Transcript

00:01

Welcome to Episode Three of Season Six of the Growing Empire Show. I'm back with Dave Rowan from Rowan Financial and Jeremy Moyer. And we're here to continue from last week's episode regarding the evolution of the real estate investor. So stay tuned.

00:16

Welcome to Growing Empires hosted by real estate entrepreneur and trusted investment advisor Jennifer de Jesus. Growing Empires provides insight to building wealth through passive income producing real estate investments for those who want to build and manage a more profitable real estate portfolio.

00:35

So let's talk now about going the opposite direction. So let's say you own properties you have your home that you're living in, you're not interested in vacation homes, but you want to buy your first investment property with a commercial loan. What should somebody looking into this expect to be their experience?

00:55

Sure. So the I would say one of the biggest changes is the the cost of capital is going to be more expensive, just with your interest rates typically are a little higher to the amount of money that you would need to bring into the the asset. Put down on the assets is typically higher. Banks want you to have a little bit more skin in the game in that regard. And then also the amortization, which is how long you can borrow that money for, you know. Traditional conventional loans are typically 30 years, you know. Most commercial loans, at least first starting out, are going to be 20. Sometimes you can get 25. But 20 is more prevalent. Which means it shortens your your time period to pay that that money back that loan back and coupled with a higher interest rate, your debt service payments going to increase. So those are important things to factors, you have that capital to put down. Sometimes banks, especially during the COVID pandemic, you know, certain banks and situations, especially if you are new borrower wants to see extra reserves, you know. Those principal and interest payments, they might ask to have those reserves actually in escrow at time of closing. So that's more money out of your pocket, and then just your cash flow calculation, just your simple income coming in versus your expenses going out. In factoring in a higher debt service payment, you need to make sure you have enough money left over for positive cash flow. So I think that's some of the biggest distinctions. And Dave, you want to speak to that at all?

02:35

Well, yeah, I'll jump in with a couple of points. That was fabulous Jeremy and, and that's actually Jeremy talked about, you know, complimentary strengths. This is a huge strength for Jeremy and I rely on his advice in this area, in terms of all of the ways you can look at financing properties, I guess I'll just look at it from the nuts and bolts standpoint, and you know. One is leave plenty of time for underwriting. It can take time to both gather all of the information as well as have the bank approve it. So that's absolutely the case. I think two, again, is looking at both halves of the equation. How well am I going to do on this property versus what is the bank going to approve? You know, I think we're currently using a debt coverage ratio of 1.2 to feel good about the bank approving us for the loan. And just you know, simple definition of debt coverage ratio is you are looking at the amount of income that the property is generating. And you have to actually make sure you subtract vacancy, that's important, along with making sure that you add all of the other expenses to get to your final income on the property. So it's the ratio of that income over the debt service. And, you know, it cuts both ways, the more income that you can show on the property, that helps the the top half of that equation, or the the lower the debt service is going to be whether that's in the form of interest rate or in terms of the amortization term, that helps the lower half of that equation.

04:17

I also want to say, you know, I was not aware of this when even after I signed the mortgage, because you typically don't read every every single.

04:27

No, you didn’t read 50 pages Jeremy?

04:31

I now have an attorney do it No. One important factor, especially if you need it, you typically don't know how long you're going to hold the property for, you know, but be mindful of any prepayment penalties. Those can get you know, typically banks will have some, some banks don't, but they might, they might not have them for repeat borrowers that they work with, you know, for a number of years. So if you're new, first time, second time, buying, especially with a commercial loan, please, please look at that, because that could catch you by surprise. You can take the sell property two or three years later if the market went up and you want to capture that appreciation.

05:12

Yeah, absolutely. Let's elaborate a little bit on what somebody should expect regarding down payment interest rates, how they differ a little bit from the conventional type of mortgage. So can you give some examples? Like, what should somebody expect, as far as a down payment for a commercial loan? What have you been seeing out there?

05:31

Sure, currently in the market, I'm seeing anywhere from 25 to 35% down. It all depends on the asset that you're buying. If you're buying a single family rental, they might ask for more. If you're buying, you know, a 20 unit apartment building that maybe doesn't have as much value add or maybe it's, it's, it's rather established, they might, you might be able to get more favorable terms. And then also, I think it's the experience of the operator yourself. If you're, if you're new, and they see that this is your first or second property, they might request more skin in the game. Versus you're more established, you know, you might be able to negotiate, you know, some better terms. And interest rates, we're seeing anywhere from four and a quarter, the four and a half right now, those fluctuate obviously with the the market. But that's currently where it is.

06:23

Yeah, I have seen as low as 20% down. But that's very unusual to get, you have to be very well capitalized, have good relationships with a bank, certainly not something for an inexperienced investor. But once you have some experience under your belt or you're active in the local market, you can get as low as 20%. But it's a little bit more challenging to get. So I agree with you, usually between 25 and 35, is what I've been seeing in interest rates. Of course, I agree with you as well, I am finding that. Go ahead Dave. What were you going to say?

