The finance industry has pretty much returned to normal, but that “normal” was different from the normal of yesteryear of 2006. Income property buyers who wish to use the finance industry need to alter how they choose properties to invest in, and how they manage those they own or buy. There is enough material about this to fill a skinny book, but here are some highlights:
1) Investors need to stay more liquid; they need to habitually keep more cash on hand in bank/brokerage accounts or in short-term liquid investments (cash equivalents). Underwriters shy away from those not in the habit of keeping cash on hand for the unexpected. If something goes wrong with a property or an investment or in some other part of personal or business life, investor is expected to be able to cover it without impacting the ability of the properties to perform. Performing means keeping loan payments, taxes and insurance paid up, while still maintaining the condition of all properties in the portfolio.
Some un-liquid investors ended up not able to pay the expenses of making vacant apartments rent-ready, or paying for commercial lease commissions or tenant improvements for a new commercial tenant. Many properties ended up with deferred maintenance, and unrentable spaces. One apartment property I toured had two apartments burned to the ground, the ashen remains having sat right there untouched for 12 years. Underwriters specifically look for situations that could end up this way, and turn them down.
A good liquidity guide to use is to keep cash as follows:
Six months of PITI payments for all properties
Cash account with $250.00 per apartment per year (2% of gross rents for commercial property) for future capital expenditures
Cash account with $500 per apartment per year (varies for commercial property) for regular repairs, maintenance, cleaning, painting and decorating (pay those bills from that account)
For commercial properties, 2% pr gross rents or more in an account to cover lease commissions and tenant improvements for when tenant turnover happens.
Some underwriters simply look for cash reserves totaling 10% of total portfolio debt load. Cash can be stored in investment-grade short-term securities, called cash equivalents
2) Keep a conservative LTV on each property, and on the entire investment portfolio. Many investors seek to maximize leverage to maximize earnings, but that strategy eventually reaches around to bite when something goes wrong. Low LTV results in higher cash flows, and higher cash flows can help solve problems when they occur. Now that Sears and K-Mart are choosing 100 stores to close, those landlords with low portfolio LTVs will be in the best position to deal with the loss of a major tenant. Those with high LTVs will be more likely to get into expensive trouble.
3) Be cautious in choosing tenants. Apartment owners should be selecting tenants with stable lifestyles, stable income source, and cash in the bank to weather a difficulty or two while still paying the rent on time. Commercial property owners need to choose tenants in good financial condition, and to get into the habit of obtaining tenant financials. One should be cognizant of the difficulties certain tenants bring… a loan broker recently brought me a three-tenant strip with a big-name convenience store, a dry cleaner, and a tattoo shop. The convenience store was a valuable tenant, but the dry cleaner brings environmental problems and the tattoo parlor image-risk problems that many commercial loan underwriters will take a pass on. Investors should not make the blanket assumption that lenders will lend on just anything and everything.
4) Investors are requested to include a real estate finance loan officer in his/her advisory team. An investor used to consult with the city planning commission, a real estate broker, a real estate attorney, and a CPA or tax preparer while planning an investment. Difficulties ensued when he/she could not get the chosen property or project financed. Today, it is best to include the real estate loan officer with appropriate background and company resources on the advisory team, because the finance industry cannot be taken for granted.
It used to be that bankers ran banks. Now, regulators run banks. When loans get done, they have to be able to pass regulatory review. Thus, it’s incumbent upon the investor who wants to use financing to deliver a situation, circumstance, and package to a lender that can actually be lent upon. In today’s world, this calls for an appropriate financing professional to be in an advisory position.
There is tons of money sitting in institutional treasuries looking for something to do. There is no shortage of cash for doable loans. Real estate loan professionals have to do twice or more the work as before to get things done and funded. When one of us makes yet another ridiculous nonsensical request for information or whatever, please don’t blame us. We would rather do less work, not more. We are preparing the file for eventual regulatory scrutiny, and this is what it takes. Mark my words though… this effort will make for a safer loan industry and banking system, and the world-wide financial damage that began here in the US will not likely recur in the future.
If the lending industry had been run to the same standards as the airline industry, we would have had just one bad loan in this country in the past four years. Flying is all about selecting risks to take on, then managing those chosen, just like investing and lending. But, that’s another blog entry.
Thanks for tuning in, and blessings to all!