Trap # 3: The Cash Credit Crunch
Anyone that tells you, you don't need money to do buy, fix, and flip is lying. Now I didn't say it had to be your money, OK? But you do need money to do a deal. So, unless you are sitting on a ton of cash, you are probably going to be look at borrowing the money for your buy, fix, and flip, deal from a hard money lender, not the bank.
Traditional Lenders
Let me describe how it really works, because I have been a real estate lender for over 30 years. I started lending with the Bank of America when I was only 22 years old. I have worked for the Bank of America and the Chemical Bank of New York, and have been a residential and commercial lender and commercial mortgage broker for the last 20+ years.
Let’s say you were going to go to a bank to try to get this deal done and buy residential property as an investment. First off, the banks are not going to be wild about making that loan in the first place, and you must go through all their hoops and rules and you must have a 20% down payment. Then they're going to do their own appraisal. They’re going to look at this fixer-upper and may say, “No, we're not make a loan in that property, not even at 20% down.” Or they may say, “We can make the loan, but it's got to be conventional loan because it won't qualify for FHA.” Or they’ll say, “This is an All Cash deal” or “We're not going to loan the money to do it. Because it needs work.”
Let’s be honest, if the property doesn't work, you're probably kidding yourself that you got a good deal in the first place.
Banks, and private lenders, will run your credit. Financial institutions, whether it’s a credit union or anybody, and even hard money lenders will run your credit. The minimum acceptable score will be 680. But more realistically they are looking for over 700. If you're going to go to a bank, they’ll want 700, 720, 730 or more.
The standard loans will also require you to have three months’ principal interest, taxes, and insurance as a liquid resource, as a reserve on top of all the requirements. And because of the Dodd-Frank law requirements, you need no more than 28% of the front-end ratio, which is your PITI (Principle, Interest, Taxes, and Insurance), divided by your take-home pay. And under Dodd Frank all your debt, PITI and other real estate loans, divided by your take-home pay must be a maximum of 42%.
The FHA and banks are not friendly to investors. They'll cap you off if you have too many loans, because that just destroys your ratios and your balance sheet for them. So, then your choice is to try and find a hard money lender.
First off, a typical hard money lender is expensive. And they will not, N-O-T, loan you a 100% of the money you need for your acquisition or for the buy, fix, flip holding costs. That’s not how it works. Anyone that is telling you that is naive.
Let’s say the ARV (After Repair Value-what it’s worth fixed up) is worth $100,000. And you want to borrow money from the hard money lender. They are going to do their own ARV calculations, what they think the ARV assumption is, notwithstanding your proof of the ARV based on actual sales comps, and your evidential material. They are going to offer you 65% of the $100,000 (only $65,000, but they take their 5 Points up front which is $3,000., so you only really get $62,000, but you still owe the hard money lender the full $65,000.). Because a hard money lender wants you to have “skin of the game” they only loan apportion of wah you really NEED. They want to know that you have also put up some of your own money. This helps the hard money lender know that you are serious about this investment and will do everything you can to make it work.
They also charge rates of 12% -15% or more per annum; that is approximately 1% to 1.5% a month, in arrears. At least 1% a month. So, in the $65,000 case, your loan will accrue at 1% per month. So, when the loan is due, you not only have to pay principle but also the interest for however many months you had the loan.
And as banks do, most hard money lenders will also pull your credit. They’ll also expect you to come up with your own liquid cash for the holding costs and closing costs, in addition to the remodeling costs.
The Cash Credit Crunch Cure
The third pillar of the residential trap I talked about was the Cash Credit Crunch. I have said, and I still say it for all properties; if anybody tells you to buy things with no money, no cash involved, they are probably lying to you. I'm not going to lie to you; I'll tell you money is involved. Did I say is was your money? No I didn't. You can get the money from partners, from investors, from the seller, from restructuring the deal in the first place. All those things are possible. You can learn how to do this this step-by-step in The Commercial Real Estate Mentorship Program. When it comes to credit you are not, N-O-T the primary source repayment on the commercial deal. That’s a matter of fact. I'm telling you point blank the Net Operating Income (NOI) is number one, way ahead of you.
The second source of commercial loan repayments will not be you but the banks, financial institutions, or pension funds, are going to require a Debt Service Coverage Ratio (DSCR), which means that if your payment is $1,000 you're going to have at least $1,300-$1500 NOI (Net Operating Income) to make the payment; that way they have the cushion. That means the property’s NOI needs to be equal to or higher than the 120% for apartment loans and about 150% of the Debt Service for most other types of commercial real estate.
The third source of loan repayment is not you. In every agreement I've ever done as a lender or mortgage broker, the lender takes as a contingency, in the event you do not pay the payments on time. At some point in time, if you haven't paid two months' payment, the lender has the absolute right to have an assignment of rents. You authorize this when you sign your loan docs. If you don’t make the payments, they are going to collect it and the money is going to go into a lockbox. It will not go to you, it will go to the bank. They are going to deduct their payments. They are going to ensure things are correct and they are going to send you after a couple of days or weeks your balance, whatever it is.
And the fourth source of payment is the actual property itself, because they loaned money against it, and they know it's worth the money. Fifth in line is you. The NOI, the DSCR, the assignment rents, and the building itself all stand in front of you, so your credit is not the critical piece. It is the NOI; it will always be the NOI in every commercial property you buy for the rest of your life.
Look at the Forbes Newcomer Billionaire List for 2018. Number 1 is MEDIA and ENTERTAINMENT. After that, the clear unequivocal 2nd is REAL ESTATE. And it is Not residential; it is Commercial real estate. Period. Not just in the United States, but around the whole world. Many billionaires from the United States to China, from England to Canada come from commercial real estate. These are the facts, anybody that tells you they create wealth from one-off deals is probably stretching the truth. And when you're doing 2, 3, 4, and 5 buy, fix, and flip deals and trading your time for another job, you’re probably working a lot harder than you need to be. But, are you making the money you thought you would by trying to flip houses? Aren’t you trying to get out of your J-O-B and you low paying and time-consuming side 2nd JOB flipping houses and You really want have real time and financial freedom?
Want to find out how easy it is to find cash-flowing commercial real estate in 3 easy steps? Take my free mini course now. Absolutely no obligation.
Dream Bigger! Succeed Faster!
Take Care,
~Doc Haller
