By Chris Moreno, CEO and Founder of GoKapital – a business and real estate lending marketplace.
Whether you’re applying for a loan for purchasing or refinancing your real estate investment property, the two most common options are through conventional financial institutions (banks, credit unions, etc.) or private mortgages (with funds being provided by individuals or non-bank lending firms). Both choices have their own advantages and disadvantages. That said, within these two sources of property financing, there are also different types of real estate loans for either commercial or residential investment properties.
In a general sense, a conventional real estate loan will offer competitive rates and a lower down payment. There is a caveat, however. The required qualification criteria will tend to be more stringent, and the approval process will be lengthier (1-3 months). Private property lenders, on the other hand, will often be more flexible in terms of approving potential borrowers. To mitigate this risk, their rates and down payment requirements will usually be higher. Under either scenario, the primary factors taken into account include: your credit history/score, investment experience, asset characteristics, and cash-flow. The ultimate goal for a lender is to determine whether a borrower can demonstrate a capacity for the repayment of a loan.
Types of Real Estate Investment Loans
Conventional real estate loans are most often offered by banks and credit unions. They are the most common types of mortgages in America and have varying loan structures depending on your needs. For example, they may offer fixed-rate loans for 30 years (meaning that the interest does not change throughout the duration of the loan) or what is known as an adjustable-rate mortgage (ARM) which will adjust according to market conditions after a predetermined amount of time (every 6 months for example). Fixed-rate mortgage loans will usually be offered with terms of 15, 20, and 30 years. Given current market conditions, conventional mortgages for investment properties currently have rates ranging from 7% to 9%. Advantages do include lower down payments and lower closing costs. These types of loans are ideal for potential borrowers with a strong credit history, solid financials, and ample time for a transaction to be finalized (over a month). It’s also worth keeping in mind, that rates for conventional loans will be higher for investment properties than for primary residential properties.
Private Mortgages/Hard Money Loans:
Private lenders do not have the same level of requirements as conventional lenders – they are more flexible and have a faster, simpler approval process. With these benefits, however, there are other aspects to consider. Hard money lenders mitigate the risk of providing financing with minimal documentation to borrowers having less-than-ideal credit history by assessing higher interest rates, shorter loan terms, and higher closing costs. These private/hard money loans are offered by non-bank financial institutions, individuals, or even the seller of a property (known as “seller-financing”). Most hard money loans will be structured with the borrower being a corporate entity – typically a Limited Liability Corporation (“LLC”), to expedite the foreclosure process in the event of a default.
Types of Real Estate Investment Properties
Residential and Commercial Real Estate
Another important aspect of real estate lending is the type of asset class being used as collateral – whether it’s residential or commercial. Overall, residential investment properties are more commonly purchased, resulting in relatively stable demand. These property types will have 1 to 4 units and include single family residences or apartments. Once purchased, an investor will either renovate the property and sell it for an increased amount (known as a “fix and flip”) and generate a profit, or the property may be rented out to tenants and produce monthly income. In the case of a “fix and flip” loan, loan terms are usually 1 to 3 years, with payments consisting of only interest (principal is paid back once the property is presumably sold). For rental investment properties, terms are typically fully amortized with terms up to 30 years. Typically, residential properties will also have lower prices than commercial ones and thus may be a better option for new investors.
Commercial real estate includes warehouses, retail stores, office buildings, industrial properties, hotels, multi-unit buildings, and more. These property types will usually have higher market values than residential properties, depending on the location. As an example, if we were to compare properties in Miami, FL, such as a 3-bedroom home and an office building with several units, the latter would most certainly have a higher value. In addition to requiring a larger financial investment, finding the ideal commercial real estate lender is another important aspect of structuring the transaction, as some lenders may be restricted from providing financing to certain commercial properties. While these property types may be slightly more complex in terms of obtaining a loan, there are several benefits. In terms of generating passive income, commercial real estate investing generally produces a more stable stream of income (since commercial leases tend to be 3 years or longer). When evaluating the economic feasibility of a commercial real estate transaction, there can be more metrics to evaluate when compared to residential properties. The importance of conducting proper due diligence to analyze the property’s income, expenses, and net operating income are vital in ensuring your investment is a profitable one. If you need quick capital or unqualified for bank financing, a private bridge loan may be the better option. Conversely, if the commercial property is financially sound, as is the borrower, a conventional loan would likely be the ideal choice.