Q & A With America’s Real Estate Professor: Investment Property Loans
Investment Property Loans
Q. I am planning to buy some rental properties and the bank requires me to put down 20 percent in order to get a loan. I’ve got perfect credit, plenty of income and assets, but I still want to put as little money at risk as possible. Can I get a 10 percent down payment loan somewhere? Brett L. Rockville, Md.
A. It’s really hard to get investor loans with less than a 20 percent down payment these days. And in fact, the pricing for any loans with less than 25 percent down are more costly. There are also probably no combination first trust and second trust or piggy back loans these days. That used to be able to get you up to 90 percent loan to value (LTV).
The banks, Fannie Mae and Freddie Mac, and all lenders learned some very tough lessons in the past 5 years and even for someone with perfect credit and plenty of money, they just won’t do high LTV loans for traditional mortgages.
Also, even if you only put down 10 percent, your money is still at risk. If you stop paying on the mortgage and the lender forecloses and the proceeds on sale don’t pay off the loan and all foreclosure costs, you may be liable for covering the rest of the funds.
If you have plenty of money, I’d put down 25 percent to get the lower interest rate – they’re incredibly low right now as you know – on a 30-year fully amortizing mortgage. And keep the property for good.
Real Estate Development Financial Analysis
Q. I’d like to learn more about what is called a discounted cash flow analysis for new real estate developments with for-sale product. I am stuck when it comes to the net present value (NPV) and internal rate of return (IRR) parts for the model for a new condominium project unit’s sales. Tony.
A. I don't provide any guidance on trying to develop real estate. For me, the reason is simple: Developing properties is so high risk, and so many people lose their money on development deals, I can't endorse for anyone to take that course of action.
That being said, you should find some people who do develop and talk to them because they will hopefully be able to help you figure out if it is for you. I’d suggest you do lots of independent investigation on what you are told. Real estate braggarts often "embellish" their credentials and professed profits. So you really need to do your research.
I'm also not a fan of NPV for real estate or IRR. I'm a straightforward, cash on cash analysis fan which is really a one-year analysis.
With NPV, you need to pick a discount rate to determine if it is a good deal, like 10 percent. But what should it really be, for the risk? With real estate, most people pick a low discount rate, which shows more cash flow. The deal looks good but they learn that if it seems too good to be true in real estate, is usually was too good to be true!
Also, both NPV and IRR need an ongoing stream of cash flows and a sale to calculate returns. It’s hard enough to even pencil out a deal for a few years, let alone project forward 5–10 years of cash flows with any surety. So again, for me, cash on cash returns work.
I believe that if it looks good in the first year, it’s probably going to be a good deal. Good luck.
Leonard Baron, MBA, is America’s Real Estate Professor®. His unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions. He is a San Diego State University lecturer, blogs at Zillow.com, and loves kicking the tires of a good piece of dirt! More at ProfessorBaron.com. Email your questions to: Leonard@ProfessorBaron.com
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