Tag Archives: private lending

Rates Are Historically Low, But It’s Extremely Hard to Get a Loan—Here’s Why (& What to Do About It)

Real estate, like all other asset classes, goes through market cycles. As the market goes up, property values increase, and the ability to get a loan generally becomes easier. As the market goes down, property values decrease, and the ability to get a loan generally becomes harder.

When the loans get harder to obtain, you may begin to ask yourself:

  • Why has it become so much more difficult to get a loan today, when two months ago it seemed easy?
  • And most importantly, how am I going to fund my next deal?

Do I have your attention yet? Good.

Read on, and be sure to watch the video below for further information.

Now, in order to answer the above questions, we need to take a step back and see how lending has evolved in real estate.

Recent History of Lending

I started investing in real estate when I purchased my first duplex in 2004 outside Philadelphia. I used a $30,000 private loan. Since that first deal, I have seen four different lending markets.

From 2005- 2008, real estate went through its infamous “no-doc” period, which basically meant giving out loans with no required documentation. As you can imagine, this did not end well—it caused a collapse in asset prices not seen since the Great Depression.

From 2007-2010, the pendulum swung the complete opposite way, and getting a loan became extremely cumbersome. This period was famous for the ample amount of deals to buy—but no capital to buy with.

For the last nine years, the process of getting money for a deal can be summarized in one word: easy. When I talk about getting money, I’m referring to the debt of the deal.

For example, say an apartment building costs $1 million. For simplicity purposes, I have to raise 25% (or $250K) for the deal from my investing partners, leaving the remaining 75% (or $750K) to be funded by a debt provider, such as a bank, agency, or private lender.

Obtaining that 75% debt has been “easy” up until COVID-19 hit. Now we enter what I call the “corona crazy” environment.

To put it simply, the world has changed—in almost every way—in the last two months. These changes have drastically affected an investor’s ability to get loans on deals.

Where Can You Get Money for Your Next Deal?

Your Network

The first place to look to get money for your next deal is your own network. I talk about the different ways to cultivate your network in order to raise capital in my BiggerPockets book Raising Private Capital.

But even if you could raise all the funds needed for a deal, you probably wouldn’t. Why? Because real estate’s greatest asset is leverage.

The ability to put down a 20- 25% down payment in order to obtain a large leveraged asset is a great wealth creator. (A word of caution here: the opposite is also true—too much leverage is a great wealth destroyer.) So after you raised your initial funds—usually consisting of your down payment, closing costs, capital expenditures, and operating expenses—you turn your attention to the debt market.

While it may be difficult to get a loan, the investor’s reward is that debt is currently experiencing historically low interest rates. As I write this article, the rates are between 2.5- 4%. Those are impossible to beat!

 

Certain Banks

Not all banks are lending these days. In fact, most aren’t. To understand which are, you need to know where the banks get their money.

Balance sheet lenders use the money that’s been deposited with them to fund loans. They lend it out and earn interest on the loan. Since the funds are staying on the balance sheets of the bank, the bank can hold onto the loan for as long as it chooses. These balance sheet lenders are typically smaller, regional banks.

The alternative to a balance sheet lender is a warehouse lender, where an enormous bank or a large institution like Fannie or Freddie provides, in essence, a line of credit for small intermediaries to originate loans. The main goal for a warehouse line is to originate loans and package them up to sell in order to pay back the warehouse line of credit and then repeat the process.

Mortgage loan agreement application with house shaped keyring

So, how do you know which banks to go to?

It’s simple, ask them if they’re a balance sheet lender. (You’re speaking their language now!) Again, if you’re unfamiliar with the term, it just means that the bank is loaning their own money and does not plan on collateralizing or selling the loan.

If they are a balance sheet lender, you will have a better chance of them funding your deal. If they’re not, then there’s a very good chance they are not lending at this time.

And if they are lending, you may have another problem…

Why Is It Much More Difficult to Get a Loan Right Now?

Two months ago, it seemed so easy to secure a loan. But because of COVID-19, these warehouse lines have dried up. Some of it is due to the fact that Wall Street funds were backing these lines of credit, but the main reason is the unpredictability of today’s environment. Large institutions are taking a pause and shutting off the spigot.

