Don’t Fall Victim To This Common Real Estate Investment Mistake
A common real estate investment mistake is often made by new investors when they begin investing. At its root is understanding the realities of what makes a deal profitable and how that can relate to obtaining the funding that is needed to complete the house flip or buy the rental property.
Rightly so, new investors will listen to seasoned investors to learn aspects of investing. They will develop a team of trusted agents, contractors and supporters to work with. And the advice of all those people is important. But there is an area where it may cause a problem, and that relates to getting the funding that you need, as a new investor, to complete your first few deals.
Why Is This An Obstacle To Success?
What I am talking about here is something pretty specific. Something that grabs some people after they have made the decision to actually pursue real estate investing and have taken steps to make it happen. This is happens soon after you find your first potential house flip, review the profit estimates and start working to obtain the funding you need to get it done. It happens when you receive feedback that the deal is not as profitable as you first thought it might be.
Profit Estimates And Stars In Your Eyes
Or, is it really dollar signs in your eyes?
So, here is the scenario I’m talking about. Let’s use a fictional new real estate investor we’ll call Diane. Diane has actually been considering real estate investing for a few years now. She reads articles online and has bought a couple of books. She even went to one of those free seminars. And she really has come to believe that real estate is one of the best paths to financial independence out there. She finally takes the plunge and starts looking for a property to flip.
We’re all familiar with the “high” that comes with starting a new endeavor. It is powerful. It is fun. For Diane this burst of energy resulted in her going right out and finding a property to flip. It was more difficult than she thought it was going to be, and it took much more time than she estimated, but she did it! She found comps within a mile of the property that show it will result in the profit she wants, an estimated $30,000. She’s even had a couple of knowledgeable people in her circle quickly review her deal and they agree it looks good. Now she needs to get the loan so she can start on the rehab. She wants the $30k and has even begun to think of how she will spend and reinvest it. Its the type of investment return she was seeking by going into real estate.
Due Diligence and Assessing the Whole Deal
This is where the rubber really hits the road, so to speak. This is the point where you are asking someone else to risk their money on your deal.
Depending on the type of funding you pursue, the conditions that need to exist in order for a lender to actually extend the loan will vary, but what it all boils down to is that if the deal or the borrower don’t meet the lender’s criteria you won’t be able to get financing from that lender. Period. I cannot stress this enough, both the borrower and the deal need to meet the lender’s requirements.
Let’s go back to Diane and her deal. Diane believes this house flip will be profitable, and she got confirmation from her real estate agent and a couple of people from her local real estate investing association. so she begins looking for a loan.
When reading in online forums and talking to those in her local REIA she has been told to shop for rates and terms and to negotiate her terms because lenders will compete for her business. This is only partly true, and only when the both the borrower and the deal meet exacting standards. And guess what, new house flippers rarely meet those borrower specific standards just simply by virtue of never having done it before. Yes, the guy in her investing club who has flipped 100 houses, can put down 20%, has perfect credit and a steady cash flow meets those conditions, but Diane needs to work with her circumstances, not his.
Most lenders will have borrower criteria like credit score, debt ratios and down payment requirements as part of the funding programs they provide. That’s the first part of the process. And for many rookie investors meeting those requirements is not possible, so the lender cannot even consider their deal.
The due diligence and compliance process that a lender will conduct when you apply for your loan will help them determine if the property and aspects of the deal itself meet their specific guidelines. A good lender will not take your word for the value of the property, they are going to either have someone from their organization value it or they will have an independent third party do so. And it is at this point that many deals new investors think are profitable and sure money makers get turned down for funding.
And that is where Diane hits this common obstacle. The property valuation on Diane’s deal came back showing that the comps she was using were not the correct ones , they were on the high end and so they turned down the loan. Diane is upset! She is losing $30,000! She had her heart set on doing this deal, she fell in love with this deal. It took her a long time to find it and she doesn’t want to go through that whole process again. It was the only deal she had in the works, because it looked so promising and besides so many “experts” told her it was a good deal. The lender is costing her that $30,000!
The Hard Truth
What happened? Diane fell in love with a specific deal. Or, more accurately in love with the initial profit potential of a specific deal. She has not lost out on $30,000, more likely she has avoided losing money on a bad deal.
When a lender turns down a deal due to the borrower not meeting requirements you can infer that the deal still may be profitable, but the lender considers the borrower to be risky. However, when a loan is denied due to either profitability assessment factors or risk calculations then you need to take a step back and look at it objectively. It in fact may not be a good deal, it may not be profitable. Or it may only be marginally profitable. Or perhaps the profit calculations look ok but there are risk factors that make it untenable for the lender.
Lenders don’t like to extend funding unless they are protected and see profit in it for them. A lender may mitigate the risk of losing on a transaction by requiring a large amount down or making the borrower personally liable for the amount of the loan for example. A lender who has a large downpayment from a borrower may be willing to loan on a deal where the profit calculations or risk assessment show it might not work out as well, because they are protected by that large downpayment.
A deal that is turned down for funding is a deal that needs further, objective, assessment. Your agent will most likely not be objective, they are getting a commission regardless.
To put it harshly, the opinion anyone who insists that your deal is profitable but will not back it up with their own money does not matter much. If multiple lenders turn down the deal that is a sure indication that there is a problem.
The Investor's Edge Loans
Here at The Investor's Edge we believe real estate investing is one of the most reliable paths the financial independence. And we also feel strongly that it should be accesable to as many people as possible. To that end, we have created products and services that remove as many obstacles as we can. Because of these products we are able to extend funding to investors that other hard money lenders ignore.
Of all the products we have, one of the most exciting is the funding that we provide to new investors, investors with bad credit and investors without a lot of capital. But in order to use this financing we require certain conditions be met.
We turn down deals when they don’t meet our profitability requirements or if the deal has factors that make it too risky. A deal may be too risky to qualify for our no/low cash to close loans or bad credit loans. That same deal may qualify for a more traditional loan with a downpayment and borrower credit requirements. Remember both the borrower and the deal need to meet the lender’s requirements. We hate having to turn down potential deals and do not do it lightly. We look into as many funding options as possible to make a deal work.
Learn From “Lost” Deals
When you find a deal that looks promising take this approach: don’t try to prove it is a profitable deal. Look at it to find all the potential problems and pitfalls that may arise. By doing that you will be able to prepare for them should you determine the deal is still worth pursuing. NEVER use comps that are at the “high end” or for properties that really are not comparable to your considered deal. Are the properties similar enough that a potential buyer will view them as such? Or does one have a distinct advantage? If so, that’s not a comp.
And if a lender who stands to make money from extending the loan turns down the opportunity to make money by turning down your deal then step back and look at it again.
Don’t fall in love with a deal, fall in love with successful real estate investing. Successful real estate investing means walking away from a deal when you realize it is not the amazing deal you first thought it to be.
Find out how you can make money flipping properties with us by attending our next webinar.
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