The Turnkey Financing Dilemma
et’s have a discussion about financing for turnkey, single-family residential rental properties,
and the two types of financing options available…
In most cases, debt leverage is a great way to finance these properties. I’m a long-term investor, not a buy-and-sell guy. I usually invest in assets that I intend to keep for years. I’ve still got rental properties in my portfolio that I bought back in the eighties.
These are properties in good locations where the demographics have stayed strong. People want to live in these neighborhoods. Demographics change sometimes, and in those cases, you’ll want to move your equity elsewhere – but that’s a conversation for another day. The real opportunity is the cash flow above and beyond any expenses and the debt service you’ve put on the property.
There are essentially two types of financing: The first is conventional, federally subsidized, 30-year, fixed-rate financing – Freddie Mac or Fannie Mae.
There’s also the option of community banks that will offer financing packages with low interest rates. It will still be amortized over 20-30 years, to keep the payments low. But there will typically be a provision for 3-7 years on the outset, where that local bank (we call them portfolio lenders) keeps its paper in-house.
After those 3-7 years, there will be a call provision where in order to renew the loan with that bank, you’ll have to go with whatever the current rates are (and that can be scary). Now, this is okay if you’re buying a property with the intention of either selling it before that call provision or using cash flow to pound that loan down and get it paid off in those seven or so years.
The problem I have with short-term call provision financing is: what are things going to look like in seven years? Again, if you’re going to dispose of the property or have the ability to pay it off within that period, I think it’s a great way to go.
If, on the other hand, you’re going to keep the property and don’t have provisions or don’t want to pay the loan off faster, you’ll want that long-term, fixed-rate financing that you won’t have to worry about in seven years.
Now, what about the front end of getting these loans?
30-year, fixed government agency paper has a higher cost and higher fees to get into. It’s also a longer, weedier, less consumer-friendly process. But remember, for long-term investors, that higher cost to get in is going to be amortized over many years. If you’re going to keep the property less than say, seven years, that higher cost likely won’t make sense, so you’ll need to go through a local community banker with a lower cost of entry.
I hope this helps you understand the controversy behind “do I go this way or that way?” as it relates to financing. Neither way is right or wrong – it depends upon your intentions with your investing model, your philosophy, and what you want to do with a particular property.
You’ll know exactly what to do if you keep that lens in mind.
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