The second major reason is that when the debt providers underwrite your deal, they look at the income available to pay down the loan. This is commonly known as the debt service coverage ratio (DSCR).

Up until the corona craziness, residential real estate has been fairly stable from an income perspective. When people decide which bills to pay, rent is usually given the highest priority in the hierarchy of expenses. Because of this factor, banks were always able to make certain assumptions on income projections—which in turn made underwriting easier for the banks.

credit-report-loan

However, in the tumultuousness we’re currently living in, underwriters have no way of projecting what the future income for a property will be. Compounding this issue, the numbers are looking worse and not better in the near future, as unemployment approaches Great Depression levels.

With this bleak outlook, a lender’s best chance to underwrite your deal is if the current month’s rent collection is strong. This can be a saving grace for current loan applicants or a death blow if the collections weren’t so hot.

Related: 12 Influential Investors Weigh in on How to Survive the Coronavirus Crisis

The Gorilla in the Room

And now it’s time to talk about the big gorilla in the room: Fannie and Freddie, who collectively are commonly referred to as agency debt. Agency debt is insured by the federal government and provides lenders the funds needed to loan on everything from a single-family all the way up to hundreds of units.

Given the vacuum created by the warehouse lenders stopping their loans, Fannie and Freddie have changed their terms. Fannie and Freddie are now requiring anywhere from six to 18 months of operating expenses. While they do give back the funds if your deal performs, it requires the investor to raise an enormous amount of escrow just to close a deal.

Conclusion

So, how are YOU going to fund your next deal?

In short, this article is a snapshot of today’s lending environment. You need to be aware of who you should go to for the best chance of securing a loan.

There are two main options in funding a deal right now: a balance sheet bank lender and agency debt. Without strong income in the current month, a balance sheet lender most likely won’t lend you the money, and without strong reserves, agency debt won’t lend you the money.

But then again, getting into a deal without strong income and reserves may not be the best thing for you anyway.

As mentioned, if you want to hear the full discussion on this, be sure to watch the video here.

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Source: BiggerPockets.com – Matt Faircloth

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As gig economy grows, borrowers shut out of mortgage market

As gig economy grows, borrowers shut out of mortgage market 

It seems as if everyone’s got a side hustle these days. More than 40% of Canada’s millennials have worked in the gig economy over the past five years, according to a study from the Angus Reid Institute, and although they’re bringing in extra cash, their side hustle can be a hurdle to qualifying for a mortgage.

Taylor Little is the CEO of Neighbourhood Holdings and noted that more than one-third of their borrowers now identify as gig economy workers, all of whom have turned to alternative sources after being denied traditional mortgage financing. More traditional mortgage lenders look specifically for stable income streams, making qualifying for a mortgage near impossible for non-salaried employees.

Increasing unaffordability in major urban markets (and even that’s expanding beyond the long-time hotspots of Toronto and Vancouver to areas like Montreal) is coinciding with a decreasing ability for a growing demographic to get a conventional loan. At the same time, people aren’t seeing their incomes grow at the same rate as their housing costs.

There are also more opportunities now for entrepreneurship. People are not only looking for additional income, but for ways to capitalize on preferred skill sets or to engage in more flexible work arrangements. The lending challenge is dealing with multiple income streams that can be based on contract, project, season, or a combination of factors.

Some lenders are changing how they approach self-employed borrowers, but many lenders, particularly banks, are still looking at the challenge of reconciling the non-standard income stream with the framework they have to make lending decisions.

“There’s no doubt a lot of work is being done to change things, but for now, the gold standard for bank lending is to have a T4 showing steady income or six months’ worth of bank statements so you can show regular deposits,” Little said. “If you don’t conform to that, the banks have a really hard time wrapping their heads around making you a big loan.”

Little noted the irony of thinking about concentration risk in a loan portfolio versus borrower income; for a borrower with a steady salaried income, there is 100% concentration risk to their job. If that person loses that job, it goes from 100 to 0, whereas for the gig economy worker, it might go from 100 to 80, with a likelihood that they will quickly fill that gap. Borrowers are looking to diversify their income sources for any number of reasons in the same way that lenders attempt to diversify their funding sources.

“From our end, it’s definitely an area where we can help on the alternative side,” Little said. “We are not originating tens if not hundreds of billions of dollars of mortgage per year. We’re in the hundreds of millions, and because of that, we can build our own systems and look at a borrower’s application more holistically. That’s given us that flexibility to serve this part of the market.”

