I know what I am about to say may be unpopular—even controversial. But I believe that my advice on deciding which lender, or lenders, you will work with will resonate with many experienced investors.
How do I know? Because although I am the co-founder of a lending company, I am also an accomplished investor with hundreds of projects under my belt.
So, here’s my statement: When choosing a lender, their rates should not be an investor’s first consideration. I understand that many people teach this approach, but I strongly disagree. Here is why.
What Could Be More Important Than A Lender’s Rates?
Yes, rates are important, but in terms of priority, I think they should be at number three or lower on your checklist.
If you are looking to be an investor for the long term, you will get farther faster if you:
1. Choose lenders that are also investors
2. Choose lenders with reliable capital
In full disclosure, these points mirror two of the primary marketing aspects of my lending company, but that is not why I am talking about it here.
I am saying it because, as an investor and a lender, with experience in a variety of market conditions, I have seen the major effect that these two criteria can have on an investor’s game plan and their ability to grow. These two things impact individual investors on a much larger scale than the slight differences between lender rates.
To prove my point, I am going to share specific examples of how choosing lenders who understood investing propelled several investors forward rather than holding them back.
I will also explain how counting on a lender, who does not have reliable capital, can stop your project mid-stream and potentially shut you down.
Finally, I will provide a mathematical example to show you how getting the lowest interest rate on a loan is not as important as you might think it is, particularly when viewed in the context of the velocity of money for investors doing multiple projects.
Lenders As Investors
You want a lender who understands your business on a gut level. Why? Because lenders who are entrepreneurial and who understand the real estate space can use both traditional and creative means to help you access capital and grow your portfolio.
These types of lenders see things differently than other lenders, calculate risks and rewards on a more insightful level, and see project pitfalls and potential based on a full range of investing experience, not just numbers on the spreadsheet.
You already know the importance of creating a team with knowledge and experience. Imagine what a game changer it would be if you had a lender who was not just someone you called when you needed money but who was an integral part of your investing team.
Here are a few examples of what that looks like, taken from our own client experiences:
We recently had a developer with over $20 million and 660 stabilized units and apartments. This highly experienced investor wanted to enter a new market, but his bank relationships and other outreaches would not support his effort.
It took lenders who were also investors to understand the potential in the developer’s team and their ability to execute. Because we are also investors, we were willing to learn alongside this client by visiting the market area in person, meeting his team, and seeing his plans. All of this allowed us to get comfortable enough to partner with this developer to make a big move into a growing market that would not have been possible otherwise.
Experienced investors who raise capital also look for higher leverage, and many would gladly pay higher rates to get more leverage. Because lending exposure is higher with an alternative lender versus the bank, and this developer wanted greater leverage to enter the new market so that he could make a larger impact, working with us was advantageous for him.
In another example, we had a borrower who was an extremely seasoned builder with 1,100 stabilized units, who ran into major liquidity issues when construction costs rose, and local municipalities were understaffed and slow to issue permits. Local banks, who held the paper, told the investor they would not refinance him and that he would have to come up with the cash to complete his project.
As investors, we understood that the last thing this builder needed was a lender who was riding him because his loans were coming due. We knew that even the most experienced builders would not have been able to forecast what took place during Covid, and the subsequent supply issues, along with the rapid rise in interest rates. This investor needed a lender who understood how commodity and labor prices were affecting his situation and who could help figure out how he could creatively use what he had already built to get him back into a position where he could keep moving forward.
As lenders and investors, we felt his pain. We were all over this, and together, we got it figured out. Because of the added leverage that alternative lenders can provide, we were able to structure the deal for the investor creatively. We allowed this investor to recover some of the imputed equity he had created thus far in the project and adjusted his construction budget to reflect the new cost of completion. This allowed the investor to continue to buy more real estate while having the correct working capital needed to complete his projects.
If you are a newer investor, having a lender who understands investing on your real estate team is a huge benefit. You want a lender who is willing to sit down with you and go through the nitty gritty of your proforma and co-underwrite your deals alongside you to help determine the viability of your investment.
