Do You Really Get What You Paid for in Real Estate Financing?

In real estate investing, agents and brokers who offer to list a property at 1% commission often come under criticism for diminishing the true value hard-working agents provide their clients. I know many investors who also have their broker license and continue to assist in the purchase and sale of real estate outside their own personal transactions. They wouldn't dream of discounting their commissions. "You get what you paid for" is the common retaliation against so-called discount brokers.

These words of caution are also targeted at general contractors and the various trades needed to get a rehab project to completion. Most investors I know advise against taking the lowest bid for fear of incompetence, lack of reliability, or skipping town altogether.

In an industry where margins are becoming skinnier and true deals harder (if not impossible in some markets) to come by, it's an interesting dichotomy between cost and value. So, why are real estate lenders immune to this pay-for-performance model? Very seldom do I hear investors caution their peers on seeking the lowest rates possible. In fact, it's quite the opposite dialogue on many online real estate investing forums I'm a member of. Posts on who's finding the cheapest financing out there seem to outnumber any other topic by at least three to one. And yet no one would dare ask for recommendations of your preferred discount real estate agent.

As a private money loan originator, I'm asked daily if I will come down in my rates or if I'll beat another lender's terms. Each week, deals are sent our way by those "rate shopping" - which I actually highly encourage so prospects will be confident and comfortable with us and how we operate should they choose to do business with us. Many leave and choose lower cost alternatives only to come back days before closing hoping we'll close a miracle for them after working with another lender that isn't performing to their expectations in some way or another.

And this conflict of cost versus value (and speed) crosses both alternative (asset-based) lending as well as conventional mortgages. Rates have been at all-time lows in both sectors further discouraging conversation about the trade-offs associated with going with the lowest rates and terms. With cost of capital as cheap as its been in recent years, newer investors lack the perspective that more seasoned veterans in the business can use as reference points about what truly "low" rates mean.

In the last year, I refinanced or purchased four properties as an investor. Each time, I was presented with a choice on how I value my time. Shop for cheaper rates or choose a lender who I know can get the job done with minimal brain damage to me so I can continue to focus on my private lending business. Each time, I chose a lender with slightly less underwriting requirements and at least a half point higher in interest rate with a small increase in loan costs and fees, too. The value to me - the least amount of time and personal involvement on my part - made the local lender an obvious choice. I know first hand that getting a commercial loan at 4.5% on a 15-yr term, amortized over 30 years was the way to go despite commercial loans available in the high 3s for well-qualified borrowers. When I started my first flip in the early 2000s, rates were commonly in the 5s and up for 30-yr fixed mortgages and hard money at 12% and 3 points all day every day.

But those increased rates affect your profit margin, right? Of course they do but the cost is higher if you can't close your loan on time or if the never-ending laundry list of underwriting requirements and conditions bogs down your ability to get other important tasks completed. Not being able to close on time is the biggest risk with plenty of other smaller consequences that could happen. In less dramatic circumstances, the cost difference between 8% and 11% is only $3000 annualized for every $100,000 financed. If you plan to flip your project in half that time, we're only talking a $1500 delta for a high degree of confidence in knowing your deal will close on time and without material underwriting changes.

I certainly don't begrudge the investor wanting and willing to shop rates, I'm truly frugal at heart. But it's interesting more real estate investors do not see the correlation between cost and value when it comes to real estate financing as they do with real estate brokers and general contractors. Indeed, as more uncertainty mounts about our economy, rates will continue to increase incrementally and access to cheap capital will slowly churn out. I am already starting to see this happen with long-term rental loans (also known as DSCR loans) taking the first hit in rate hikes as those loans are typically the ones backed with institutional capital. Bridge loans are also experiencing some volatility in rates but more so in general lending guidelines being restricted such as lower LTVs, larger capital requirements, or more restrictive lending in certain market locations.

Perhaps a year from now, we won't even need to press for these types of cost benefit conversations as the lender playing field is leveled once again as it did post-Covid. In the meantime, I'll continue to push our own value proposition as being one of the most creative and most reliable lenders in our state and gladly accept business from those investors willing to pay a small premium for our high level of performance.