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Investment Property Loans: Things to Consider
There are a few things to consider with investment property loans. There are pros and cons of using bank financing versus seller-buyer financing. With bank financing, it’s much more straight forward and traditional.
You have a bank, a third party lending funds to get a commercial building or real estate. And there are terms and covenants in that loan. It’s more usual that it requires a down payment of anywhere from 10 to 30%. The closing takes about ninety days, give or take. You would need to get an appraisal that’s satisfactory with the bank. Of course, there’s a pre-qualification process and an underwriting process. With both, you have to go through the bank. Once you do all that and assuming you have the close the transaction. Now your relationship is with the bank. It’s based on ensuring that you have proper service of the debt.
With seller based financing, it’s usual that the buyer would give the seller a promissory note. And the buyer would be responsible for making payments to the seller. There are pros and cons there. The pros are clear. You don’t need to go through everything I described with commercial financing with a bank. You don’t need to go through due diligence and underwriting.
Pros and Cons of Commercial Financing
The cons are that it’s going to be more expensive. You’re going to pay a higher rate of interest. And also the satisfaction of buying the seller out is gone. Because the seller still has a security interest in that property. So you’re going to be dealing with the seller. Also, that could create future hurdles. But this depends on the sophistication level of the seller. For example, the seller asking questions about the financial performance of the buyer. The seller could ask to see books and records of the buyer. This ensures that that buyer has the financial ability to service the debt.
Each set of financial possibilities has its own set of challenges and benefits. This is whether it’s bank-based financing or seller based financing. If you’re flipping real estate and you are successful, first of all, congratulations. But second, you definitely need good legal counseling in your corner. There are consequences to selling real estate so fast.
An Example of Investment Property Loans
Here’s an example. You must incorporate adequate covenants and clauses in your purchase and sale agreement. They must also be in your escrow instructions. You must also make sure that there is no trailing liability after you close the deal. You must also make sure that you have adequate protection from a tax perspective. Now, you’ve got to put that money somewhere else, to ensure that you mitigate your tax liability. Having good legal counsel. This is even in the context of flipping residential real estate is important.
Your loan value is an important consideration when acquiring commercial real estate. That means, what’s the value of the real estate versus the loan that you’re going to be able to finance on the property. It’s usual that banks will lend anywhere from 80, 70-80% on a transaction. This depends on the guarantor’s credit. Depending on the balance sheet of the borrower. And underwriting, of course.
Down Payments for Investment Property Loans
That means that you’ve got to have enough of an equity cushion to buy the real estate. And in that, would be in the form of a down payment. There can be issues beyond that. What I’ve seen with clients is they have enough for the down payment when they close the transaction. But they don’t have anything left after the transaction closes.
It’s typical that there’s still a lot of work to do after the transaction closes. You have improvements that may or may not need to make. Compliance issues, an aged fax system may break. Plumbing issues, things that you may not expect. You would need to take note of all those. You would need to account for all these costs after the closing. That should be there as well. So in that loan to value, I always add an extra 5 or 10% of a cushion. That’s the advice I give to my clients. That way, it ensures that there is enough runway to close the deal. It also makes sure that there’s enough capital after the deal closes.