This is an invaluable service for new investors and a partnership that could mean the difference between you making a great move or a problematic one. If you are not using a lender who is willing to work with you on this level, you get absolutely zero value from what could be one of your most important resources.
Speaking of resources, your lender should also be a full professional investment resource for you—willing to share connections for everything from reputable architects and reliable contractors to trustworthy attorneys, title companies, and real estate agents.
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A lot of investors have just gone with what is easiest in terms of the lowest rate for accessing capital. They treat lenders like commodities and always look for the lowest bid.
But some investors who approach lenders this way and who lack strong, long-term relationships with lenders that have reliable capital are experiencing major project setbacks in our changing market.
Over the past few months, we have had many investors calling us whose lenders have either temporarily stopped their loan draws or who have ducked out on them altogether.
This has happened because some lenders do not have the liquidity to withstand market fluctuations (and others are simply brokers masquerading as lenders). When Wall Street recently stopped buying loans from retail lenders, who loan to real estate investors, lenders who lacked the depth on their own balance sheets to carry their investor’s loans had to temporarily or permanently stop lending. Some lenders even left buyers and sellers at the closing table!
So, especially now, you want lenders who have reliable capital—meaning, they have enough resources to back you if things get even more unpredictable.
In addition to assuring your lenders have reliable capital, find lenders with a full range of loan products. When you want to go from a 1-4 unit multifamily home to a 1-30 unit apartment building, it is important to know that the lender you have put the time into developing a relationship with can get you there.
In practice, most experienced investors have relationships with more than one lender, not to play their interest rates against one another, but because they offer various products for distinct reasons that could be more optimal as you grow. (A lender’s product offerings are largely driven by the amount of capital they have on their balance sheet and the relationship they have with institutional investors.)
Regardless of which lender you choose, treat them not as commodities but as integral parts of your ecosystem. The most successful investors treat their lenders like family—trusted members of their inner circle who have the invaluable knowledge and resources they need to help them get where they want to go.
How Much Do Rates Really Matter?
Don’t misunderstand me. It is not that rates are not important—they are just not the most important thing when choosing a lender, especially when you consider how moving more quickly with non-bank loans can allow you to accomplish more with your money faster.
Here is a mathematical example to show this:
The Deal: Fix and flip project that takes five months to complete.
Purchase Price: $375K
Rehab Cost: $100K
Total Project Cost: $475K
After Repair Value: $575K
LTC (Loan to Cost): Assuming all lenders are lending at 85% LTC*
Loan Amount: $403,750
Bank loan: 7% interest-only loan payment is $2,355/month x 5 months = $11,775.
Alternative loan: 9.5% interest-only loan payment is $3,196/month x 5 months= $15,980.
Cost comparison: Alternative loan costs $841 more/month in interest ($4,205 over 5 months).
The benefit of fast loan closings to the velocity of your money: You can close an alternative loan in three weeks, versus closing a bank loan in two months. For ease of showing this point, everything else being equal, this means that you could theoretically complete two of these same projects in 11.5 months with an alternative loan and two of these projects in 14 months with a bank loan.
Alternative loan profit = $100K/project x 2 = $200K – $8,410 (the additional alternative loan interest versus a bank loan)/11.5 months = $16,660/month
Bank loan profit = $100K/project x 2 = $200K/14 months = $14,286/month
In this scenario, the additional profit you gain by using an alternative loan versus a bank loan, after factoring in the higher alternative loan rate, is $2,374/month.
*The additional benefit of higher leverage: The above example does not take into account the added benefit you gain by getting higher leverage from an alternative lender (85%) versus the typical bank’s leverage (75%). For simplicity in this example, we used an LTC of 85% for both. This is one more factor to consider, as less money out of your pocket means you have more to put down on your next project.
Challenging Long-Held Assumptions In Institutional Lending
The entire landscape of lending is changing.
It is time that we, as both lenders and investors, challenge some of the long-held assumptions of traditional institutional lending systems. One of those assumptions is how investors should be making decisions about which lenders are the most optimal for them to use across a range of scenarios.
Prioritizing your lender choice based more on their investment experience and their reliability of funds, rather than solely on their rates, will give your investments the advantage over the long run.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.