By Douglas Katz – 08/15/2022
Much of the investment lending world is unregulated with little or no certification, regulation or licensing requirements.
There exists very little consumer protection for borrowers using many programs designed specifically for investment real estate.
A price myopia can cause you to miss warning signs or positive aspects of potential lender.
I got into lending in the early 2000’s and, at that time, it was a much different market than you see today. It was regulated but somewhat weakly so and there were little to no requirements for training, certification and licensing for the originators. While good companies had policies and procedures to uphold a standard, many did not. We all know what this led to in 2008 and this fast and loose approach was one contributing factor. Criminals, scammers and just plain unethical business people gravitate to where risk is low and profitability is high. We learned a lot from the crash and the residential lending market is much different with licensing and regulatory requirements that help ensure fairness and client experience while protecting them from unsavory characters. Today, however, there is lending outside of this space focused on financing investors interested in renovating, flipping and/or renting investment properties. Because these generally exist outside of the regulatory umbrella for primary residences and second homes, the market is much different. It is much more like the residential market prior to 2008 and the same dangers exist for those seeking finance for a flip or new rental deal.
To help you understand the landscape, let me provide a bit more color. The investment real estate lending market has always been a part of the market, but, as the residential market tightened up with requirements for mortgages and significant customer protections under these new requirements, these was a shift. Basically, any residential loan where the client could live in the house fell under the aforementioned rules. Homes and properties purchased specifically for investment could under some circumstances avoid these protections when the client agrees to not occupy the home before the either sell or refinance. When the property is clearly categorized as an investment property, the entire situation changes. Under these loans, the borrower gets less protection, the lender has no licensing or training requirement, the loan has no caps on rates and costs, etc. Let me be clear that this is a major oversimplification, but it hopefully makes the point. These loans are a bit easier to get, but as you can see the peril is real for mistakes and/or the opportunity to be serviced by an unethical or incompetent lender.
Here are some tips that I can offer you if you are considering financing some investment real estate:
- EXPERIENCE MATTERS – I think that it is safe to say that in almost everything that you do to fill a specialized need that you value experience. Any professional from a home contractor to a doctor learns from what they do and when you need a job done, you want someone who has the breadth of experience to do it right at a fair price. Somehow, when it comes to lending, people forget or ignore this. They focus on the price and terms. I will talk about these later in greater detail but in many ways it comes down to experience. Financing real estate is a simple process but it is far from easy. It is my recommendation that you look at the lender before you pull the trigger.
- How long have they been in the business?
- How long have they been doing focused investment real estate lending?
- Do they have a digital footprint that supports this experience, i.e. LinkedIn, Website, etc.?
- If they recently moved to this world, what did they do before and were they successful at it?
- ETHICAL BEHAVIOR DEFINITELY MATTERS T– This touches on some of the same aspects but this is more about the person and not the lender. Although there are many exceptional people in this part of the lending industry, there are a lot scammers and crooks. Remember this is the unregulated world of lending and, as a result, there are little to no consumer protections. A business with little to no barriers to entry where you can charge what you want and make a lot of money and not be vulnerable to regulatory measures to prevent unethical behavior draws opportunistic criminals. It is just part of reality, but you are not helpless unless you choose to be.
- Look at the lenders resume and background. Does he/she even have an accessible one and if not why?
- Look at what type of persona they project. Is there messaging about your success or theirs?
- What are their interests and activities outside work? Are they involved in charitable and other organizations?
- Would you lend them your money? This one is important because if you would not trust them in that capacity, why would you trust them to deliver for you.
- DOCUMENT EVERYTHING – This one is important because unlike the typical residential loan, there is little to no consistency from lender to lender for documents and communication. This is not a problem, but it is essential that you both understand and are OK with the way the transaction will go. Things change on these deal way more than in the residential world and not because someone is trying to scam you. A good lender will keep you up-to-speed, explain why the change happened and ensure you fully grasp the impact. You will likely sign an agreement in the beginning especially with a broker. Ensure that you understand under what circumstances you pay them and what they are agreeing to. I actually had a very experienced client recently recount to me the story of another lender who charged him a fee for a deal that did not close. This was stated in the agreement so he had no recourse, but he should have killed the deal in the beginning.
- PRICING IS NOT THE ONLY THING – Price is important, but not exclusively so. This is a bit redundant as the reasons for full evaluation of the lender and the deal should be very apparent now, but it is worth remembering that in a world with very little consumer protection, the bait-and-switch is alive and well. If you are conspicuously price driven you will be a target for the lender who sells you on price only to change to deal later. Documentation helps, but it is always better to avoid these traps from the start. As an investor you rarely use the low cost provider for anything else on your project, why would you do it on lending. That is not to say that sometimes the cheapest may be the best, but make sure before pulling the trigger.
- HAVE REASONABLE EXPECTATION THAT MATCH YOUR SCENARIO – It goes without saying that you should have attainable expectations of a lender, but sometimes the market, ego or other factors work against this. A good lender will take the time to fully articulate the expectations and risks with any deal. Sure, some things cannot be anticipated but many can (SEE BULLET ONE ON EXPERIENCE). They should also communicate was is expected of you. Meeting your expectations is a team effort and good lenders reiterate this and clearly put you on the path to success.
In the end this is not rocket science, but it does take some effort. The human trait of homogenizing the options for simplicity of comparison can and will if you. You will go into a deal unprepared and vulnerable. It takes a little time and effort but protecting your hard earned dollars is the key to the right execution on your deals and projects. This is your deal and you must choose wisely and deliberately but if you follow my advice, you will able to correctly focus on what is important – building and growing your business.