Currently, 29 states and the District of Columbia (DC) have enacted laws that make the use of marijuana legal. Seven of those states, and DC, have legalized the recreational use of marijuana. Several more have legalized medical marijuana. Naturally, the growth, harvesting, manufacturing, and sale of cannabis-related products will have an impact on real estate. Real estate space will have to be dedicated to each stage of the production process from growing marijuana plants to selling the product to the end user. Here’s how borrowing and lending 420 loans for cannabis-related businesses is having an impact on real estate across the U.S.
Banks Are Out, Hard Money Lenders Are In
Even though marijuana is legal in more than half the states, it is still illegal federally. Because of that, banks see lending 420 loans to marijuana-related enterprises as risky business. If they run afoul of the federal government, the fear is they could lose their banking license. For that reason, banks have been reluctant to lend 420 loans to cannabis-related businesses for any reason, including for the purchase of real estate, an activity for which banks have historically been eager to lend money to business owners.
This reality does not mean that marijuana businesses are out in the cold, however. Many of these businesses are turning to private money lenders, instead. Inc. Magazine says the pot business is really the real estate business.
What Marijuana Product Manufacturers Use Real Estate For
Two areas of real estate development that are impacted heavily by the legalization of marijuana are commercial real estate and industrial real estate.
Commercial real estate is used for the sale and distribution of pot-related products. Whether for recreational or medical use, cannabis must be sold over the counter in places where there is no longer a prohibition against it. Therefore, retail shops and medical marijuana dispensaries are either leased or purchased to keep the product available for those who want or need it.
Industrial real estate involves the growth and harvesting of marijuana plants and the manufacturing of the end product in whatever form it may eventually take. In Denver, Colorado, for instance, marijuana growth operations grew by 14% to 4.2 million square feet from Q2 2015 to Q4 2016.
A New York Times article published in April this year reported that California saw $100 million in real estate transactions related to marijuana businesses since recreational marijuana was legalized in 1996. And across the board, in states where marijuana-related real estate transactions are taking place, real estate values are on the rise. Rents as well as buying terms are all on the rise. Cannabis is driving huge real estate transactions.
What Kind of Real Estate Properties Are Affected?
Because marijuana is a plant that is often grown indoors, mostly because it is still illegal according to the federal government and indoor cultivation allows growers to shield their operations, pot businesses need a place to grow the merchandise. This is often done in greenhouses and warehouses.
Because there are many different types of marijuana products, warehouse facilities can be retrofitted to meet the needs of manufacturers. From food products, which require kitchens and bakeries, to oils and tablets for medical use, industrial real estate for cannabis is as diverse as the broad industrial real estate category in the U.S. The space has grown so lucrative that some investment-minded entrepreneurs have established marijuana real estate REITs and funds for those who want to get in on the green without getting their hands dirty.
Then there are the storefronts. Medical marijuana dispensaries can look like a regular retail outlet or a doctor’s office. Some are simply locations where users with the right qualifications simply show up, pick up their prescription, and head home—much like a trip to the pharmacy.
In states where it is legal, marijuana has become a multi-billion business. In order to keep the production going, business owners will need to purchase or lease real estate, and many of them are borrowing the money to do so. To cover the demand, lenders specializing in 420 loans have popped up in most of the states, and they’re not expected to go anywhere any time soon.
Every location has some element of inclement weather that the residents of that area must deal with on an ongoing basis. There may be very pleasant days at some times. When the dirge of the specific weather condition comes, everyone must contend with it. For some locations it is the potential for hurricanes or tornadoes. For others it is the seasonal change from fall to winter.
Investing in residential real estate in colder climates sometimes means the real estate investor has to pay attention to primary household systems. These house hold systems may seem to add little to the marketability of a home. However, it is good to remember that the buyer of that investment property will live in that colder climate. The buyer may appreciate the climate specific renovations that the investor completed.
Insulation For Your Residential Investment Property
Older housing stock may not have the amount of insulation required by current building codes or preferred by current buyers. While insulation in walls is difficult to improve, blown in attic insulation is both inexpensive and easy to install. It is, however, a messy and sweaty job. Cellulite insulation made from recycled newspaper, and other sources, is a good option for the fix and flip investor. It provides the required insulation at the lowest cost.