06:55

Yeah, just a quick point here, which Jeremy talked about the value of partnerships. In terms of complimentary skill sets. This is another area which, again, if you're so inclined to invest with others, you know, when you need to come up with that 25%, and you're in a partnership with two other people, you're only needing to come up with a third of that. And so it's great from a stretching your cash standpoint, it's also great from a diversification standpoint. So now instead of one property, I can buy three. And if something goes sideways on one, and you know, my calculations of how it was going to run proved to be wrong, or you get caught with some major maintenance, that was unexpected, you have the other two properties in the mix to offset that. So just another really good. And again, partnerships are not right for everybody. You know, some people, many people do quite well, by themselves or as a couple, as real estate investors. But this is another great reason to be in a partnership.

08:04

Yeah, I completely agree with you. There's definitely strengths, the numbers. But I've also watched partnerships fall apart, you know, because they didn't have similar investing ideas, you know. So if you're going to enter into a partnership, you just got to make sure like you guys said before, somebody has to compliment your strengths and weaknesses, right, you have to complement each other and your ideas about investing should align very well. As well as the time that you're going to hold the property. You know, what your long term short term and long term goals will be? Those could be the things where partnerships get a little rocky if they're not in line.

08:35

Jen, that's such a good point. And you know this, this sounds really mean, but you're considering forming a partnership. The first thing you should decide among group members is under what terms would we dissolve the partnership? Yeah. And if you can't even finish that conversation, you may as well stop right there. Yeah. So such a good point, Jen.

09:04

Yeah, I agree with you. It's just like I said before about landlord friendly states, right. It's all good until it's not good. So you actually need to enter into I think my personally, at least I do I enter into a lot of business decisions, thinking about the worst case scenario, and what I would do in the event of that, right, and if I can stomach that, then I know that we're in a good path. Right. But if I can't stomach that, I know that it's probably not the best decision.

09:31

Absolutely.

09:32

So the other thing with commercial loans is, you know, and tell me if you agree or disagree with me, but I have found that when you go from a conventional loan to a commercial mortgage, what the banks are looking at changes drastically. My experience has been commercial lenders look strictly at the building and the numbers. Not you as the borrower per se. Whereas in the conventional world, it's still heavily reliant on you and your assets and your income. Do you guys agree with that or disagree with that?

10:05

Yeah, I do agree with that. I think the larger the asset, the more that they do look at the building alone. Especially if there's a lot more units. Those leases, you know, if you're looking at four or five, lets say a commercial, so just go five, six units, you know, they still might look at a depends what banks you're working with. But they still might look at your personal financial statements. Do you have strong borrowers. But yeah, I do agree that they do, they do primarily look at the asset, they want to make sure that the asset can pay for itself. They want to see the leases in place. Which kind of goes to the, you know, the, I think the common acronym, the BRRRR method, which is you know, you buy, you rehab, you rent, you refinance, and you repeat. You know that refinance, the bank loan comes after the renting for a reason. They want to see that you have income coming in that can support the debt that they're going to lend you going to what Dave was describing earlier was the debt service coverage ratio, which the banks want to see a surplus of income that can support the building and the debt that you're borrowing from them.

11:18

By just going back to a point that Jeremy made earlier on prepayment penalties, you know. Let's say you're buying a building, and this is such a great model, a lot of deferred maintenance, and below market rents in there. And you end up doing the maintenance, increasing the rents. And now the bank is going to look at that building much more differently. And you may have the opportunity to refinance it, pull out some cash from the building. But again, if the prepayment penalties are there, that that's a problem. So just another good reason to look at that so that you if you do do that, you can recapture that possible benefit.

11:59

The episode will continue in just a moment.

12:02

The best investments with the highest potential for a solid return always start with the right real estate purchase. But it's not just about a flips potential margin or how fast you can ready a property for leasing. It's about creating a future of financial stability for yourself and for your family. One that supports the lifestyle that you want. If you're an active investor and purchase, renovate and lease your own properties, and you love the process, the chase and the returns, you're in the right place listening to this show. Especially this season, because we're talking about a deep dive into how to purchase the best property for you. However, if you're more of a passive investor, and one who wants to diversify your stock portfolio with real estate, but you don't want to get involved in the active management of those properties, you're also in the right place. As we serve both types of investors. To gauge where your real estate investment tolerance sits, and what would be the best fit to grow your income with real estate, I invite you on a call with me. To book your call visit growingempires.com and click book a consult. That's g-r-o-w-i-n-g-e-m-p-i-r-e-s.com and I'll help you choose the best real estate model to help you achieve your real estate investment goals.

13:07

Let's get a little bit more into doing the math. So we were talking a little bit about debt service coverage ratio. What other factors do you guys use when you are analyzing a property? Do you focus at all on cap rate?

