In this episode of the Creating Wealth podcast, Jason Hartman covered different ways to finance properties by taking a deeper look at real estate investment financing. He spoke with lender Aaron about rates today and what’s occurring to affect them, how they’re changing in recent months, and where we can expect rates to go in the future.
The two discussed how higher interest rates don’t always mean that the investment won’t make sense. Higher rates can also mean more tax write-offs and with the tenant paying the debts, a good situation can still develop. There might be a lower visible cash flow, but the property has potential to be a great investment that betters itself over time with a locked-in, fixed interest rate.
Real Estate Investment Financing and the Importance of Home Inspections
Jason Hartman begins the episode stating that lender Aaron is back on the show and is going to be discussing real estate finance for investment properties. He mentions that they’re covering the finer details of real estate investment financing, and he wants to dive into finance topics in depth in the future. Hartman notes that he’s going to begin a series on appraisals, underwriting, financing, and other related topics over time because discussing these topics in-depth would be valuable to listeners and investors.
Before getting into the interview, Hartman mentions that it’s very important to get home inspections on a property before buying it. He notes that this might not be necessary if you’re purchasing a brand-new home from a big builder, but most of the time a home inspection is a benefit. He advises listeners to never purchase a property without a home inspection, because they’re always worth the expense. He encourages listeners to promise that they’re going to require a home inspection and virtually shakes their hands on the deal.
Hartman mentions that there are several great events coming up. The first Northeastern US event is taking place very soon, and a venue is about to be determined either in Washington DC or Philadelphia, Pennsylvania. Another person has joined the Ice Hotel trip by the name of Carmen. The trip is now full and sold out for this year. Hartman notes that maybe in a few years another Ice Hotel trip will take place.
As for tropical events, Hartman explains that he is working on an October event in Hawaii. He notes that while he is not a lawyer or tax professional, listeners might be able to deduct at least some of the trip on their taxes, as the trip is intended to put hours toward professional status.
House Hunting in Austin, TX
Hartman is currently in Austin, Texas during this episode and explains that he is house hunting. He states that the time has come to move to another city and notes that house hunting is a lot harder than buying an income property, which also is not easy, especially when supply is low.
He reminds listeners again to keep an eye out for the series on real estate investment financing that will be coming up in the near future, and for now, Aaron is going to discuss his knowledge on financing and rate hikes.
Fees and Regulations That Impact Them
Hartman introduces Aaron to the episode, a returning guest and lender that spoke at the most recent Jason Hartman University event where he covered different topics on financing. He mentions that financing is challenging, but not as much as it was post-recession. The rates are still pretty low, but they’re set to go up in the near future, so there is a bit of urgency to lock in great fixed rates before they rise too dramatically.
Hartman mentions that our world has changed, and that there used to be a lot of brand new A-class properties available. He notes that some investors want a broader range of properties, with some liking C-class properties. Hartman states that he prefers the A and B-class properties. He mentions that when it comes to closing costs on real estate investment financing, a lot of the fees are flat. When someone purchases a less expensive property, the closing cost ends up being higher as a percentage. If the property is $130,000 or $140,000, then the 4% fees will work.
Aaron notes that if we go back a decade or more, it was very common to see banks put flat fees of $400-$500 on a loan. He recalls seeing $398 in total lender fees and people were complaining about it being high. Then, it started to increase in expense because the overhead jumped quite a bit once Dodd Frank and CFPDs were instituted.
There were increased regulations and it wasn’t only two or three people working on the transaction anymore. A lot more people became involved and Aaron mentions that sometimes there are two to four audits on a transaction both during and after closing. All of that overhead has to be covered so now there are more significant fees, with lenders charging $1,500-$2,000 in some places.
There has also been an increase in appraisal fees because of the way that things have to be appraised today. There is an increase in title fees and taxes are going up across the board, Aaron says. When you stack all that up, it’s an increase in the percentage and an increase in loan sizes below $100,000 because the lower the loan size, the higher the percentage goes up because of the flat fees. That fee is going to cost the same whether the transaction is for $50,000 or $100,000.
The Costs of New Regulations
Hartman mentions something that’s paradoxical that his friends on the left side of politic don’t seem to grasp. When the government gets involved and starts regulating things, there are always consequences, unintended or not. The result of a lot of these regulations to protect the consumer end up costing the consumer more money. The government does the opposite of what they say.
Aaron agrees and states that every time the government creates a new regulation, lenders have to hire someone to ensure that these regulations are met, a compliance person. He notes that he has a stack of them involved and they’re involved from different angles, all different facets of the loan. All of those facets have to be adhered to, and compliance people often adhere to different regulations. When Dodd Frank was being released, it was in segments, Aaron recalls. Some of those segments contradicted other parts of the whole, and with those conflicts, other forms of legal protection were needed in case the conflicts became an issue.
Expected Rates with 20% Down
Hartman mentions that right now, investors can have ten properties per spouse, with 20% down. He states that this could still change, but in the past, the opportunity was for the first four properties with 20% down and the remaining six with 20% down. He clarifies that these are the Fannie Mae and Freddy Mac agency loans that are very desirable and subsidized by the government. They’re great deals if you can get in on them. After the ten properties, there are other creative options.