Plugging holes in the house is the proverbial no-brainer. Incredibly, even houses in cold climates often have shifted and created gaps along the foundation and other structural elements. Pay close attention to areas such as outdoor water spigots where pipes pass through walls. Calk and expanding foam are inexpensive, but unfortunately do little to improve resale value.
Window and Door Renovations For Real Estate Investments
This category is where there can be a significant payback in resale value. Replacing older single pane windows with energy efficient double pane improves the heat retention of the house while adding to the curb appeal. Potential buyers will probably immediately notice the windows, especially those who have lived in the cold climate for any length of time.
Exterior doors are also a prime candidate for an upgrade in colder climates. Again, the payback in marketability is noticeable. In fact, painting a front door is one of the most commonly recommended ways to increase curb appeal. Potential buyers stepping across a well insulated threshold and who notice the tight fit of the front door have moved one step closer to buying.
Garden Renovations For Fix and Flip Investments
Even for a fix and flip investment, some major value can be gained from planting trees at the renovated property. Arborvitaes are a relatively inexpensive shrub that can grow to over 6 feet and act as an effective windbreak. Consider putting a line along the north and west property lines. Keep in mind that west sun is valuable for warmth. If there is enough room plant the arborvitae far enough from the house so that it only blocks the wind, not the sun.
Older, mature trees on the property may require some attention as well. Heavy snow is a hazard for tree branches, so make sure trees are properly pruned so branches do not overhang the house. Hire a professional arborist for this job. Like attic insulation, this might not translate into curb appeal, but individuals accustomed to living in a cold climate will appreciate the attention to detail.
All these renovations are in addition to the painting, renovating, and remodeling that are the stock in trade for fix and flip residential real estate investors. Like hurricane-proof roofs in Tampa, Florida, these climate specific ideas have their place. Make a list of them and be sure every prospective buyer knows how the house has been upgraded and prepared for the coming winter chill.
Storm damaged residential real estate seems like the perfect fix and flip opportunity. The premise of repairing the storm damage and flipping the house may seem straightforward. As anyone experienced in renovations can testify there is nothing straightforward about this aspect of the real estate investment business.
Find The Right Fix and Flip Investment Opportunity
Storm damage is typically covered by homeowners insurance. The owner has little to no financial incentive to sell a house simply because it has been damaged by a storm. Homeowners policies even cover loss-of-use. This means an owner who cannot live in the house can receive reimbursement for staying at a hotel while repairs are being made. This limits the fix and flip opportunity to homes that are already owned by a bank or some other atypical owner.
Those houses may or may not have been good fix and flip opportunities before the storm damage happened. The storm damage has certainly made a bad situation worse. The question of economics that applies to all real estate investments still applies to storm damaged properties. Will the eventual sale price cover the cost of all the necessary repairs and renovations? Will it provide an acceptable return on investment for the time involved?
Have Available Contractors to Repair The Real Estate Investment
If the answer to that question is yes, the real estate still may not qualify for a fix and flip investment. Homes that have suffered storm damage are very likely located in storm damaged areas. Heavily storm damaged areas mean contractors in those areas are in high demand. Contractors have their pick of jobs to accept. Even an established relationship with a contractor is no guarantee they will be available at the right price following a major storm.
Fix and flip investors who typically do their own work may find that storm damaged homes present a challenge beyond their ability. Roof repairs generally require professionals. Many times the problem may be much worse than just missing shingles. Siding that has blown off requires specialized tools and expertise to repair effectively.
Protect the Investment Property From Future Storms
If contractors are not readily available to do the work at the right price, it is absolutely critical to secure the property to prevent further damage. More storms may be on the way. Storm damaged homes are weakened in some way. Another high wind can pick up on those weaknesses and create extensive damage. The cost of these emergency repairs has to be included in the economic calculation.
