By Douglas Katz – 12/17/2022
Real estate investment is bigger than ever and with it comes the need for financing. What has changed from many past cycles is the more substantial array of lending options available to current and prospective investors. Granted there has always been and still are the traditional conventional options available but those are often fraught with bureaucracy, restrictive guidelines and regulatory challenges. Enter the non-conventional programs which are also referred to by a host of other names, but basically means programs outside of the conventional space specifically designed for investors with more flexibility and less regulatory issues.
These programs are not without their requirements and guidelines, so this is not the old have a pulse get approved environment. The guidelines are heavily focused on the individual and, while not in manner conventional loans do, they have their own hurdles that prospective investors should know of ahead of time and plan for. The one that borrowers seem unaware of is the need for experience. By experience, lenders want to see documented, verifiable and relevant experience. Believe it or not, experience is one of the highest determinants of whether a loan will perform, especially in the investment space where there are much more lessons to learn than in the residential world.
In the mind of a lender, experience is any renovation project, either for flipping or holding, that you have done in the past as well as any rental properties that you have owned in the last 12-months. This will generally need to be your own experience or that of anyone borrowing with you or who is part of the borrowing entity. I get a lot of clients who try to equate experience as a sub-contractor or non-documented partner to experience to provide the lender. This is usually an issue with newer investors and actually shines a clarifying light on why lenders do this. They want to know that you had actual skin in the game for the project or property. While generally requiring records, closing documents and tax returns, lenders will sometimes accept non-standard documentation, but the situation and the narrative need to make sense. Additionally, some lenders will take real estate industry or other relevant non-specific property related experience as a compensating factor, but not as a substitute for the aforementioned experience.
Now that you hopefully understand the general requirements, it is essential for you to understand that the answer to the experience question will have an impact on everything from underwriting to pricing. Many lenders will categorize their clients in tiers based on their experience with each a set of allowable loan sizes, loans-to-value, rates and project types, especially new construction. The ability to reach a tier will depend on what experience you can provide and document. This is why it is so important to plan ahead and to properly build your file and narrative prior to applying. More often than not, borrowers come to me right before or right after they have signed a contract and they are trying to get the deal financed. It is also not uncommon for these deals to have a short close where there is no time to forensically build a file.
So my advice is actually pretty darn similar to the advice that I give my residential clients – plan ahead. This means several things. First and foremost, speak to a lender early and get “pre-approved.” I put it in quotes because the process and the documentation that you will get will differ from that which you would see in a residential deal. This process is hands down the best way to determine your borrowing capabilities now and what you need to do to enhance your file. Secondly, I recommend assembling a full file based on the lender guidance. Too often, I have clients who walk away for an initial consultation with an “I can get that” attitude about the documentation and they wait. When the time comes to provide it, they find out it is insufficient or that more is needed and it kills the deal.
This is by no means the deep dive that I recommend investors take in all aspects of obtaining leverage, but it is a huge and important start. As you can see, experience can make or break a deal. I should clarify that this requirement is usually only for renovation loans, so rental property loans will have not weight experience as heavily or at all. Since, however, it is not uncommon for a rental property acquisition to need to some work, it can still impact investors focused on income properties, especially the BRRRR proponents who may be reading this. And, of course, do not forget to update your experience as it increases. This is, in a sense, your investment real estate resume and if you want funding, keeping it current and well documented is key.