Declined Again? Don’t Give Up!

It’s been two weeks since your lender told you: “Your loan approval is coming any day now”. Guess what – you have a problem!

Yet you were told your credit score is acceptable, your debt-to-income ratio is comfortably below 43%, and your savings will satisfy the down payment, reserve and closing cost requirements…

Well, unfortunately it didn’t register with your lending officer that you are renting the home you are buying, and that in lieu of rent you are paying for utilities and capital improvements (plus you paid cash for almost all of your housing expenses, and do not have much of a checking account paper trail). And, by the way, the landlord is in default with her lender who is about to foreclose on the home you want to purchase! [Yes, this is a real example]

Without proper explanation, the ultimate buyer of your loan (Fannie Mae) would most definitely conclude that you do not have an arm’s length or independent relationship with your landlord. More importantly, this loan will require too much effort for most lenders, especially if you do not have an established working relationship with them.

By: (i) properly and clearly documenting your receipts, (ii) demonstrating the legality and reasonability of your tenancy, (iii) evidencing proof of your residency, and (iv) ensuring you have an adequate letter of explanation acknowledged by yourself and your landlord, you should be able to get the loan – and avoid having to move your family elsewhere.

Don’t Put All Your Eggs in the Stock Market Basket

(Thanks for putting up with my Easter pun.)  As a real estate investor, it’s time for a “feel good” reminder:

Commercial Real Estate (CRE) represents an attractive asset class.

Here are a few of the obvious reasons for some reinforcement:

– Inflation Protection (with contractual rent increases, CRE can offer the perfect inflationary hedge

– Long-Term Capital Appreciation (according to the National Council of Real Estate Investment Fiduciaries or NCREIF, CRE returns have outperformed the S&P 500 since the late 1970’s – ignoring the correction of property values in 2008-09)

– Low Return Volatility (CRE can lead to more predictable, recurring cash flows – especially well-located properties having a stable roll-over schedule of creditworthy tenants on longer-term leases)

– Diversification (CRE returns generally have a low correlation to stock and bond returns)

And for those of you who just can’t stay out of the stock market… Although 2013 was an exceptional year for the S&P 500 (32.7% return), equity REIT’s in 2014 are likely to outperform last year’s abysmal 2.7% return.  The threat of interest rate increases weighed heavily on the REIT sector in 2013, but these returns should improve with the focus now leaning on company earnings – which should lead to additional demand for space in markets with limited supply.

Take Your Time

USA Today recently published an article on the “continued housing recovery”, written by a journalist from the Des Moines Register.

The excitement started when Wells Fargo Home Mortgage announced they were building a complex in Des Moines for 1,800 employees. Wells has increased headcount by 18% over the past year because, as their senior economist stated: “…more people are interested in selling their house to buy larger ones.” The optimism was apparently fueled by the Fed’s commitment to keep interest rates low, which one Iowan banker in the article said has given people more confidence because “…everyone agrees we won’t see the unemployment rate coming down anytime soon.”

Pardon?! Sounds like illogical conjecture to me. People don’t build confidence and buy larger homes when they are out of a job. News of the unemployment rate dipping below 8% was welcomed, but the unemployment rate has been less than 6% on average over the past 30 years. Yes, loan delinquencies are at their lowest level in four years – but such delinquencies are still over 5% of banks’ portfolios (versus under 2% well before the housing crisis).

Don’t rush to buy a bigger house and lock in a bunch of debt right now just because rates are low. With the QE stimulus ending and people still out of jobs (while banks continue to unload their foreclosed product), and with taxes going up and the federal debt continuing to rise… there is still time before the other shoe drops.

Developing to a 6% Cap?

Sounds crazy doesn’t it?

It wasn’t that long ago when a 10% cap rate was the norm. If you couldn’t achieve a 10% unlevered NOI return on investment, it didn’t make sense to pursue an acquisition. But remember, that was for a cash-flowing stable income property asset. Not only are industry professionals today interested in acquisitions well below that old 10% threshold, there are veterans (even after having been through at least two real estate cycles) who are rolling-up their sleeves to make a development deal work at that low 6% level – without “blinking an eye” to the associated development, interest rate and market risks.

Well, as crazy as that sounds, the old principle of making sure a 2%+ spread exists between the cap rate and interest rate indeed holds true today under a 6% cap rate threshold. And, it doesn’t appear that commercial borrowing rates are positioned to sky-rocket (who would have thought that U.S. dollar LIBOR would reduce to 0.20%). But the more prudent way to underwrite these deals is by focusing on unlevered and levered IRR’s, using conservative assumptions. The latter measurement is down from the old 20%+ days, but something less than 15% today is still risky. If you can make it work at that level (ensuring a more reasonable return on cost margin), you would be well-advised to build and sell quickly so that you yield a reasonable developer’s profit – that is, before LIBOR starts moving north or your tenant leaves.

Start blinking your eyes.