would. Or worry about the 5 or 7 year balloon too much - generally lenders will just reset the rate to what is current.

@Stephen Glover thanks for the tip! Do most local banks offer a portfolio loan, or is it a more specialized product? If it’s not widely available, what are the best ways to find portfolio loan opportunities?

@Mark S. I appreciate you taking a look! One roadblock I've been running into when running the DSCR on potential investments is the wide range of rates and terms for commercial lending (as @Caleb Heimsoth  mentioned). Any suggestions on conservative terms I should use in preliminary analyses?

Hi @Caleb Heimsoth , thanks for the response! That’s a great point. If I end up qualifying for a commercial loan, what I would be getting in return is the chance to use leverage in my investing. The question I must answer is whether or not that is enough to warrant the thinner margins and other points you laid out!

@Rachel Smith it has been a month or so since I talked with the commercial lenders I have used but the rates then were 4 to 4.85%, 20 year amortization with a rate reset at 5 years, 20 to 30% down.

@Rachel Smith Yes ma'am! I only invest in Richmond, VA but I met with 7-8 local banks and most of them did portfolio loans... some did not but they had another "department" of sorts that they worked with that could handle that for me. The important thing is that you find a lender that knows what they are talking about. Some local lenders had no idea what I was doing, and some completely understood. Ask some local investors what banks they use, and for a connection to a lender in your area. You might be able to skip a lot of the phone calls and emails to vet them. Also, keep in mind that portfolio loan simply refers to a loan that the bank keeps in their portfolio, it doesn't mean you have to buy 34 houses at once. That's a common misconception so I figure I'd point that out.

Lastly, as I mentioned above, many banks have different terms and types of portfolio loans.  Ask around, find the right fit for your investment.  I have 3-4 banks that I continue a relationship with for that reason.  Hope this helps!


@Rachel Smith Portfolio/Commercial are great options for what you are doing. The advice on terms above is good. I would say 5.25% and 20 year am is a good baseline. The other question you want to ask the lenders is their "seasoning" requirement. That is the six months you are getting from the first bank. You may have to work at it, but you should find a lender who doesn't have a seasoning. That is how @stephen glover is "close to close in 45 days" which will give you more freedom for speed.

Lastly, I assume you can go from commercial/portfolio to a traditional residential mortgage in two years, however that is probably rarely done so I would ask a mortgage broker.

As an example, some residential lenders won't let you have a title change within the last 6mo. If you are titled in an LLC, you might need to change the title to your personal name 6 months before the refi. Again, should be doable but worth asking the question now.

Lastly - I would have more caution about the balloon payment and planning to just reset the rate. If the economy, the financial performance of the property and your financial situation are similar or more positive than now, @Mark S is spot on. However, if one or both of those change for the worse - the balloon and/or resetting of the rate could be a huge problem. That combination probably sunk more investors than anything else in the last downturn. That definitely isn't a reason to avoid Commercial/Portfolio loans but it is definitely something to plan for now.

@Stephen Glover  

Great! I’m already in touch with a few lenders so I’ll make sure to add that to my list of questions.

I completely agree with your point on asking other investors for good banks and lenders to work with. Most of this past week has been taken up with those exact vetting emails and calls. Fortunately, Alexander Felice mentioned banks he has had luck with, so that should help narrow it down.

Also, thanks for the clarification on portfolio loans. Honestly, that is probably what I would have thought at first!

@Dave DeMarinis

Thank you for explaining that there is a possibility to find lenders that don’t have seasoning requirements. That would be a great way to continue building my portfolio at a pace that works for my goals.

The chance of a ballon payment or a large rate increases definitely weighed heavily on the cons of commercial lending. I do have it in the back of my head that there is a possibility to refinance into a conventional mortgage a few years out. I appreciate your point of making sure to asking about the allowable timeframe for a title change and how it could effect the refi to a conventional loan. I wouldn’t have thought to look into that. Thanks!

Hi @Rachel Smith - SFR in that price range are on the bubble in terms of lending options. If the property truly will appraise between 100-130K you're ok. That's right at the minimum for most lenders so if your appraisal comes in lower than expected you'll have trouble getting financing. You should be able to get a 30 year with a lender that bases the loan on the property and not you. They are out there, you just need to know which ones walk the walk and which ones are all talk. I have a bunch of go to lenders I work with to grow my portfolio that I've developed relationships with over the years. I also have others that I would never ever use again.

@Lane Kawaoka Great! I sent you a follow up message, I look forward to hearing from you.

@Salvatore Lentini Thank you for the advice. I’ll make sure to keep the point you made about the price point in mind when I do the renovations. I also appreciate you mentioning that you have many different lenders you’ll work with. As I’m going through this initial screening process, I’ll make sure to keep in touch with lenders that are supportive (and knowledgable) of real estate investing.

Originally posted by @Stephen Glover:

@Rachel Smith look into portfolio loans with local banks. Different banks will have different products. My last BRRRR was 45 days close to close. I have 3 more BRRRRs going on right now. If you want to do conventional then you'll have to wait 6 months, otherwise plenty of options to speed things up.

Did they use the new appraisal instead of lower of purchase price vs appraisal?