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There are other problems with storm damaged real estate as an investment, but these three alone may give the fix and flip investor reason enough to avoid the property. However, this real estate segment is not for the faint-of-heart in the first place. Tackling significant problems is how investors profit in this sector.
Weather affects home sales. This is a very straightforward conclusion that can be drawn by anyone trying to sell a home during a blizzard, hurricane or other severe weather event. If potential buyers cannot get to the house, they cannot make a decision to buy it. A flooded street ends foot traffic and destroys curb appeal.
Closely related to this is the theory that weather affects mood, and buyers in a lousy mood do not decide to buy. They may find something they like, but their natural inclination is to say “no” because of a bleak mood. This is a theory from behavioral science that has been repeatedly tested as it relates to the stock market. Obviously there is a significant financial reward for anyone who can predict an up or down day on Wall Street, and weather seems an obvious driver.
What Drives The Residential Real Estate Market?
Residential real estate investing can be very lucrative, but there is no doubt that it is difficult. In fact, the two may be very closely related. The old saying, “If it was easy everyone would do it.” certainly applies to making money on real estate investments. Fortunately, with everything else that has to be considered, real estate investors can rest assured that it is rare for any deal or project to go down the tubes because of the weather.
The simple fact is that there are so many factors which impact the value and strength of the real estate market that weather is simply not a contributing factor. The studies on weather and the stock market have been inconclusive. A potential buyer who does not come out because it is raining will come out 24 hours later when the rain lets up.
The fact is that residential real estate buyers are brought to the market for a variety of reasons, none of which have anything to do with the weather. They set aside time based on work and activity schedules and look at houses at these pre-determined times. The blog post linked at the start of this article blamed rain in Seattle for low traffic at the property. If people in Seattle stayed inside when it rained they would never come outside.
Home Sales Indicate Real Estate Investors Are Still Active
The National Association of Realtors (NAR) reports that home sales fell in August to an adjusted low of 5.35 million homes. This is down 1.7% from the previous month. However, the primary factor they cite is the continued lack of supply in the market. Incidentally, the NAR report says cash deals still account for about 20% of the market, up from the previous month but down slightly from this time last year. This indicates real estate investors are still very active in this market.
Of course, all real estate is local, and all weather is local too. We may commiserate with folks in Houston or Florida, but it is the weather outside our own windows that impacts our behavior. This means that a blizzard or hurricane will impact the real estate market in that location for a period of time. But eventually the streets get plowed and the storm damaged is cleared away. Business, and life, tends to get back to normal fairly quickly.
Cause and effect is often very difficult to see amid the clutter and influence of different factors. In fact, it is so easy to draw wrong conclusions between two items that there is a fallacy in logic that covers this practice. Real estate investors do well to avoid this when it comes to weather and stick to the fundamentals when buying or trying to sell a piece of residential real estate.
Curb appeal is a critical part of marketing real estate investment properties, and each season brings its own unique challenges and opportunities. The need to make a great first impression in the fall is just as great as any other time of year, but the distinct quality of fall presents some fantastic opportunities that are just not available in the winter, spring or summer.
Maintain The Lawn and Garden
Of course, well maintained plants that can be seen from the car are a great way to make a warm welcome to a prospective buyer. This is true even if they are in planters or other temporary containers. Cold overnight temperatures can kill ornamental plants even if the day before was warm and sunny. If possible, cover plants overnight with a drop cloth to protect them and preserve the curb appeal of a well planned and tended garden.
If this is too labor intensive, just be sure to remove dead plants as quickly as possible. Nothing gives a worst first impression than greeting buyers with a job to be done. Consider replacing annual flowers with hearty Mums that withstand the early frost and provide a brilliant splash of color. A fall decoration like corn stalks or pumpkins can add a festive touch as well.
Be sure the lawn is cleaned of leaves regularly. Again, raking leaves is a chore and while a lawn full of them is colorful and is unique to fall, not everyone appreciates the beauty. A lush green lawn is appealing at any time of year, so if you have invested in one be sure to show it off to prospective buyers as they pull up in their cars. Also, be absolutely sure that the gutters are cleared of leaves as well.