Around 40% of Neighbourhood Holdings’ borrowers are self-employed, Little said. He sees their role as helping borrowers buy time; they get a short-term mortgage but as they pay off their interest-only loan, they’re working with a mortgage broker to help reframe their situation and income to fit into a bank’s box.

Brokers might even want to make the extra effort to market to self-employed individuals because in many cases, these people are unable to walk into a bank and walk out with a mortgage because they’re often shut out by the banks at first glance. Changing expectations and figuring out a plan to get to their ultimate goal takes time. There’s work that borrowers can do, Little said, but it doesn’t happen overnight.

In actuality, Little said, the credit quality of their borrowers is pretty high, and they’re often some of the best types of borrowers that a lender could ask for.

“It’s not criminals and deadbeats . . . these are some of the scrappiest people that you probably want to lend to. They have three different income sources, or four, and these are people that if, if one contract goes away, they’re good at finding another,” Little said.

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These Homeowners Need a Private Mortgage

 

But that is totally not true. More often than not, they are needed when bad things happen to good people.

And private mortgages and B-lender mortgages are the fastest-growing segment of the Canadian mortgage industry.

One reason is because it’s much harder to qualify for an A-lender mortgage now than at any time in recent memory. High home prices, in major cities particularly, result in large mortgage requirements, and the mortgage stress test can put qualification out of reach for homeowners who previously had no such concerns.

In addition, there are several situations people find themselves in which are not attractive to regular mortgage lenders. These problems require solutions, but a different type of lender needs to step forward and help the homeowner get on track. Let’s look at three such situations.

#1) This homeowner has too many debts, and his credit score is low. Notwithstanding lots of equity in his home, the banks have said no.

#2) These homeowners are in the middle of a consumer proposal. The doors to the banks are firmly closed, yet they need to finance a car purchase, and they would like to improve their monthly cashflow.

#3) This homeowner has large CRA debt. Banks and other A-lenders do not like refinancing to pay off CRA debt.

#1) Too Much Debt And Credit Score Too Low

How to use home equity to pay overdue taxesThis fellow has been living proud and mortgage-free for several years, but meanwhile has racked up credit card debt that just won’t go away. At first, people believe they can manage it down, but the crippling high interest rates of 19.99% or more make it really hard.

And when the cycle starts, they next tap into other available credit to pay off the credit cards that are giving them a problem.

When he approached us, he had a nice town home in the west end of Toronto, $115,000 of unsecured debt, and a credit score of 557. And he had no mortgage.

The minimum monthly payment on the credit card debt was not much less than his take home pay from his job!

The Solution

We could see his credit score would zoom upwards once all the debts were cleared and no remaining balances. So, we found a private lender who was happy to lend a new first mortgage on very favourable terms. An annual mortgage interest rate of 5.99%, and a mortgage fully open after three months. This means as soon as he is ready, he can refinance to an A-lender without penalty.

And when that happens, all the ugly credit card debt will be scrunched up into a mortgage at roughly 3% interest, with a monthly payment of around $500. This is a game-changer compared to the $3,000 per month or so he was paying before.

#2) In A Consumer Proposal

measures of financial distress in canadaThese homeowners both have decent jobs and more than $200,000 equity in their detached B.C. home. Three years ago they both had to file a consumer proposal after a new business venture failed and left them with lots of consumer debt.

They reached out to us for three reasons:

1) Their bank, which holds their first mortgage, has told them they will not offer a renewal in late 2020.

2) Their car lease is expiring in January 2020, and they want to exercise the buy-out option. They are being quoted crazy high interest rates on a car loan.

3) They are finding it tough, paying $1,300 each month towards the proposals, on top of their car payment, and also their mortgage, taxes and utilities.

The Solution

The solution here is a one-year, private second mortgage for around $60,000. Interest-only payments at a rate of 12%, and the monthly payment is only $600, which is half of what they are paying now on their consumer proposal.

This small new mortgage will pay off their proposal completely, and also allow them to buy the car when it comes off lease.

And after their proposal is paid off, we will coach them on rebuilding their personal credit histories. And we will send an investigation package to Equifax Canada requesting they clean up all the reporting errors. (Sadly, there are ALWAYS reporting errors in the credit report after filing a consumer proposal.)

