All Forum Posts by: Nick Schoch

Most analyses I see consider property tax and other local taxes in their calculation of Net Operating Income. 

Regarding income tax, most properties are organized into entities that pass taxes through to the partners, each with their own tax situations and rates. As such, it is hard to include tax in your analysis since the tax amount is specific to the individual investor.

How big is the loan you're asking for? If it's at least $1 million, have you contacted an agency lender?

Have you contacted national banks (e.g. Chase)?

Have you considered a commercial mortgage broker?

Below are a some questions I would ask when researching a real estate line of credit:

1. Do you offer revolving lines of credit secured by investor real estate? You will want to specify whether your proposed collateral/property is 1-4 unit or 5+ commercial.
2. What property types do you lend against?
3. What geographic areas do you lend in?
4. Can the security interest in the property be a second deed of trust or does it need to be senior? This question addresses whether you can keep an existing loan ahead of the new line of credit.
5. Do you lend unsecured with a negative pledge, which is a promise not to put debt on a property?
6. Will you lend against a portfolio of properties?
7. What is the minimum loan amount?
8. What is the maximum loan amount?
9. What is the maximum LTV and minimum debt service coverage ratio used to size the loan?
10. Does the DSCR sizing test use an interest rate floor or the rate at the time of underwriting?
11. What is the maximum loan term?
12. How does the renewal compare to the initial origination in terms of cost and time?
13. What index do you use for the adjustable/floating rate?
14. What spread over the index do you expect? (Spread + Index = the rate you pay)
15. What fees do you charge to originate the loan?
16. Are there any fees charged based on usage or lack thereof?
17. Are there any restrictions on draws or how the funds are used?
18. Are there any fees for closing the line early?

An investor property line of credit is definitely harder to find than a mortgage/term loan. They generally do not come with terms as friendly as a Home Equity Line of Credit (HELOC).

When I sold and underwrote these types of facilities at a large regional bank, we generally limited the offering to strong relationship clients. Even then, we would charge unused fees to ensure that we collected enough income so the deal made sense. Lots of investors like having the capital available and never use it. Consequently, they never pay interest. This is great for the investor because they pay only if they need it. No so great for the lender who still has a commitment and isn't collecting interest. The bank still has to reserve capital for the potential usage and it costs them money. 

The downside for the investor is that most lenders limit the term on their lines of credit between 12-36 months. This means that to renew the facility, the borrower must go through the underwriting process every 12-36 months. Depending on the size of the loan, this could mean paying for new third party reports like an appraisal. Some lenders streamline this process, but it can still be a hassle. You can mitigate the appraisal/third party costs by providing a negative pledge on the would-be collateral property and getting an unsecured line of credit. This may be only available for high net worth individuals with strong balance sheets.

Ultimately, I would call around to local banks and credit unions to see if they have an offering. The less standardized the loan product, the more variance you will see in offerings. As such, calling around will get you the best deal.

What makes investing during a recession challenging? 

For one thing, capital availability. Lenders see increased risk in the market and either charge higher interest rates or, more likely, stop lending altogether. Recessions make it harder to fill vacancies in your properties and put downward pressure on rental rates. This decreases your cash flow, which in addition to the obvious issue, also makes it harder to refinance if you happen to need to.

How can you protect yourself and investments during a recession?

Use leverage (debt) responsibly. 

Let's use an example:

• Purchase. You purchase a 10-unit property. The units rent for an average of $1,000/unit/month. You assume 5% vacancy and a 40% expense ratio. Your NOI is $68,400/year. Using a 6% cap rate, your direct cap. value is $1,140,000 ($68,400/6%). You finance the property with 25% down, resulting in a loan amount of $855,000. The interest rate is fixed at 5% until maturity in 5-years and the loan amortizes over 30-years. The LTV is 75% and the Debt Service Coverage Ratio is 1.24x. You're happy and looking forward to your future sipping Mai Tais on the beach.
• Recession hits 4-years later. It's time to refinance since your loan matures this year. Unfortunately, the market is soft due to the recession. Rents have decreased about 5% in your market since purchase, resulting in an average unit rent of $950/mo. You followed the market down to maintain average occupancy of 95%. You keep your tenants on 6-12 month leases because you're confident this is a temporary dip and rents will recover when the market stabilizes. Cap rates have increased 50 bps to about 6.50%. Holding your operating expense estimate constant at 40%, your annual NOI is $64,980, resulting in a direct cap. value of $1,000,000. Over the past 4-years, your loan has amortized down to $800,000. Your current LTV is 80%. This is above your lenders maximum LTV of 75%. To refinance with this lender, you will have to remargin (pay down) the loan by $50,000.
  Will you have this $50,000 in the depth of a recession? 

I worked out troubled commercial real estate loans during the last downturn. Bullet/balloon maturities were usually what caused borrowers trouble during a recession. The best positioned borrowers were those that didn't have high leverage to begin with or those investors that had loans with no covenants and no maturities during the recession. If you have a portfolio, it helps to stagger loan maturities.

Do recessions provide opportunities to buy?

Absolutely, if you can. As mentioned in the example above, property prices generally decrease in a recession. This provides a buying opportunity. The hard part is timing the market so that you have cash available to buy properties, especially at a time when most lenders step out of the market or require onerous down payments.

Have you spoken with banks and credit unions near the property?

What is the expected loan to value ratio (LTV) and debt service coverage ratio (DSC/DSCR)?

What fees are you being quoted?

What fixed rate period are these rates for?

What kind of prepayment premium/penalty is being quoted?

In general, commercial loans less than $1 million are expensive because it takes about the same amount of work to do a $1 million loan as a $100k loan and the lender has to make up for the fixed costs somewhere.

For 5+ units, I would use the Freddie Mac Small Balance Program terms as a starting point. While Freddie's program requires a minimum loan amount of $1 million, there are still plenty of banks and local credit unions that will lend on similar terms for loan requests under $1 million. Call around to lenders near the property.

LIBOR + 170 is attractive pricing compared to Freddie's current SBL pricing that is about 185 bps over the index.

FHA offers attractive terms and pricing for 5+ multifamily, but the origination process is arduous and causes many owners to look elsewhere.

The terminology can be confusing. The loan officer at the bank likely considers themselves an "originator." That said, it sounds like you're asking whether you should go direct to lenders or use a commercial mortgage broker.

First, I am biased since I am a commercial mortgage broker, so consider what I say with that in mind.

Long story short, you can do it yourself and go direct if you have time to get familiar with the market and call numerous lenders. 

I have written about this question elsewhere, but I cannot link to it here since that would be blatant self promotion. So instead, I will share a draft article that I intend to publish about DIY financing below:

I hope that helps. Good luck.

For residential (as opposed to retail, industrial, office), most lenders will consider month-to-month leases. That said, it generally does raise an eyebrow from underwriting and credit. For example, Freddie Mac Small Balance guidelines raise a flag if more than 20% of the leases have less than 6-months remaining.

You can usually solve this by asking the tenants to sign new leases. You can incentivize them to sign by offering to keep the rent the same for the next 12-months.

Every bank will appraise the property. Appraisers will tour the property and enter a sampling of units. They will take pictures. Some lenders will require a property condition report/assessment regardless. Others will determine the need for a property condition report based on factors such as age or the appraisal pictures.

Hard money lenders will be more willing to skip appraisals and inspections.