Financing: Wins & Losses!
Financing is one of the hardest aspects of being a real estate investor; second only to finding the deal. Financing can be amazing, but also incredibly gear grinding. Today, I am going to share some of my biggest wins and losses with financing, and what you should learn from them.
(Read to the bottom to hear about a financing horror story.)
1. 8 Plex - Commercial Financing - WIN!
This was a situation that proves the saying "You miss every shot that you don't take." to be true. At this point in time, my debt to income ratio was tapped out, I didn't have a job, and I had already been turned down several times by different banks. Let me tell you how creative this deal was. I had been contacting different people around my town who owned multi-unit properties, and eventually got a hit. I met up with the owners of these two fourplexes that were directly across from each other. After talking to them, we decided that they would be willing to sell them to me if I could pay them $262,500 for each one. At the time, I figured they were worth $350,000 each with some renovations, because I knew that rents could be increased.
1. I put the properties under contract, even though I knew my ability to obtain financing was shaky. The first step to every real estate transaction is to put it under contract. Your odds of getting financing increase greatly. Nobody takes you seriously if you're pitching them a hypothetical transaction. My first problem was that these were two separate fourplexes on two separate parcels of land. There is no way I could get residential fannie mae loans without a job, and I knew that you could only obtain commercial financing on a property that had 5+ units. I had never applied for commercial financing in my life, but I knew for sure that it was my only chance at actually closing this deal.
2. I applied for tentative city approval to combine the two fourplexes into one parcel, creating a single eight unit property. After I had a letter saying that the city would allow it, I took it to the commercial bank to pitch them my idea.
When I took it to the commercial bank, I did not have much money for a down payment. The very first thing they asked me for were my tax returns and verification of whatever funds I was using for my down payment. The average commercial loan on this type of property is 75% LTV, which means that I would have to put 25% down on this property... equaling roughly $131,250. I had maybe $25,000 saved up, so I was quite a bit short. The loan officer told me my chances of qualifying for a loan were very low. I had heard however, that in place of a down payment, banks could use equity in the property being purchased instead. He was initially very resistant to the idea, but after essentially begging him to take a look at it, he said "If you're willing to pay for the appraisal out of your own pocket, I'll take a look at it."
3. I decided to take the gamble and purchase an appraisal on a property that I had been told I had a very low chance of actually purchasing. I was gambling on myself, that the property was worth what I thought it might be. Appraisals can make or break your deal, so here is a golden nugget: ALWAYS meet your appraiser at the property. Make friends with them, ask them about their life, tell them the value you'd like, and most of all provide EVIDENCE. I always show up to meet my appraiser with comparable sales I'd like them to consider IN MY HAND.
I sat around and sweat waiting for my appraisal to come back. The appraisal was not cheap, and the days left on my contract were ticking. When I finally got the email confirmation that my appraisal had been received by the bank, I ran down to the bank so fast and caught my loan officer while he was on his lunch break. I think I was starting to grow on him, because he stopped eating and was like "Alright, let's go see what it says." He printed out two copies of the appraisal and handed one copy to me. When I saw the value, I had the goofiest grin on my face, and before I could even say that I told you so, my lender looked at me and said "I didn't think so, but it looks like you may have a chance!" The value on each fourplex came back at $345,000 each, AS IS. Without any repairs.
4. After receiving the appraisal back, we began to prep for loan committee. When you apply for commercial financing, a committee makes the decision to extend a loan to you or not, and often times, that decision doesn't come until near the end of the time that you have to purchase the property in your contract, so if it doesn't work out, you're not in a very good spot. Always make sure to be working with more than one bank as a safeguard. I wrote a full cover letter of myself, detailing my goals, dreams, and objectives. I put together an entire accounting of the rehab I planned to complete on the property, and a proforma of what I would be able to increase the value to. I decided that I would spend roughly $4,000 on each apartment, and do the work myself. I provided pictures of my previous work, and bought my lender lunch every day leading up to the loan committee. It's your loan officer who has to represent you and your project, so making sure that they're in your corner is absolutely necessary. I don't think he cared about the lunch, but it did give me an excuse to talk to him every day. As it grew closer and closer to the closing date on my contract, I really started to sweat. I couldn't think about anything else, and I was pacing around my apartment constantly. At the very end of the day, I received the call from my loan officer. I had been approved for the loan, but I still needed to come up with the money. The equity in the property was really phenomenal, so they were willing to get creative with me, but they still wanted to see that I had some skin in the game.
5. I had another property at this time that had roughly $66,000 in equity. They were able to put a lien on that house and cross collateralize it, and use that money to qualify towards my down payment. I was a licensed real estate agent at the time, and the bank allowed me to take a commission of 6% from THEM not the seller, in cash and use it towards the down payment. They essentially gave me $31,500 to use towards my down payment because I was a licensed realtor (and really because they wanted me to get this loan.) and then they accepted the $20,000 I had in my bank as my down payment. They essentially let me purchase a $525,000 property for $20,000 down. That's less than 5%.
A transaction that started with almost no chance of being able to succeed, ended up as one of the best financing I ever obtained on a property, for very little down. 6. After I completed my renovations, the property re-appraised for $760,000, and the bank graciously agreed to release their lien on my cross collateralized property. I sold the property 6 months later for $810,000. I received a check for almost $350,000, for a year of work, and only 5% down.