Stage Inside The Investment Property For Fall
Although anything inside the house is technically not curb appeal, there is a fantastic strategy for staging a house in the fall that needs to be mentioned. Bring in a dining room table and set it for a holiday dinner! Any buyer looking at a house in the fall is considering what it would be like to live there at Thanksgiving and other upcoming holidays. Setting a table with some decent china bought at Goodwill or other second hand store helps them easily see themselves living in the house at the holiday.
Of course, before prospective buyers can see inside they have to come in the front door, and this portal can be seen from the curb. Decorating the lawn with cornstalks and pumpkins was already mentioned, but the opportunity to add a door decoration should not be passed up. Think of someone living there would welcome visitors to Thanksgiving dinner. An appropriate door decoration featuring this theme, even well before Halloween, can get the prospect thinking how nice it would be to live there in the coming months.
Invest in Proper Lighting For The Real Estate Property
Outdoor lighting is a more significant upgrade, but one that is well worth considering. Keep in mind that fall means shorter days, and prospective buyers may well be coming by in the evening after the sun has set. A well-lit porch or entranceway is very inviting and adds a touch of security as well. Just be sure the lights are on when buyers are expected. In fact, leaving them on will add little to the electric bill and welcome unexpected buyers.
Of course, it is better if real estate agents call before showing a house, but marketing a residential real estate property means being ready for prospective buyers at all times. In fact, a real estate agent who has the listing can be a true ally in the fall or any time of the year. They may be able to be at the house to point out the benefits at a moment’s notice.
Real estate investing is one of the most lucrative alternative asset classes and has resulted in thousands of people in the U.S. rising to millionaire status within a few years. While it does have its risks, it also has many rewards. Here are nine reasons real estate investing is a steady road to riches as opposed to a get rich quick promise that will likely go unfulfilled.
Ways to Earn Income by Real Estate Investing
1. Rental properties deliver ongoing passive income. Whether you buy and hold single-family residential properties or multi-family real estate, the opportunity to earn passive income can’t be beat. Sure, there are ongoing expenses, but well-managed properties earn investors monthly dividends for as long as they own the real estate.
2. Real estate crowdfunding makes real estate investing more convenient, affordable, and accessible to more investors allowing those investors to build diversified portfolios by spreading their money around in different types of real estate investments such as commercial, industrial, rentals, fix-and-flips, and more.
3. REITs are tied to the stock market but make your investment portfolio more diversified. REITs are popular right now because they don’t require investors to actually touch the real estate they own. This investment vehicle works more like a stock, but it’s real estate. Today’s REITs are earning investors consistent double-digit returns.
4. Real estate investments can be held in a self-directed IRA with your earnings re-invested, which will save you on capital gains taxes and increase your distributed earnings exponentially over time. Even real estate crowdfunding investments can be held in a self-directed IRA.
5. 1031 exchanges are another way to keep your investment earning by compounding the benefits on top of one another. The idea is to sell a piece of real estate that you own and buy another of greater value. By doing so, you avoid paying taxes on the gains of the first piece of real estate. There are strict rules you have to follow regarding hold times, property values, and property identification, but if you follow all the rules, 1031 exchanges can propel you to greater returns.
6. Property flipping can earn you short-term profits, which you can then re-invest for greater returns. Buying a piece of real estate, improving it, and putting it back on the marketplace is a great way to earn short-term returns. Re-invest those returns into the purchase of your next property. By growing your business slowly, you can walk your way up the financial ladder of success.
7. Now, investors can use cryptocurrencies to invest in real estate. It’s risky, but it is another channel that offers diversification and security in your real estate transactions.
8. Commercial leasing offers long-term benefits and passive income, too. Unlike residential rental properties, commercial leases tend to be long term, as in years. You can have a tenant for 10 or 20 years. Commercial office leasing is very lucrative.
9. Airbnb allows you to rent out a room of your home to travelers earning short-term profits from real estate not currently being used. You can rent out single rooms allowing you to capitalize on your own residence, a great option for empty nesters whose children have moved on and left empty rooms behind, or you can rent out entire properties for short durations. If you live near a tourist destination, this option allows you to compete with bed and breakfasts and other hospitality sector businesses without actually being in the hospitality industry. This could be a great way to earn extra income that you can re-invest in other real estate deals.
