Debt is always a tricky thing in real estate and the recent market has made it even more important to get it right on each deal. Over the past 18 months, we've seen deals that have some extra cushion become razor thin because of changes in the debt market. This has caused us to reflect on our previous underwriting practices when it comes to getting debt for a project. So how exactly do we go about getting debt in today's ever-changing market?
Find an Awesome Mortgage Broker
Often our first step is to contact our preferred mortgage broker with some initial details to see if the project is something they believe they can find a lender for. A good mortgage broker will have a deep pocket of contacts that he can get your project in front of to find the best option. Anything from large institutional lenders like life insurance companies to smaller local credit unions. The broker will collect all the necessary info from you that they need to get terms for your proposed loan. They make the process easy because they interact with several banks for you so you don't need to worry about juggling all the different lenders.
Build a Pro Forma to Analyze Options
After getting quotes from different lenders your mortgage broker will present the basic terms from each to you. Usually includes interest rate, term, amortization, prepayment penalties, and lender fees. Often the details will seem very similar on the proposed options but, we have found that the small changes between lenders can make a massive difference in the project as a whole. In the past, we had just modeled to see the difference in rate and term and gut-checked the other pieces of the loan options. We would look at the lender fees and prepayment penalties without really diving into the numbers. We changed that a while back and it has made a massive difference on some deals. As an example, we saw a lender that was offering a lower interest rate but had a big prepayment penalty if we paid off the loan in the first year. At first glance, the higher rate seemed like the easy choice because we were expecting to exit the property in a little under a year and didn't want to deal with the massive prepayment penalty. When we dove into the numbers however we found that our IRR on the project was about 5% higher if we got the lower rate and held the property longer than 12 months to avoid the penalty. We have found many similar stories like this that fully modeling out the options can give a much clearer picture of which lender is going to be the best choice for your project.
Discuss with your Mortgage Broker
After looking over all the options go back to your mortgage broker and give them your thoughts on the presented options. Remember terms provided to the broker are not the final say in the loan. If you have two options that are close with some slight differences your mortgage broker can go back to those lenders, tell them they are in the running, and try and negotiate out some of the issues you have with their presented offer. We have had multiple loans where our broker has pushed back on the lender to change their prepayment penalty structure to something that we feel more comfortable with. Remember it can't hurt to just ask for these little modifications but, those little changes can move a deal drastically.
Work Towards Closing
At this point, you should have an option that fits your project and your development timeline. The next steps are to provide your broker with more concrete details about the project as the lender will need to do their underwriting of the project to provide the firm term commitment and generate loan docs. A good mortgage broker will do all the communicating between you and the lender. They will provide a list of things the lender needs and push the whole transaction forward to meet closing deadlines.
We are living through a wild time in the real estate world right now. Rates have been ticking up and changing rapidly. The higher rates make finding the right lender for your project much more important than it was previously. Take your time and go over your options in-depth. Never underestimate the power of diving into the numbers and having a really good mortgage broker on your side!
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