13:21

I'll just answer that for me. And it's probably because I'm a financial advisor, I like to look at cash on cash. That to me is more of an apples to apples comparison of this investment, versus investing in the stock or a bond or a read some other traditional investment product. And so, you know, if I have a building that's potentially generating 15 to 20% cash on cash, boy, I really like that asset. Particularly that the that the stock market is extremely overvalued right now. And I think it will be very difficult to achieve those kinds of returns going forward. So and hand in hand with that. It's basically the same calculation, but it's stated a different way is, I also like to look at payback period. When am I getting all of my cash back? Because I need my cash to invest in another another piece of real estate. You know, cap rate is is fine. It's useful, for example, when comparing, you know, deals that you're looking at out there in relative terms. But, you know, I like some of those other less less common metrics to the real estate industry. Jeremy, I don’t know what your point of view is.

14:49

Yeah, I think cap rate is a snapshot in time of what a building is. And a building can be a five cap today and it could be a ten cap a year from now. Because basically cap rate is looking at your your net operating income. So how much income you bring in minus your operating expenses. So it's a snapshot of what's going on right now that there could be a lot of vacancy in the building, your cap rate effectively would be lower. Could have a ton of expenses or rents could be under market. You know, it's that seesaw relationship of income and expenses that drive the cap rate. And on what you might buy it at. Like, Dave and I were looking at our other partner, were looking at a building that, you know, we're looking at a building last week, it was an eight unit, and the cap rate was just under six, you know, thinking that's crazy. You know, and traditionally buildings are selling, you know, in the eights in this area. But it wasn't, that didn't scare us was looking at a cap rate so low it was what could we do to that building? To make it a worthwhile investment long term? And, you know, the details of this specific investment was the rents were severely under market, you know. Probably by 40%. You know, expenses seemed a little high, you know. So at the current price we were buying at Sure, it was a, it didn't look very stellar. But the more you run these numbers, I mean, it's going to take a couple years to reposition it. But it would be a stronger investment, higher cap rate down the road. So it's, I think it's all relative, you need to be aware of what cap rate is, I believe. I just so you know it and you're factoring in it. But I don't think it's, as Dave was saying, it's not the end all be all, the only thing you go off of. It's just one metric within your underwriting.

16:49

Yeah, that's, that's a great point. Because it is. Unfortunately, I experienced some investors that are very much tunnel vision. And, you know, because they heard a podcast or listen to something where, you know, cap rate was talked about as the only metric they truly live by that, and it's the only metric. But I agree with both of you, and Dave, you know, with your cash on cash method, you know, and how quickly you're going to get that money back. So, so let's talk about that a little bit more, because I think that makes a lot of sense, right? It's the amount of money that's left in the deal. On a related note, your payback period, let's say why don't you elaborate a little bit more on your payback period. How are you analyzing that? And, in your mind, what makes a good payback period? Are you looking at a couple of years? Is it specific to the investment? Is it you know, specific to the partnership or how are you analyzing that?

17:45

Yeah, so I'd say, a good payback period is, at least for me, in real estate is anything less than five years. Because again, just looking at that cash on cash relative to other. If I'm going to invest money in astock, and I spend $100, on that stock, would I be happy five years from now, if it was worth $200? Which is essentially the same thing as as a payback period. And the answer is yes, I'd very happy with that. And so, you know, that's, that's one piece of the equation, I do think another piece of the equation that you have to look at, and it's kind of where it gets complicated, is you have a lot of moving pieces. So you have the moving piece of the planned maintenance that you intend to do on the building. You're going in and or any any renovation. You have the planned the increases in rent you intend to command on that basis. And in particular, right now, something as landlords that we all have to be cognizant of, not, not from a dollars and cents standpoint, but just from a basic caring standpoint is, you can't plan to just evict a bunch of people out of a building right now. And, and shut it down. Yeah, for renovations. So you know, that this, these are, these are strange times we're living in right now. And it's just not appropriate from a humanitarian standpoint. We'll call it that. And then the third piece, again to look at is are you going to refinance the property at any time within those five years and pull some of that cash out? What can you expect in terms of the rate of appreciation of the building? Because that will factor into that refinance equation. What can you expect in terms of increase in rents over time? Not just initially. So, you know, you can go down a real rabbit hole with the equation or with the calculation. But it's, it's, it's important and this is why I'll go back to your point, Jen. calculating a simple cap rate is it's a good start. A good start. But to really dig into what's going on with this property, say just over a five year period, much more valuable ways just looking at cash flows.

20:35

Yeah, I completely agree. Thank you for listening to part two segment with Dave Rowan and Jeremy Moyer. We will be back next week for our last segment and until next time, take care.

20:48

For more information about how Jennifer can help you plan, develop and manage a strong real estate investment portfolio, visit growingempires.com