Real estate investing is getting better and the many faces of real estate crowdfunding is one reason why.
For the Atlantic and Gulf Coasts, the thought of a hurricane is a fact of life. Recently, the fact is that violent storms have made life unbearable for millions of coastal residents. In spite of this recurring devastation, there are increasing numbers of Americans living in coastal areas prone to hurricanes. This fact demonstrates the importance of differentiating between short term impacts and long term trends in real estate investing.
Real Estate Markets Triumph in Coastal Areas
There is absolutely no doubt that Americans like to live on the coast and are moving there in increasing numbers. Between 2010 and 2016, coastal counties of South Carolina increased their population by over 13%. This is despite being hit by Hurricane Hugo in 1989, Hurricane Bonnie in 1998, Hurricane Floyd in 1999, Hurricane Charley in 2004 and Hurricane Joaquin in 2015. It does not matter if hurricanes follow each other quickly or after a long lag. The population increases.
The city of Houston is another prime example of this. According to the U.S. Census Bureau, the Houston metropolitan area grew by an average of more than 2,600 people per week from 2010 to 2016. The total population increased from 5.92 million to 6.77 million over this time. Again, this is despite the fact that the Houston area is hit by a major tropical storm every 15 years on average, and that studies have predicted that a direct hit will result in a major environmental catastrophe.
The most telling example of this dynamic is the Miami metropolitan area. In 1992, the area received almost a direct hit from Hurricane Andrew, a category 5 monster that caused $26.5 billion in damage. It was the most powerful storm to hit the state. At the time, the population of the area was just over 4 million people. Hurricane Wilma hit the area in 2005 and caused $21 billion in damage. The metropolitan population at the time was just over 5 million. By 2010 the population was 5.5 million, and by 2015 it was the 8th largest metropolitan area in America with over 6 million people.
Irma and Harvey’s Influence on Real Estate Investing
The dynamic of increasing population in areas that will inevitably be hit by a hurricane is not willful ignorance. It demonstrates that people making informed choices about where they want to live have done a cost to benefit analysis and decided the benefits of coastal living outweigh the costs of hurricanes. This cost, both the inconvenience of evacuation and the property damage caused by a hurricane, is “baked into” the real estate value of the area.
Real estate investors understand this dynamic. There is no “perfect” property. Each project, each parcel, has its strengths and its weaknesses. The financial analysis is to weigh each of these and determine if a project is worth the risk. Hurricanes, and the risk of hurricanes, are just another factor impacting real estate values. Over the long term property values would be higher without hurricanes, but since hurricanes happen, they impact long term values.
Naturally, they have a greater impact on short-term market conditions. Nothing shuts down a real estate market like a major tropical storm. And values might take some time after a storm to fully recover their pre-storm levels. However, the upward dynamic of people moving to an area will eventually take over. In fact, someone planning a move to an area might see the temporary fall in values following a storm as a buying opportunity.
This all means that real estate investors can comfortably consider hurricane prone areas for investment opportunities. They should be aware that a storm can disrupt an investment and potentially delay a sale and time their investments accordingly. Because although it is impossible to tell when the next time Miami will be hit with by a hurricane, it is certainly not going to be during January or February.
While it’s difficult to know for sure what will be included in a final draft of a proposed tax reform plan, let alone one that is passed by Congress and approved by the president, we do have some clues about what may be included in the plan. As a result, we can make a few guesses about how the proposed plan might affect real estate crowdfunding (RECF) investments.
According to the Washington Examiner, the tax reform plan as it is envisioned right now consists of two parts – eliminating taxes and lower tax rates (first part) and eliminating tax breaks (second part). How each of these will affect RECF investors depends on the specifics, which haven’t been outlined yet. Here are some general observations.
How the Proposed Tax Reform Plan Can Affect Real Estate Crowdfunding
- If plans to lower the corporate tax rate goes as planned, this would benefit institutional investors and corporations that invest in RECF. It could also benefit some RECF platforms depending on their business structure.
- Both the GOP and President Trump propose to lower individual tax rates, but Trump wants to go lower than the GOP. Regardless of what is settled upon, individuals who save on federal taxes could have more to invest in RECF. Putting those investments into a self-directed IRA and re-investing them could compound to some excellent future growth.
- However, the plan calls for reducing the current seven income tax brackets to only three. Since we don’t know where those income levels would fall, it’s possible that some people’s income taxes could go up under this provision. For instance, if the 33% tax bracket was rolled into the 35% bracket being proposed, a small percentage of taxpayers would see a tax increase, and that could affect their ability to invest in RECF.
- Another provision in the tax reform plan is the elimination of itemized tax deductions. Real estate borrowers may be affected on this end. Those living in states that impose state income taxes, such as New York and California where there a lot of RECF companies, could be influenced on both ends— on the federal end and on the state side.
- Interest payment deductibility for businesses has been a huge boon for businesses that operate on high debt. Companies that borrow a lot to undertake capital improvement projects, even purchasing real estate, could see their taxes go up. If they use debt-based real estate crowdfunding at all, then this provision can influence their business strategy. It will require business owners to get creative with how they structure RECF deals.
- On the flip side, if companies can write off new investments immediately, then the previously mentioned downside could become a huge upside.
Why It’s Difficult To Know How Tax Reform Will Affect RECF
To be honest, it’s very difficult to know for sure just how tax reform will impact real estate crowdfunding investments. This article at Forbes explains why. Nevertheless, there are four sets of RECF taxpayers that will be impacted either in the positive or in the negative, but likely both. The only question for each set of taxpayers is, will it be a net positive or a net negative? At this point, no one can tell. Those three sets of taxpayers with regard to RECF are:
- RECF deal borrowers – Deal borrowers are likely to be impacted by lost itemized deductions causing them to pay higher taxes. However, depending on the structure of their business, they could win or lose in other ways.
- RECF investors – Investors will likely be affected most by the tax bracket they fit into. While the president and GOP leaders promise to reduce the taxes for most Americans, there is the possibility that some taxpayers will pay more.
- Institutional investors – Institutional investors will likely benefit if they get the tax cuts promised by President Trump. They’ll benefit a little less if other GOP leaders get their way.
- RECF platforms – What will determine whether RECF platforms and their owners/shareholders win or lose will be the net effect of all the reforms. If borrowers and investors see a net positive, then we’ll likely see more deals and the industry as a whole will do even better than it has the last couple of years.
As you can see, we are in a wait-and-hold pattern on tax reform. The word is taxes are going down for most taxpayers, corporate and individual, but no one knows by how much just yet.
A real estate loan borrower’s profile plays a salient role in the lender’s due diligence process and analysis. The mortgagee reviews the mortgagor, in a comprehensive manner, in order to deem any lending activity a prudent risk to the loan portfolio. Each hard money lending institution has its own underwriting guidelines. The hard money lender evaluates a potential borrower according to these standards. However, there are elements that are regarded as significant across the industry. The ideal real estate loan borrower for Sharestates has excellent credit, an extensive track record, and robust liquidity. A bridge lender will also scrutinize the real estate loan borrower’s investment and exit strategies to ensure they are reasonable. These factors, working in tandem, serve to construct the borrower’s risk profile.
Real Estate Loan Borrowers Need to Have Good Credit
Borrower credit is essential as it provides a detailed history of the borrower’s experiences and tendencies in that role. The hard money lender has the opportunity to review this data and determine whether the real estate loan borrower has developed positive, or negative patterns with their credit. The examination of active tradelines, at least five for Sharestates, is vital. These payment patterns are more representative of the borrower’s current activity and trends. A high credit score detailing consistent timely payments, especially of mortgage debt, is a boon to the lender’s risk analysis.
Track Record of Successful Real Estate Transactions
Experience in real estate transactions also reduces risk to the lender. There is a high degree of regulation that a real estate loan borrower must navigate during the real estate investment process. Furthermore, issues can arise on the ground. Issues from real estate development to disposition, can put the investment property, and therefore the mortgage, in jeopardy. Ergo the ability to manage these challenges is important to a hard money lender.
