Real estate investing provides certain unique advantages. The commercial mortgage is one advantage, as it can make purchasing investment property a possibility for many people who would not otherwise be able to do it. The individual investor’s commercial mortgage is much the same as the financing for any investment property, including a luxury skyscraper in the center of a major city. It is a mechanism that works very well at any scale.
The Personal Aspects of Purchasing Investment Property
Debt can be good for your financial health. It should be your goal to earn returns on an investment property that are higher than the interest you pay on the loan. In such a case, you are making a profit from having debt. Additionally, debt can magnify your potential to succeed: You can buy more property and build your portfolio faster when you use debt to finance it, and you can do more when you have more money.
Debt can also magnify your potential to fail, however. That is why lenders perform an analysis on borrowers to determine how much debt you should have. Understanding what to expect from lenders will help you become the most attractive candidate possible for commercial financing.
There are ways to limit your liability for your business activities to the amount of your investment, thus protecting your personal property. Business structures such as limited liability companies (LLCs) and limited partnerships (LPs) do this. If you are a first-time investor with little collateral or credit history, lenders may not be willing to consider those options. Even if they do, they will take an interest in your personal finances and judge them, as personal financial problems greatly increase the likelihood of business financial problems.
One analytical tool lenders use to ensure that borrowers are not taking on more debt than they can service is the debt-to-income ratio (DTI). In addition, a good credit score is important because it reflects your past financial behavior and is considered a predictor of your future behavior. If you do not have a high credit score, be prepared to explain the situation that brought you to that point and what you are doing to remedy it. If you have a mediocre credit score, it is likely to add to the cost of your financing, rather than ruin your chances of obtaining it.
You should also remember that there will be a sizable down payment on your loan, ranging from a minimum of 20 percent to much higher than that. You may be able to finance some or all of your down payment as a second mortgage from an alternative lending source, such as a bridge loan or peer-to-peer lending service, but you will likely pay a higher interest rate for that financing since it will be secondary in position upon foreclosure. If you have the option of paying more than the minimum down payment required by the lender, you may be able to negotiate a better rate for your loan. In addition, you will see that, with the interest factored in, your savings could be significant.
Companies Face Scrutiny, Too, When Purchasing Investment Property
The corporate equivalents to the DTI are leverage ratios, which are calculated in several ways. The most common of these is the debt-to-equity ratio. You can note that debt is assumed to be the larger component in the equation. A ratio of one means that debt and equity are equal. A positive number indicates debt is larger than equity. A ratio greater than 2.0 is considered a risk. Businesses also have credit scores, and an excessive amount of debt can affect them badly as well.
You shouldn’t take these generalizations as hard and fast rules. Lenders can be highly resourceful and creative. A simple principle can be observed, though: Banks are businesses that want to generate profits. You are a customer and should shop around for the best loan you can find.
At CWS Capital Partners, we provide partnership agreements and other pertinent legal documents that are created for our business partnerships by experienced attorneys with whom we have long-term relationships. We are a fully-integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country, and we employ a team of experts who can help you hone your investment strategy.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.
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