Every property I have ever purchased has been with the help of a mortgage broker. After my recent trip, I have started to wonder why this is the case. The obvious answer is simply their access to cheaper capital. Brokers can secure rates 50 to 100 basis points (.5%-1%) lower than most local and national banks. Additionally, the terms tend to be more investor friendly, with longer amortization and no recourse. With all of these benefits, why would anyone consider going anywhere else?
The answers lie in two things: Technology and Relationships. The easiest explanation is simple disintermediation through technology. The Internet has opened the mortgage world to investors by allowing them to search many national and local bank rates, as well as, look across the country for the most aggressive mortgage lenders. The time will come (probably very soon, if not already) when some forward thinking investor will provide a site that connects investors and lenders in the same way mortgage brokers do now (think Lending Tree for Commercial Loans).
Additionally, looking at Brian Brady’s recent post, Interview: The XBroker, the industry seems poised for positive transparent change. This change will further allow disintermediation and provide investors unparalleled access lenders. Furthermore, increases in information will drive down pricing. I have consistently been quoted prices in the 1% (of loan value) range for broker services, which can be fairly steep as a percentage of closing cost when purchasing properties in the $500,000 to $1,000,000 range. I would love to see this come down to 50 to 75 basis points (sorry to the brokers out there, but business is business).
The less obvious answer is relationship building. I probably mention that real estate is a relationship business in 90% of my post because I really believe this. This concept is no different when working with banks. The value of the relationship, however, is not apparent right away. Most banks have specific lending criteria and will only be able to offer certain terms based on their risk assessment model. This fact alone keeps mortgage brokers employed. What investors fail to realize, however, is that banks have latitude in other aspects of lending; I want to specifically address foreclosure here.
No investor goes into a property thinking it will be foreclosed, but it happens. The catch is that banks can choose when to foreclose and they can even choose to offer bridge loans instead. Enter the investor relationship. While the relationship is not solely responsible for these decisions, it helps tremendously. Properties that show good fundamentals with a cash gap are prime opportunities for bridge financing. This financing is almost always easier (and cheaper) to get from the original lending institution because they have the most to gain or lose from foreclosure. Having a strong past relationship with the lending institution increases the likelihood of workout financing and decreases the likelihood of foreclosure.
So what should the investor do with this information? Consider this information like a real option. If you do a lot of investing in one market and have a good relationship with a commercial bank, first, make sure you are getting their best rates. Then, consider the market cycles. When the market is strong this real option will probably have little value because the risk of foreclosure is very low. However, as the risk of the investment goes up (or as market fundamentals decline), this option becomes more valuable.
Financing is one of many tools that real estate investors have in their arsenal. There are clear times when it is appropriate to go for the best rate and terms possible, but do not always assume this is the case. A good relationship with a strong commercial lender has value as well. While that value will fluctuate by market condition, it should always be considered when vetting financing alternatives.Related posts: