Financing 1-4 Unit Rental Properties - EP13

build-to-rent conventional loans financing a project lending multifamily multifamily financing real estate financing Nov 16, 2021

"The mortgage industry is never quick to adapt to something that significant. Especially when the name of the game in finance is a paper trail. If you're going to come in and put 25% down, we need to make sure that was legit. And that you are not borrowing and therefore we can calculate a true debt to income ratio because if we can't paper trail that money, we must assume you borrowed it." - Lane Aldrich, First Colony Mortgage

Lane Aldrich joins the Build-to-Rent Podcast to discuss some of the following...

  • 10-loan limits for long-term conventional financing.

  • Self-employment & tips for helping a spouse qualify for real estate financing.

  • Owner-occupied loans vs rental properties.

  • Example: Getting a loan on a new-build fourplex.

  • How does buying multifamily affect your debt-to-income ratio?

  • Qualifying as a 1099 employee.

  • Lenders and Cryptocurrency.

Steve Olson: Welcome to the Build-to-Rent Podcast. Steve Olson here, along with Sherida Zenger and our guest host, Lane Aldrich of First Colony Mortgage.

Lane gave us some great information on the macro environment for conventional financing in the last episode. We went into a high level, so check that episode out. The one before this one, if you want to see what he thinks about interest rates and qualifying for these kinds of loans, and are they going to be around? That's always a question.

When we talk about this kind of financing, and to clarify for everybody, one-to-four-unit conventional financing, if you're trying to build and rent a 50 unit townhouse project, this probably isn't for you. However, if you're going to build that and eventually sell it, how you plan it and how you understand the ability to get financing does matter.

In fact, Sherida, we're coming up against that on one of our projects. We won't give specifics here because we've got to figure out the details where we might be forced to use commercial financing that affects the long-term liquidity a little bit. Does it not?

Sherida Zenger: Yeah, absolutely. How they're going to qualify for it. That'll be a fun one.

Steve Olson: We like fun ones.

Lane is here and we want to ask Lane some questions. Let's say you are a dentist, and you live somewhere in Missouri. And you want to build a fourplex, right? Was that random enough? A dentist in Missouri... Sherida is acting like it's not random enough. We're going to say a pharmacist in Tennessee. Are you happy now? Yeah. Okay.

A pharmacist in Tennessee and there's a couple of lots around the corner from your house. You want to build some fourplexes on these. You think that would be a very good idea.

Well, let's talk about what that means. And I have a couple of questions for lane and I'm sure that Sheridan. As well, but lane, the biggest thing to tell us about...

What's this whole 10 loan limit thing, what is it?

Lane Aldrich: It's a limit of 10 loans. Believe it or not. It's a Fannie Mae Freddie Mac.

 The best type of financing you can get in the one to four spaces is the type of financing that I specialize in just because you've got 30-year amortization, fixed rates. The qualifying is more standardized.

And if you're working with a professional, you can typically make it a pretty smooth experience.

They set their limits, not off of a dollar amount that you can borrow. It really comes down to the number of properties that they allow you to borrow against in your name. And what qualifies as that as any one-to-four-unit property, where your name is on the note personally.

And once you have up to 10 of those properties, Fannie Mae and Freddie Mac have said, you're done with us. Congratulations for building your portfolio. You have now graduated on to other commercial outlets that may or may not have as good of terms, but you need to start borrowing as an entity.

At this point. Now you can have multiple loans on the same property and that still counts as one. For example, some people have a mortgage on their primary residence and a home equity line behind it that still counts as one. It's not loan counts. And it doesn't matter, what the balance of the loans is.

You could have 10, $100,000 loans or 10, $1 million loans, um, that, that is not scrutinized as part of that process, but that's when, when people refer to the 10-loan limit, that's specifically what it boils down to.

Sherida Zenger: Now, what if I want 10 loans in my husband wants 10 loans. Can we do that?

Lane Aldrich: The answer is yes. This is something that I'll typically bring up with clients that I know want to get aggressive with building their portfolio, meaning that they've, they've got the funds for the down payment requirements, and I can see that they want to get aggressive and tap into this financing.

Where if, if you were to do that, you would want to make sure that you and your spouse were on the loan separately because when you co-sign on loans together and you have more than 10 loans between the two of you, that loan can help.

If you have five in your name and your husband has five in his name, you were already at 10. You would want to qualify for these loans individually. And, um, there's a strategy for that. We want to sit down. Income has to be in line because the debt-to-income ratio is that the name of the game when it comes to this type of financing.

The individual would need to be employed, have a great credit score, but, uh, but absolutely that's a process I've worked out with numerous clients over the years to help grow a very, very healthy, large portfolio.

Steve Olson: We were on a trip last week; we went down to Phoenix to check on some of the build-to-rent projects that we're working on down there.

And I asked Lane because I try to buy a fourplex or two every year for myself, specifically taking advantage of this kind of financing. I've got other things going on outside of that, but it's just such a good long-term investment... that true 30- year fixed mortgage. If you make your payment every month, nobody's bothering you.

That's not the case with commercials. We can do that on another episode, but I looked at you and I said, lane, I've been qualifying for these loans all by myself. I'm getting close to 10. I think. I can't go much longer. My wife has zero loans in her name. Now she helps me run our business. She's very much a part of it.

I said, Can I make it official, and employ my wife because I get paid through an S-corporation, which can have employees, and then she can have the documentation necessary. That a lender says, oh yeah, you make money. I'm going to give you a loan. So, what do you see on that? When, when spouses need to qualify, especially when there's some self-employment in the house, what are some tips and tricks on that?

Lane Aldrich: Sure. The term self-employment is very broad and a lot of these situations, but doable. Um, it really comes down to an individual, has to show that they have a two-year work history. That to your work history does not all have to be with the same name. Uh, it just has to be two years, total and specifically being on the job most recent for at least a six-month period.

Ideally, this individual in this type of situation would be W2 because if they were, if you didn't make a W2 and this individual or spouse became a partner in the business that switches to a different guideline parameter, where now this, she must be self-employed as a business owner with you for two weeks.

And then it's averaging that income over a two-year period. So, the path of least resistance to get this done is to make a spouse, a W2 employee. And I've got multiple clients right now, uh, who are facilitating this type of setup to expand their, their portfolio. And I've, I've worked with a lot in the past on the same thing, common.

There's nothing wrong with it. It's a great way to continue to tap into financing.

Steve Olson: If I had a dollar for every time I was talking to an investor and they said, well, I think I can get a rate of 2.875 because the Quicken Loans guy said, so last night on TV, then I'd, I'd have like $70.

Lane Aldrich: I'd have like $200 yesterday.

Steve Olson: I'm going to leave it to you to elaborate on that, but why is that wrong? Talk about the actual terms and some of these restrictions that, that investors get duped by. They think they're getting some of the attributes of an owner-occupied loan. When they are not, what does an investor loan actually look like?

Lane Aldrich: Something that's common that comes up a lot is. Bob, the loan officer who may work for a Quicken or an online company, the bulk of the transactions that they do are primary residence, single-family homes, where you're calling in and saying, I want to refi my personal property. They're just built and geared to give information and quotes based on that format.

Interest rates for investment properties are different on a 30-year fixed, there's a little bit of a risk adjustment. When, when as the entity lending, the money is making a sale. Of what they feel the interest rate should be or what the risk factor is. And so, a fourplex is typically a quarter, excuse me, three-quarters percent higher as an investment property, two to four-unit than a primary residence, single-family home.

And so, it's, it's easy to go online and get a quote, a lot of quote systems don't know how to run investment properties very well, but there is a difference. And so, when, when you're working with someone and you're trying to collect information on what the financing looks like, you need to make it very clear.

That you're working with someone who won, first, understands investment, property financing. And to understand that this particular property is also investment financing. Um, cause I've got a lot of clients that I work with, and I always want to make sure we're competitive on the market and offer great terms and rates.

And sometimes someone will send over a sheet and I'll just, I have to say, look, that's not real. Um, but if you ask all these questions, then they can offer that. That's great, but chances are, that's probably not going to happen because Bob, the loan officer is a great guy he just doesn't do investment properties.

Sherida Zenger: It's funny. I got a text this morning from a gentleman that just said, "Hey, we got a second call, and it looks like it's a little bit better than what Lane's team sent our way."

I haven't replied back to this gentleman, but obviously what I'm going to reply back is we want to make sure we're comparing apples to apples. Please send that over to Lane and his company will match or beat whatever that is.

Usually again, like Lane was saying, you're not looking at the same product type. They're just giving them. And he's not going into all the detail of what really, he is purchasing, and maybe they don't even understand what he's purchasing and don't specialize in fourplexes.

Lane Aldrich: A lot of the products that I finance are new construction, two to four-unit where there are a lot of moving parts. So, we do want to make sure we offer the best rates and pricing. If somebody sends me a sheet, I take it right back to the lenders and say that someone did better than you out in the market. We make them come down and beat it.

Our capture rate with the development that I'm associated with is typically very high from a competency standpoint and our understanding, working with investors, understanding the development, and also making sure our pricing is competitive to help yield the best cash flow as well.

These are all things that we're very cognizant as cognizant of. It's a fun word, um, and making sure that, that we get that message out in front of investors.

When someone has to call if I'm a preferred lender for a builder and they'll call and say, “Oh, hey, I've I already have my investment loan officer.” And I say, that's fine. I say, "why don't we talk about this one". Expertise and knowledge go such a long way. That a lot of times, by the end of those phone calls, they'll say, “Hey, can you finance all of my properties from here on out?” And my last guy was just really nice. You just have a deep understanding of how these work better than anyone I've spoken to.

I always liked those. I'll give myself a little. At the end of those conversations. Yeah. Typically, I'm alone and there's no one to high five when right.

Steve Olson: There's nobody there. Well, you got your plugin. No, we didn't intend for this to be a plug. We are genuinely a competent lender, whether it's laying or somebody else making your life so much different.

Now I want to highlight the fact, this is the build-to-rent podcast. We've just been talking about getting loans. That could be on anything, but when we bring construction into this. Right. That's not a Fannie Mae. That's not a conventional product. A construction loan is unique and it's different. I mean, your, your model is you approve somebody for the long-term.

Fannie may take that to a local bank who then approves a construction loan, knowing that. Phil the optometrist from Rhode Island. Yeah. Yeah. That fill is qualified by lane to do a takeout loan or that long-term loan.

Tell us what your observations are and what you see when it comes to a construction loan. I want to get a loan and build my fourplex. What should I expect?

Lane Aldrich: That is different. I'm just about to roll up on 500 million in loans for this type of product, which means about 300 million of that was brain damage when building out this process and understanding how to do this at scale.

It is a little bit different from a build-to-own perspective with the formats that I'm accustomed to because banks are not super keen on lending money for investment properties. They consider that " speculative financing", and they want to limit the amount that they're issuing in that financing bucket, so to speak.

I must come in and convince them to do an entire development. Based on my underwriting requirements that they don't want to deal with someone that they don't understand. And then by the end of the development, I must have them think, okay, Lane understands these developments, these programs better than, than our own loan committee.

Because every time we challenged him on how he got his income or, or, or backed into you know, debt to income ratio is he was correct. So, in the different states that we lend in, have it come into my office, we look at it from a Fannie Mae, Freddie Mac. One of the most exciting things I'm excited about is to tell investors when they call in and say, “Hey, I don't know if I'm going to qualify or not.”

This is so foreign to me. What's going to happen. We can use rents from the fourplex that's being built for qualifying purposes to offset that payment when it's not even built. There are no tenants and we can use up to 75% of whatever an appraiser will determine what fair market rents are for that property when it's done without leases.

