The other day a man walked into our MSM Team office in Bethesda with an address written on a wadded up piece of paper. He saw a property down the street and wanted to find out more information on how much it was listing for, how long it had been on market, and information on what kind of next steps he should be taking as an interested investment property buyer. He said he had previously successfully bought and sold a property before and considered it a rock solid business venture with practically no risk.
I mean, what risk is there? It is a seller's market after all, isn't it?
He's right. With supply of inventory well below buyer demand, this is historically indicates a “Seller's Market” in Montgomery County. but the scars from the 2007 housing crisis still linger. And while this man, let's call him Gregory, was thinking entrepreneurially, he was perhaps a little premature in his search and little overly optimistic as to his available financing options to help him meet his investment goals. With the words "seller's market" ringing in people's ears, I thought this would be a great opportunity to help individuals like him who are looking into buying investment property get informed and educated on where to start.
No plan, no matter how great it is, can survive an encounter with reality. And like we tell all our clients, it always starts and ends with the money. Gregory was looking to buy a $1.2 million property in Bethesda and hold it for a few months until he could sell it over to a buyer. With no current income, investing and turning this property over would be his job–but just for this one house. After turning this property, he wanted to move on from real estate. He said had already set an appointment with a banker for that week and was ready to pitch his idea and get a loan to buy property. "I mean, where's the risk?" he asked referring to the banks, "It's a seller's market."
He needed a collision with reality. While in theory his idea sounds great, it all comes down to 'Do you have the money to make it happen?' To become a seller in a seller's market, you first have to become an owner. And if you don't have the money, the reality is that becoming an owner will be a little more difficult. Banks are not giving out cash if there isn't collateral to back it up. Money was cheap in 2005 and banks gave out freely, but they have since gone through fire for giving out risky loans on supposedly fail-proof real estate and were left with millions of dollars of property that they are still trying to get rid of, and doing so poorly.
So where's the risk? The risk for them is that that if Mr. Gregory–who, remember won't be living in the home, doesn't have collateral, and essentially won't have any skin in the game–can't sell the property and walks away from it, it's the bank that will be stuck with it. While in Gregory's view it was a no-brainer, he didn't see the reasons how banks are still risk-averse to investment property, even in a good market. Not only are banks reluctant to finance property without the requisite credit and numbers to back it up, they are laden with Fannie and Freddie guidelines and rules which require checkmarks to be checked before banks even consider giving out money.
Meaning, Mr. Gregory would almost automatically be denied a loan from a big bank because he simply didn't meet any of the checkmarks. His next option would be to establish a relationship with a private bank or a hard money lender. Although, this will come with a price. Compared to your Wells Fargo or Bank of America's who aren't willing to take a risk on you, private banks are more willing to do so, but they make you pay for it in the form of an exponentially higher interest rate. Not only that, banks tend to charge higher interest rates for investment property because it is a riskier venture. "But if the house is going to sell, does the interest rate really matter?"
Absolutely! Consider if you took out a one year $50,000 loan from a big bank at an interest rate of 3%. You'd be paying an extra $1,500 over the year with your monthly loan payment at about $4,291 a month. Now, if you went to a private lender and got a one year $50,000 loan with an interest rate of 16%, you'd be paying an extra $8,000 in interest, with your monthly payments at $4,833. That's a $542 a month difference! And if you're the one having to make that payment every month, that will directly affect your quality of life. So, yes, interest rate matters!
"Oh… my payments." It was starting to sink in with Gregory. If this investment property was going to be Gregory's sole source of income, his monthly payments were going to matter to him. The decision between getting a partner with income or credit and trying to get a loan through a big bank versus pitching his idea to a hard money lender with a high interest rate was going to be an important one. So even before Gregory should begin looking at property or thinking about buying that beautiful $1.2 million home in Bethesda, he needs to plan and get his finances in order.
It starts and ends with the money.
We're committed to providing good service to all our clients, and that sometimes means helping them face reality! As alluring as a seller's market is, it still entails risk. And if you're looking into buying for investment, there are many things to consider before you jump in. This is where being informed counts and having an agent who knows the rules and expectations is invaluable. Our short conversation with Gregory probably saved him weeks of frustration and confusion–and now he has us as a resource for any new questions he has. Being prepared will help you on the path to achieve your investment goals, and to do so in a quicker time frame. And we're here to help! If you have any questions about the rules or next steps, just walk in or give us a call!
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