Financing the Renovations of Run-Down Properties

If you invest using a renovations strategy and you buy run down properties, then read this post to learn more about how you should go about the financing of your investment property.
This post is based on a real client story …

Nicholas and Hilary are husband and wife investors. Nicholas is a self-employed contractor and Hilary is a stay-at-home mom.
With Nicholas’s renovation and contracting experience, the couple’s plan was to buy under-run properties in high prime locations, renovate them and sometimes change the zoning to add extra suites or extensions.
After completing their first renovation, Nicholas and Hilary’s aim was to refinance the property at the newly increased value. This would allow them to take out some of their initial capital investment as well as take out some of the extra equity that they have built to buy more properties.
With the property now in much better shape, Nicholas and Hilary will be able to attract higher caliber tenants who are willing to pay higher rents and therefore boost the cash flow.
In 2012, Nicholas and Hilary bought a run-down triplex in a metropolitan city in a prime location.
The property was not only in original condition and vacant but also had an oil tank in the basement, some asbestos (an insulation material used in the 60s and 70s that was found to cause cancer) as well as outdated electrical wiring (knob and tubing).
With market knowledge of the area and an understanding of how much would need to be spent on the renovations to bring this property to a higher standard, Nicholas and Hilary put in an offer and came to us for financing.
They asked:
“Can we finance this deal with our bank? We see that the bank has some great mortgage rate promotions going on. Also, it would be great to have the mortgage through the bank for ease of banking.”

The Solution
While we had a great relationship with Nicholas and Hilary’s bank and access to all of the mortgage products they were referring to, taking their application to the bank would have been the wrong move.
Given the nature of the property they bought, and knowing that their plan was to improve, refinance and hold on to it for the long term, we suggested a two-stage financing strategy:

Stage 1: Financing the AS IS Property
While no “A” lender is willing to finance a property that is run-down with all the issues outlined above, “B” lenders—such as trust companies—will.
We approved the purchase for 75% financing (i.e. clients putting down 25%) for a one-year opened rate.
The “B” lender held back an amount of the funds equivalent to the costs associated with the removal of the oil tank, asbestos and knob and tubing. Once the client provided proof that these issues were addressed, the lender advanced the remaining funds.
While Nicholas and Hilary paid a slightly higher interest rate with a “B” lender compared to what an “A” lender offers, in addition to the lender fee of 1% (lender fees of 1% to 1.5% of the loan amount is standard for “B” lenders), financing the deal with the “B” lender made economic sense and allowed the couple to purchase the property and start the renovations.

Stage 2: Financing the IMPROVED Property
Upon the completion of all renovations and the rental of all three units; the plan was to re-appraise the property at the newly increased value with an “A” lender.
We took the deal to the couple’s bank and got them a fantastic five-year rate on the deal that allowed them to continue to hold on to this property for the long run with a strong cash flow and an additional $150,000 in hand to use toward their next investment. The couple did not incur any penalties as part of this exercise as their mortgage with the “B” lender was opened and that permitted them to pay it off at any point without penalties.

The Takeaway
The type of property you are buying plays a key role in the amount lenders are willing to lend you as well as the rates they charge.
If you are into a renovations strategy and you are looking to buy under-run properties a two stage financing strategy may work best depending on the state your property is at. You may be able to finance the property with an “A” lender (the group of lenders offering the lowest rates) from the get go but it will all depend on what state the property is at , its location as well as your financial situation (income, credit and networh).

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