There's not a lot of new construction fourplexes in the market. Fannie Mae and Freddie Mac have just kind of left it as a gray area, and this is how they've interpreted it. And it's been that way for over 10 years.

Very, very favorable for investors that want to come in and do one build-to-rent a fourplex, let alone multiple, you know, if you're not working with a multi-million-dollar annual income, you can make a couple hundred thousand dollars a year and put up a couple of different fourplexes at the same time.

When a lot of people felt that something like that would never be achievable but getting familiar with all these different banks understanding what their guidelines are and then making sure I underwrite accordingly has definitely been an undertaking but allows me to advocate really well on the fourplex owner and give absolute answers on, on if you're going to be able to move forward on a property or not.

That's been an exciting part of what I've been building out for the last five or six years.

Steve Olson: You inadvertently danced around debt-to-income ratio. When we qualify for a commercial loan, this is referred to as a global underwrite. The bank looks at you, the asset, they take everything into account.

The kind of loans that we're talking about on Fannie Mae... I think credit score and debt to income ratio are what like 95% of this equation. Maybe more. a lot of times people worry, "well, I get more properties and more debt. It hurts my ratio." Now, if you're buying good investment properties, wouldn't your debt-to-income ratio be getting better the more debt you get?

Lane Aldrich: Better or essentially just stay the same. We're only using 75% and you've got that Delta that we just must essentially eliminate for those, those conservative purposes. Someone can come in and say, I want to qualify for a primary residence, and I look at what their debt to income ratio is adding that primary residence or that new housing expense.

And let's say it's 31%. Let's say that this house, uh, principal interest taxes, insurance, any, any debts, the individual has car payments, student loans, credit cards, personal loans for a new Mastercraft boat, or maybe not. scrape boat. Uh, all that total is 31% of the individual's gross monthly income, right?

So that's what you pinpoint is their debt-to-income ratio. Then they can come in and say, now I want to add a fourplex and I go ahead and add what this potential fourplex would add from a cost perspective. Um, and then the liability perspective, as far as the monthly payment principal and interest taxes, HP applicable HOA dues, then I can plug in the applicable rents that I can use to offset that.

And this individual's debt to income ratio could still just be right at 31%, um, net, once you have built this fourplex and you, it is considered a retained property at that point, if you have it at that point and you don't lease it out well, then your debt to income ratios are going to be completely out of whack because you have a non-performing asset regardless of income for the debt, right?

At that point, once you have, have completed the fourplex and you refinance and you own it, and you want to go buy an additional property after. You're going to have to show leases to be able to offset that payment. At that's when that becomes important, but at the time of completion and turnover, it's just whatever an appraiser says, fair market rents are.

And that's been wonderful, um, with, with our understanding that and the banks working with us and, and working on these pre-approvals for investors it's helped us get more aggressive with qualifying and getting individuals to, to build a bigger portfolio than I think they thought was possible.

Steve Olson: I have two questions. Number one. Did I just see you try to get Mastercraft to send you a free boat?

Lane Aldrich: I think so. X star, you know, any Mastercraft dealers out there, you know, great products. Oh, wonderful. But G23 Paragon Nautique is kind of the king of the water right now, too.

Steve Olson: If we get a free one out of the show, then we'll post a picture. Do we have a website? Preston.

We're doing some stuff. That's essentially what Preston said. Okay.

A more real question is what debt to income ratio makes Fannie Mae say no more. We're not doing this loan.

Lane Aldrich: You can get up to 48-49%, which is pretty ludicrous in a lot of ways. I like to cap it at 43-44%. Because on the front end, when, when you're, when you're prepping to build a four-plex, there's, there's a three-to-six-month process, then you break ground, and then there's another transaction that takes place upon completion. And so, when I'm doing a risk assessment to see if somebody qualifies, it's a dynamic approach because I must see, does this person qualify now and if their income or expenses trending in a way that they will likely qualify again for the refinance a year after that.

I do like to leave a little bit of wiggle room in case someone's expenses do fluctuate. But I'm trying to typically hit the 43% number for the type of product that I am pre-approving for.

