Scary Stories Lenders Tell in the Dark

Halloween may be over for another year, but there are still a few spooky phrases that are sure to chill any investor-focused lender to the bone. These are the Scary Stories Lenders Tell in the Dark . . . “If I finish renovation and the property doesn’t sell, I’ll just rent it out.” “I like this property, but I’m not sure what it’s going to sell for.” “I haven’t decided whether to sell it off or hold it as a rental property.” “I’m not sure what market rent would be.” Every single one of these phrases immediately and dramatically lowers my expectation that this given loan go smoothly and ultimately close. One of the underrated problems that we run into is our borrowers not having a relatively fleshed out plan for their project or some semblance of an exit strategy. Buying an investment property will take time, capital, large amounts of risk, good partners, and sometimes a decent amount of luck. We like to reduce the amount of luck required. In fact, the most common reason we turn down properties is because we don’t think the borrower is going to achieve the profit margin that they are expecting, even if the loan technically works for us. I’m going to tackle all the above horror stories and show you why they terrify our team.
  1. If a flip property doesn’t sell, it will do just fine as a rental.
Raise your hand if you’ve lived in properties that you wouldn’t want to own. My hand is up for sure. Expectations for a rental versus a freshly renovated home are often leagues apart. Most flippers will aim to have their properties sell in the mid to high portion of market prices. In an area with sale prices between $250,000-$350,000 they are probably going to aim for $320,000+. When renovating properties for rental, most investors are not putting in high end finishes. The countertop probably isn’t going to be high end granite or marble. It’s likely going to be cheaper quartz, laminate, sometimes even ceramic or porcelain tile. Other finishings are going to follow suit.
  1. Not knowing an accurate estimate of after repair value, or future sale price.
Imagine saying the following phrase in any other business, “I want to sell this new product, but I’m not sure how much it’s going to be worth, or how much to sell it for, or what the profit margin will be. Do you want to invest?” It’s an easy answer for everyone. That’s what we hear when a client says that they aren’t sure what they expect the property to sell for. It’s especially concerning when you think that the vast majority of good investors work backward from their expected future sales price, also known as after repair value (ARV), and use that to establish a maximum allowable offer. Often their offer will be based on a total cost of less than 70-75% of the ARV. They will then subtract renovation costs to establish their purchase offer. Without an understanding of the ARV, an investor is really hoping to get lucky and make a profit, rather than planning for one.
  1. Not sure what you want to do with the property.
The favorite words of anyone who is making a large financial investment are loosely as follows, “I don’t really have a plan, but I really like it. It’s a great deal.” Obviously that’s a joke (albeit not a great one), but you might be amazed how often we hear it. There’s one main rule in real estate investing: do not get emotionally invested in the property. If you love it, you should walk away or you will end up treating it as if you were going to move in instead of a property that should make you money. This usually means unnecessary expensive renovations. Real estate should be profit driven. It’s fine if you don’t have a plan for the property at first, but you should decide before you go to a lender to ask them for financing. Lenders are looking for the best loans they can make based on hard numbers and ratios. Telling them how much you love the property makes them concerned that you may be willfully ignoring key negatives or overestimating values. It means you’re less likely to be driven by numbers, and your decisions directly affect a lender’s bottom line.
  1. Not sure what to expect for rents.
Not knowing what the future rent is going to be is a gamble on your future cash flow. This is telling the lender, “I really don’t know what I’m doing, but I will probably make money here, and might be able to pay back your loan.” Not the strongest statement. Figuring out market rent for properties isn’t that difficult. Search on sites like Craigslist, Zillow, Trulia, and ask industry professionals. Other landlords or property managers are a great tool here. Few comments inspire fear in lenders as much as those four. We don’t need perfection, but every lender is looking for is a borrower who has a solid plan, and seems capable of executing that plan. The same way that an experienced borrower wouldn’t want to work with a lender that is unprepared, lenders want to work with borrowers that are prepared to handle all unknowns of their projects. If you have any questions, or you’re looking for a lender that isn’t a nightmare to work with, feel free to reach out to the team at RCN Capital. This article originally appeared on the Mortgage Professional America website, Scary Stories Lenders Tell in the Dark. View the full article here