And in late 2020, when their first mortgage matures, they won’t have to worry about the renewal. We will refinance both mortgages into one new mortgage with a different lender. They will be ready.

#3) CRA Debt Problem

Owing taxes to the Canada Revenue AgencySeveral months ago, we met a Mississauga homeowner who only owed $70,000 on his first mortgage, but he had neglected filing corporate taxes for a few years, and owed CRA significant money. There was a judgment against him for $49,000, which had been registered as a lien against the family home. And another one looming for $133,000. And he had also accumulated a large amount of unsecured debt.

If you are self-employed and owe a lot of money to CRA, your borrowing options are very slim in the world of conventional mortgage lenders. We talked about this in a previous article. Occasionally we encounter homeowners whose tax debt is so large it cannot be readily paid. The end result is a debt that can’t be negotiated away, with a creditor you can’t afford to ignore.

The Solution

The solution for our clients was either going to be a very large, disproportionate private second mortgage at a high interest rate (close to 12%) or to refinance the small first mortgage to a new private first mortgage at only 6.99%.

For a lengthier discussion about the costs associated with a private mortgage, you can read this article.

We took the first mortgage approach; paid off the CRA liens and all other personal debts. As a bonus, the lender allowed us to partially prepay the mortgage payments in advance, so that the monthly payment for the new mortgage would be roughly what it will be when they refinance down the road – avoiding payment shock!

Then we contacted Equifax Canada to confirm the tax liens had been cleared and waited for the client’s credit score to rocket upwards, unencumbered by a high debt load.

Sure enough, it all came to pass, and now we are refinancing the private mortgage into an A-lender, only six months later.

The Wrap

pay down debt using home equityIn our first two cases, we also gave consideration to B lender solutions. They were a legitimate option, but here the private mortgage made more “dollars and sense.”

There are many other reasons why you might one day need a private mortgage. This article told the story of three fairly common situations.

You can find a more in-depth look at why you might need a private mortgage here. If a private mortgage is in your future, you should tread carefully and satisfy yourself you are dealing with reputable people who will treat you fairly.

Source: Canadian Mortgage Trends – ROSS TAYLOR 

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Why the wealthy are heavily focused on real estate

Getty Images/iStockphoto

Real estate averages 27 per cent of the investments of the ultra wealthy.

SHELDON KRALSTEIN/GETTY IMAGES/ISTOCKPHOTO

With markets roiling in 2016 and commodities lingering in low-price limbo, the holdings of high-net-worth investors can serve as indicators of where the rest of us might consider parking our nest eggs. It turns out that a good chunk of wealthy peoples’ investments is in real estate.

“Real estate is generally accepted as an alternative investment [by high-net-worth investors],” says Simon Jochlin, portfolio analytics associate at StennerZohny Investment Partners, part of Richardson GMP in Vancouver.

“It has the characteristics of an inflation hedge: yield, leverage and cap gains. It does well in upwardly trending markets, it pays you to wait during market corrections and typically it lags equities in market declines – it buys you time to assess the market.”

While the definition of high net worth can be flexible, in Canada and the United States it is generally considered to be someone who has at least $1-million in investable assets.

Thane Stenner, StennerZohny’s director of wealth management and portfolio manager, says a good way for determining what the wealthy do with their investments is to look at reports from Tiger 21, an ultra-high-net-worth peer-to-peer network for North American investors who have a minimum of $10-million to invest and want to manage their capital carefully.

Every quarter the network surveys its members, who number about 400 members across Canada and the United States. Some of the participants are billionaires, and most have a keen eye for business, Mr. Stenner says.

Though the Tiger 21’s Asset Allocation Report for the fourth quarter of 2015 found that its members were becoming cautious about Canadian real estate, they still on average put 27 per cent of their investment into real estate, the largest portion of their allocations. The next largest were public equities (23 per cent) and private equity (22 per cent) with smaller percentages going to hedge funds, fixed income, commodities, foreign currencies, cash and miscellaneous investments.

The real estate portion declined by 1 percentage point from the previous quarter. “While this is the lowest we have seen this year, it is at the same level observed in the fourth quarter of last year, which consequently was the high of 2014,” the report said.