Sherida Zenger: Let's talk a little bit about 1099 because I'm a 1099 employee. My husband owns a company as well. When people say, “Hey, why is it important to talk with Lane? Why is it important to get pre-approved?

My main thing is one of the things you want to make sure of is that you can qualify. And by that, if you are a 1099 self-employed person, you're going to want to make sure that your taxes are structured in a way that you can qualify.

I know that lane says that you know, hey, he can add some of the depreciation back in. So, every year I do my taxes. I have my accountants send my taxes to Lane and say, Lane, hey, this is my goal. I want to buy four fourplexes this year, or my husband wants to buy two. I want to buy three and we're going to buy a second home, whatever it is.

I paint the picture to Lane look at my taxes and say, okay, you need to structure this slightly different or do this slightly different or no, those look great. So that's, I think has been a key benefit to me is being able to use Lane. And I know I tell that to investors all the time. Because there's knowledge of looking over your tax returns for someone's self-employed, I think is huge.

Lane Aldrich: Yeah. Then you hit on something that's important with working with the right people in this type of situation where there's a lot of moving parts for a lot of business owners in the sense, what, how is your income projecting? Are you going to sell a steak? Are you selling your company?

Are you growing? Are you downsizing? Where, where I can assess that? A lot of us, it's not just, hey, so I can buy one fourplex. It's Hey, how do I need to file my taxes this year? Because I want to strike to find balance as a business owner, making sure I show enough income to qualify, but I also don't want to overpay Uncle Sam because that's no fun for anybody.

And so, I can go in and make that assessment and say, all right, based on what your plans are for this year, let's make sure that you don't get as heavy in certain deductions that could ruin your plan. To acquire additional properties. So that's fun. I'm happy to do that with investors that call in on the different developments that I'm associated with.

And I think we do better than anybody in the country, just because we eat, sleep and drink Fourplex new construction financing.

Steve Olson: Overpaying uncle Sam is the worst.

Can you use cryptocurrency as an asset?

Lane Aldrich: I hate that question. Because I wish it was yes. And the answer is no. The mortgage industry is never quick to adapt to something that significant. Especially when the name of the game in finance is a paper trail. If you're going to come in and put 25% down, we need to make sure that was legit.

And that you are not borrowing and therefore we can calculate a true debt-to-income ratio because if we can't paper trail that money, we must assume you borrowed it. And how do we know what your cost is? And so how can we pinpoint a debt-to-income ratio to show that you qualify? Because everyone got hammered in the recession in 2008, 2011, because of the circus going on. There was no paper trailing.

Steve Olson: And that's the essence of crypto? No trail. There's nothing.

Sherida Zenger: Did you listen to that book that I told you to listen to? Oh my gosh, you guys, this was like a phenomenal book.

Steve Olson: I just finished a book called Bitcoin Billionaires. The Winklevoss twins and when Bitcoin first started the big knock on it was silk road, which was massive.

The very purpose is to be anonymous. And that's the last thing a lender wants to verify your income.

Lane Aldrich: Because you can't paper trail very well. A bank statement I can go and say, “Hey, I need a 30-day e-statement.”

Well, this is Tom Jones with fidelity 30-day. Incoming deposits, outgoing transfers that meet that meet guideline. The industry is just not caught up in crypto and Lane has not caught up to crypto. So, I feel like I'm a little out of place in this room, but we can move past that.

Steve Olson: Yeah, Preston's pretty heavy into the crypto.

Lane Aldrich: Everybody is.

Steve Olson: We don't know anything about crypto. We don't pretend that we do

Lane Aldrich: Do we need to make a financial disclaimer that this is not that if you invest in dos right now that we're not seeing.

That's going to turn into something great. It's going to the moon.

Steve Olson: We'll probably have Lane back soon. He gives some good information. We appreciate you coming on the show Lane. Everybody, that's it for the Build-to-Rent Podcast today. We'll catch you next time. Thanks.

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