Strong Liquidity is a Must to Close The Real Estate Loan
Liquidity is necessary in order to close the real estate loan, to cover the down payment and closing costs, and serves as a cushion. While the cash-flow from an investment property would cover the mortgage under normal circumstances, strong borrower liquidity would prevent the mortgage from defaulting in the event cash-flow were to decrease.
Sound Investment Strategy is Key For a Real Estate Loan Borrower
Both the borrower investment and exit strategies are paramount to the analysis of the potential loan, especially for a bridge lender. The investment strategy outlines the project as core, value-add, or even opportunistic in nature. It needs to be viable and sensible as it relates to the acquisition or refinance.
This is where the exit strategy then comes into play. The bridge loan is temporary in nature and the balloon payment at the end of the term must be covered. A strong real estate loan borrower will arrange for conventional financing if she wishes to hold the property, or a sale, or if she wishes to fix and flip the property, before the bridge loan matures. The investment and exit strategies work in a synergistic manner. A sound investment allows for a smooth exit.
These five factors are integral to the assessment of risk. A real estate loan borrower that exhibits these features, and considered or addressed his or her investment and exit strategies in an astute fashion, will sail through a loan committee review.
Changes in the interest rate environment and changes in financial circumstances have made refinancing a fact of life for the active real estate investor. Individual homeowners may be able to stick their head in the sand and steadfastly pay off a 30 year fully amortized mortgage. Real estate investors on the other hand need to keep an eye out for the opportunity to tweak their financial situation. This includes willingness to go through the paperwork of a refinance.
It is important to be clear on this point. Refinancing a mortgage requires time and effort. Regulations that were put in place as a result of the mortgage meltdown of 2008 put a burden on lenders and borrowers alike. In light of this, a successful refinance is one that puts the borrower in a better financial position while considering the cost of the process itself.
Importance of Bookkeeping and a Good Credit Score
Like the warning label on a box containing a child’s toy, loan applications have a warning label. The need to provide factual data regarding a personal financial situation along with the corresponding documentation proving those assertions can be intimidating for the sloppy bookkeeper. But there is simply no way around it. Financial hygiene requires good bookkeeping. Completing a mortgage application is a test of this skill.
Of course, the earlier this skill is developed the better. Good bookkeeping includes managing household cash flow, which typically results in a good credit score. This is one element in the refinancing process that cannot be pulled out of a file cabinet. It must be developed over time. In fact, a credit score that has been increased due to prudent financial management can be one reason to refinance a mortgage on more favorable terms.
How to Refinance a Mortgage on Better Terms
“More favorable terms” is sometimes difficult to define. It can vary based on the financial needs of the borrower. For someone who wants to increase the amount of their mortgage in order to invest the equity in a different property, “better” does not mean a lower monthly payment. The same is true for someone who shortens the term of their mortgage from 30 to 15 years with the goal of being debt-free in retirement. A workable definition of better means that the refinance satisfies the financial motivation for the refinance.
But sometimes defining better is even more complicated than that. The example in the previous paragraph of shortening a mortgage term from 30 to 15 years might not be the best way to eliminate mortgage debt by retirement. Creating a side fund with the difference in payments might be a more effective strategy. This strategy depends on the rate of interest that can be earned and the diligence of saving the difference. The same can be said for deciding if it is beneficial to pay for a lower interest rate.
This last question involves a financial calculation known as the time value of money. The formulas involved are sophisticated, but use interest rates, dollar amounts and periods of time to equate a dollar today with a dollar in the future. Online financial calculators are available along with useful examples to explain key concepts. Often times though, deciding which interest rate to use in the calculation is the hardest part.
More Perks of a Successful Refinance
Setting aside technical questions, achieving a successful refinance also means entering a financial relationship with a lender. Sometimes a successful refinance means the real estate borrower has begun building an important business relationship with a new source of operating capital, such as a hard money lender. The ability to return to that lender in the future may, in and of itself, be considered important and a key measure of success.