June 22, 2006
Real Estate — Financing For Investors
For decades the way to finance a property purchase was 80-20, 20 percent down, 80 percent on loan. Certainly, there have been many who put more down, but 20 percent was considered the bare minimum. Happily, things have changed.
While it's nice to invest less for the same property, the downside is not limited to the higher interest rate on the second mortgage loan. Since the buyer doesn't meet the standard 20 percent minimum, lenders almost always require PMI (private mortgage insurance). Fees are usually hefty.
Though it's theoretically possible to have the lender remove the PMI requirement after enough payments have been made it rarely happens. In theory, once the loan(s) have been paid down so that the LTV (loan-to-value ratio) is at 80 percent — usually by a combination of paying down the second mortgage and appreciation of the value of the property — the lender will be willing to consider removing the PMI cost from monthly payments. Most often, before that happens, the loan is refinanced or the property sold.
The ambitious can find other sources of financing. When considering property in a new development, such as a planned community or new housing tract, manufacturers will often be willing to fund a home loan for early buyers. Such loans are frequently available at only 5 percent of the purchase price.
For the really daring it's possible to 'buy' a property, then sell it, without ever owning it — at least not for long. It's possible to buy a property, establish a contract, and then sell the contract for anywhere from $500-$5,000 without ever taking possession or even being on the title. Profits are usually smaller, but obtained quicker, though deals require excellent credit.
'Sub2' deals are another form of creative financing. The typical 'subject-to' deal involves having a seller deed you the property while leaving the existing mortgage in place. You never legally assume the loan, but simply start making the payments. There are lots of variations on this new way of buying property. Not recommended for the beginner.
You can finance a property investment by forming a limited partnership. Arrangements cover the spectrum. In some, each partner puts up some percentage of the cost, usually half and half, but sometimes profit is apportioned according the original percent invested. In some cases, it's possible for one partner to invest money, while the other(s) performs services —— such as repairs on a 'fixer-upper'. The deals are as varied as people.
For those with low incomes, or military service, or other special circumstances various government loan programs are available — though they're usually limited to individuals intending to occupy the property.
It's even possible to fund a property purchase with credit cards, but there are several obvious downsides to this method. Apart from the substantially higher interest rates, lenders look at all outstanding debt when judging whether to grant a loan on the remaining balance. Taking out a cash advance to cover a shortfall between the needed 5-20 percent down will usually get you turned down.
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Friends, family, and other sources of money are usually viewed the same way, unless you can prove to the bank that the money is a gift and not just a loan. Mortgage lenders have seen it all! Don't try to fool them.
Posted by RealEstate at 11:18 AM | Comments (0)
May 26, 2006
Real Estate Financial Instruments
Real Estate —— Property or Paper?
Appraisals and inspections, marketing, renters, rehabs... it can all add up to a huge headache. But real estate investing is still exciting and lucrative. What to do? Consider investing in real estate-based financial instruments instead.
There are Equity REITS which invest in and own properties. Revenues come primarily from rents. Mortgage REITs deal in investment and ownership of mortgages rather than property with revenue coming mainly from interest on the loans. Hybrid REITs do both.
Keep in mind, however, that REITs are closed-end — mutual funds that have a specific number of shares for sale and once sold can't be redeemed through the fund. They have to be bought and sold to other investors as you would corporate stock, through a broker.
REITs are required to pay out at least 90% of their taxable profits as dividends to shareholders, so they can be relatively high yield. In terms of total return — dividends plus price appreciation — they're similar to small-cap stocks, with on average two-thirds of the return coming from dividends. They're therefore sensitive to interest rate changes. As interest rates increase REIT prices tend to decline.
MBS
MBS (Mortgage-Backed Securities) are a type of bond in which the paper is backed by a pool of mortgage loans. In the U.S. lenders make about $2.8 trillion in such loans annually with about 80% being covered by mortgage-backed securities.
Investors in mortgage securities earn a coupon rate of interest, like other kinds of bonds. But in contrast to other bonds, they receive repayments of the principle in increments over the life of the security, as the underlying mortgage loans are paid off, rather than on one large payment at maturity.
One of the advantages, one which lends the security some stability, is the statistical effect of pooling loans. No single or small number of loans that pre-pay or default wipes out the investor's entire investment.
But pre-payment of mortgages does occur for a certain percentage and that introduces some risk. The investor isn't aware of or interested in which loans pre-pay, but the fact that some do causes them to be sensitive to interest rate changes, one of the major influences in pre-pay rate. If borrowers took mortgages at 8% and rates drop to 5% a certain number are going to re-finance, causing the original to pay off early.
So, if interest rates are likely to fall, it's best to avoid pre-payable MBS. Closed MBS are, in that scenario, a better alternative.
There are specialized instruments like CMOs — collateralized mortgage obligations — and REMICs — Real Estate Mortgage Investment Conduits with similar behavior and risks. ETFs — Fixed Income Exchange-Traded Funds, too, sometimes are supported by underlying mortgage-backed securities and trade on the major stock exchanges. They're designed to track the performance of specific bond indexes, which track performance of an underlying bond market, such as MBS.
SELF-DIRECTED IRAs
You can even set up an individual IRA (Individual Retirement Account) that allows you to add assets in the form of raw land, single-family homes, apartments and other commercial buildings, rather than straight cash inputs. This allows you to take advantage of your knowledge of real estate, while avoiding some of the downside of actual property management.
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Whichever instrument you choose, and there are many others, be sure to do your homework and get the advice of a financial professional before investing large amounts. The sharks can always smell fresh blood in the water.
Posted by RealEstate at 11:30 PM | Comments (0)