When it comes to 20% down, the rates today depend on the loan size, Aaron says. It’s common to have rates in the high 5% range. Before the turn of 2017, the rates were in the high 4% range.
Hartman mentions that he was just quoted 5.25% with 20% down today by a company he spoke to. He mentions to listeners that if they’re shopping around online and they’re seeing lower rates, it’s because the listed rates are for owner-occupied properties, and not investment properties. He asks Aaron about potential rates if an applicant has 25% down, mentioning that in his experience, the rate went down to 4.875% in the quote he was given.
Aaron answers that it depends on the individual and what’s being done. He states that he did some loans today that were at 5.5% for some and for 5.25% there needs to be more money spent. He has seen on average, some rates bumping up and 5.75% rates are potentially coming. Th tariffs are sending a ripple through the market and Aaron states that he tries to be a little more conservative about throwing out numbers, but 5.5% is fairly common with a credit score of 740 and above.
Are Adjustable Rates Still Done?
Hartman mentions to listeners that like everything in life, this is complicated. He recalls when he used to think that all FICO scores were the same, but that isn’t true. Car dealers use one model of the FICO score while mortgage companies use a different model. There are also multiple credit bureaus. Lenders look at all three scores and take the middle score from them. He then asks Aaron if adjustable loans are in the market at all for investment properties.
Aaron answers that when it comes to regularly-styled loans, most people stick with the 30-year fixed-rate because the adjustable rate does not seem to be that much better. He notes that if you look back at what happened in the crash, a lot of properties went into foreclosure and a good deal of those were adjustable loans. Because of that mess, there isn’t as much money to lend in the adjustable pools as there used to be.
Hartman states that he loves the 30-year fixed-rate loan, but he adds that there may come a time where he thinks that adjustable loans are not a bad idea. If it happens to where the delta between fixed and adjustable loans are high enough and the choice is to get a low teaser rate for a few years before going adjustable, it might be an idea. He wants to keep an open mind to changes, but states that we’re still in a good fixed market.
Aaron mentions that his company was not always one to explore the 25% down idea like they have recently. Now, there’s a bigger gap between these percentages. He used to be big about the 20% because at one time, the 25% down didn’t improve the rate by much. Now it’s important to look at the transaction closely, as an individual transaction. We can’t blanket it, Aaron says.
The Business Mindset
Hartman agrees that the rate might be low enough with an extra 5% that it’s worth losing a bit of leverage. He asks what Aaron wants people to know about financing and qualifying.
Aaron mentions that it’s important to get into the right mindset. As an investor, you’re no longer a consumer. You’re a business owner looking to expand ownership of your cash-flowing assets. Look at not only the cashflow, but the asset as well. You’re getting someone else to pay down the note or expense and, in a way, you’ve almost got a cash-flowing asset for free. When you get into the right mindset and stop looking at your situation as a consumer, it helps get a grasp on things.
With an interest rate that has gone up in the last few months, Aaron notes that he ran some numbers to understand what he was dealing with. With a 1% differential on a $100,000 investment, if things spiked to where the average rate was 5.75%, we can see that there would be a difference in cashflow of about $594 per year.
He states that this is significant depending on how you look at it. $594 in cashflow change might deter a person from purchasing a property but if they look deeper into it, the interest they write off on their taxes also changes by $800 per year. The cashflow changes but the tax write-off increases.
Hartman adds that investors outsource the obligation to pay the debts to their tenants. The tenant pays the debt and the investor gets the write-off. Part of his “refi til you die” system is to take the money out and not have a lot of cashflow because cashflow is taxable. The idea is to have more income in the portfolio and leverage it with debt. Then, the return is higher, leverage is higher, and debt destruction is higher. Hartman states that he’d hate debt if he had to pay it, but it’s great when someone else pays it.
Aaron agrees that debt is terrible when you have to pay it and he notices that so many people have been tied up in debt over the years that they deduce debt as something terrible. Getting out of that mindset is tough. Now, consumer debt is going through the roof. In 2017 as a whole, people started trading personal savings for debt.
Aaron explains that debt has gone up significantly, which is why there was end-of-the-year data saying that personal expenditures were going up. People were spending more money on goods but when you look at their savings, it was dropping significantly. 5.5% of a person’s income was being saved in the second quarter of 2017 and only 2.4% was saved at the end of the year.
Lock in 30-Year Fixed-Rates When Possible
Aaron mentions that we need to keep in mind that as things inflate, interest rates suffer. It’s important to look at this from the right perspective, though. You might not see the cashflow into your pocket every month, but what you’re able to do with your taxes brings your money back in a different form.
Hartman adds that bond markets and interest rates are opposite, and they swing in opposite directions. If bond investors think they have inflation risks, the capital flees.
He reminds listeners to remember that as an investor, you’re not in the for-sale market necessarily, you’re mostly in the yield or rental market. You see more upward pressure on those rents so it’s wise to lock in as many cheap 30-year fixed-rates as you can. Buy and wait. Don’t wait to buy.