2. Triplex - Conventional Investment Loan - LOSS!
"Success is going from failure to failure without a loss of enthusiasm." While this property did end up closing and eventually making me quite a bit of money, the road was rocky, and awful. Everything that could have gone wrong in this transaction, did. This was the first dedicated investment property I decided to purchase. I chose to use a conventional investment loan with 25% down on the property. I could qualify for the loan, but I didn't have the down payment. I found an investor who was willing to help me, but didn't want to be attached to the loan. The property needed repairs, but I thought I could increase the rents and get the cash flow to a good place.
A standard transaction should close in 30 days. This property took me 90. It was a nightmare, start to finish. 1. I put the property under contract. I give myself 45 days to close, with the option to close sooner. With a purchase price of $152,500, it was a fairly small transaction. I had roughly $40,000 in the bank thanks to my investor, and I was ready to rock and roll.
Thinking this transaction would be a breeze due to the large down payment and the ease at which I purchased my first property, I negotiated with the seller to evict his tenants and allow me to begin renovating the property. I wanted to hit the ground running and have the units rented the day I closed on the property. Being a major buyer's market at the time, the seller agreed, and I began using my own money and time rehabilitating the property.
About two weeks in, I ran into my first problem. I had already completed one unit and rented it, when the bank called me. They were not going to accept my down payment. If the investor that you're using in the transaction does not want to be attached to the loan, banks will not allow you to use that money for the down payment. They want to be able to trace and source the money to show where it came from and how it was earned. Investment money cannot be gifted to you. The two ways around this are to 1. Get your investor to co-sign or 2. Season the money.
2. Seasoning the money essentially means to wait two months. The money coming into your account can't show on two months of bank statements. After this amount of time, the bank no longer needs to source the funds, and they can be used for the loan. Knowing that due to the seasoning requirement I could no longer meet my contractual deadline with the seller and assured by my lender that we could close as soon as the money seasoned, I asked for my first extension of 15 days, which the sellers gave me.
Roughly three weeks went by, and I had finished the second apartment, and rented it out as well. I was just beginning on the third apartment. I had increased rents, and put my blood and sweat into each unit. I had roughly two weeks until my closing date, and everything seemed well. We submitted my file for underwriting, and disaster struck again. The underwriters came back and said that they wanted to see me with an additional 6 months of cash reserves, which they had previously believed I would not need. This amounted to roughly an additional $9,000 that I needed in the bank, now less than two weeks before closing time. 3. Having the underwriters tell me that I needed to have an additional $9,000 in two weeks time after I had just spent most of my personal cash on the renovations was world shattering. I didn't have it, and I didn't have any real way to get it. I was about to lose my earnest money, my renovation money, my time, and ultimately, the property. The seller's graciously agreed to let me use the rents from the property, to get closer to the $9,000 I needed, and my friends and family were able to help me scrounge a few thousand. Still a thousand short, I had to sell plasma, and take as many odd jobs as I could around town.
Somehow, by the skin of my teeth, I was able to pull together the $9,000 I needed, three days before closing. I've now finished all three apartments, and increase rents significantly.
The universe wasn't done with me yet. It really wanted to test how badly I wanted this property.
4. Two days before I am supposed to close, we do another pull on my credit. It's completely tanked, from a 720, down to a 530. There is a new collections on my credit, for medical bills unpaid by someone with my exact name, but in a state that I've never lived in, or visited. Completed blind sided, frustrated, and at the end of my rope, I begin calling the collection agencies, and hospitals. Another person with exactly my name had an Emergency Room bill that they had not paid, and I had been mistakenly sent to collections somehow instead of them. While they insisted that they could fix it, and get the collection removed from my credit, it was going to take time, and with days left to close, I didn't have any to spare.
5. I approached the sellers and asked for another extension. I needed thirty days to get all of this cleared up, but the sellers were already fed up. They had given me extensions, rent money, and plenty of patience... but most of all, I had made a huge mistake. When I rehabbed their apartments and increased the rents before I owned it, I greatly increased the value of their property... for free. They were no longer inclined to grant me an extension. Not now that they could sell their property easily on the market, and for $40,000 more. After having to get an attorney involved, I was able to convince the sellers to give me one last extension. 30 days, and no do-overs. (Ask me if I could really afford to pay those attorneys. No. But I was already in too deep.)
6. It's 5 days from closing time. The sellers are antsy. My loan officer is standing by, and the title company is getting the docs prepped. The collections has officially been removed from my credit, and my credit score has been restored. We have the green light to close. Not inclined to test fate any further, I told everyone I wanted to close right then. As we're sitting down at the closing table to sign docs, they do one last pull of my credit. (Not a very common thing to do at all, but nothing was common in this transaction.) MY CREDIT HAD DROPPED 30 POINTS. I had been carrying a $25 balance on one of my credit cards, and a few days before closing, I had paid it off completely. Down to $0. Did you know that paying a card off down to $0 can cause your credit score to dip? Me neither. We literally had to delay closing, while I was instructed to go spend exactly $10 on my credit card, and do a rapid rescore to get my credit back up to par. Apparently, $10 is the magic number that makes credit work. It took 3 more days for my credit to repost, and we went to the closing table, and signed docs with barely one day to spare. Not even a full 24 hours. I was less than one day away from catastrophic failure. I have never signed my name so many times, so quickly. There were tons of lessons that I learned in this journey, and they have really helped me out since then, however, it was one of the most stressful transactions that I have ever done. I ended up making almost double the cost of the building when I sold it just a few years later, and it really helped springboard me into bigger and better things. The big take away here? Don't start working on someone else's property before you own it. It really, REALLY, complicates things. If you learned anything from this post, or it struck a cord with you, please sign up! It's free! Leave me a comment below! Follow us! Facebook: https://www.facebook.com/DWinvestors19
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