“Real estate is very popular and one of the reasons, in my opinion, is that investors can actually see and touch their investment,” says Darren Coleman, senior vice-president and portfolio manager at Raymond James Ltd. in Toronto.

In his experience, real-estate investors, wealthy or otherwise, seem to behave with more logic than those who focus on markets. “For example, if you own a rental condo, and the one across the hall goes on sale for 30 per cent less than you think it’s worth, you wouldn’t automatically put yours on the market and sell, too, because you think there is a problem. Indeed, you may actually buy the other condo,” he says.

“And yet when a stock drops on the market, instead of thinking of buying more, most people automatically become fearful and think they should sell.”

Real estate also allows for considerable leverage, Mr. Coleman adds: “Banks love to lend against it. Over time, this lets you own a property with a much smaller investment than if you had to buy all of it at once.”

At the same time, Mr. Jochlin says there are disadvantages to real estate that investors should beware of. Property is not particularly liquid, so if you need to sell you could be stuck for a while.

“It’s also sensitive to interest rates and risks from project development,” he says. There are administrative and maintenance costs, and an investor who buys commercial rental property will be exposed to the ups and downs of the entire economy – look at Calgary’s glut of unleased office space, for example.

“Timing is key. You do not want to chase the performance of a hot real estate market,” Mr. Jochlin says.

“Buying at highs will significantly reduce your overall return on investment. You want to buy in very depressed markets at a discount. In other words, look toward relative multiples, as you would an equity.”

As to how one goes about investing in real estate, Mr. Jochlin says it depends. The factors to consider include determining whether your investment objective is short- or longer-term, your liquidity requirements, your targeted return and whether you have any experience as a real estate manager.

“Sophisticated high-net-worth investors have a family office, and thus a specialist to manage their real estate assets,” he says.

How the rich buy real estate

The wealthy don’t necessarily buy and sell real estate the same way ordinary investors do, says Mr. Stenner. Ordinary people buy something and hope that when they sell it they’ll get a better price. Meanwhile, they like to do things like live on the property or rent it out, whether it is residential or commercial. If it is vacant land they might build something. Not always so for high-net-worth (HNW) investors, Mr. Stenner says. While everyone who invests hopes their investment will rise, Mr. Stenner says that in real estate, HNW people tend to fall into four categories:

Developers

“The real estate developer is looking for substantial returns from individual/basket real estate projects, typically 30-50 per cent IRRs [internal rates of return],” Mr. Stenner says. Developers are highly experienced investors who often take big risks, looking at a raw, undeveloped property and envisioning what it could look like with, say, a shopping mall or office tower. This requires lots of access to capital and a strong stomach, as there can be huge delays and setbacks.

Income Investors

“These HNW investors typically look for a stable, secure yield, tax-preferred in nature and structure if possible, with modest capital growth potential,” Mr. Stenner says. They take the same businesslike approach to property as the developer-types, but they’re more conservative, focusing on cash flow and long-term profit as opposed to getting money out after a development is complete. Often they’re building a legacy that they hope to pass down through generations. Mr. Stenner says lower net worth people can emulate income investors, for example, through REITs that are based on apartment buildings.

Opportunists

These HNW investors tend to look for more short-term higher risk, higher return “asymmetric” payoffs. Income from the investment or project is secondary — they’re in it for the quick buck. Often they see real estate in contrarian terms – investments to look at when the market is low and to sell on the way up, rather than hold. After 2008, many HNW investors bought up depressed-price housing in the U.S. Sunbelt. The sizzling Vancouver and Toronto markets might be the opposite of what they’re looking for right now; commercial property in the stagnant Canadian economy that can be purchased for low-trading loonies right now might be more interesting.

Lenders

This refers to HNW investors who lend capital to developers or opportunistic investors, for a fixed return, plus as much asset coverage from the property as possible. They fund mortgages, invest in real estate financing pools or put money into companies involved in this type of investment. “Because wealthier investors tend to have more liquidity, this also creates more optionality to deploy capital in various ways, while using the real estate as collateral or protection,” Mr. Stenner says.

Being a lender is a way to diversify. In addition, money lent in this way puts the lender high up in the creditor line if something goes wrong. If things go right, it generates income as the mortgage is paid back to the HNW investors or the funds they buy into.

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