🔤 THE BASICS 🔤 Flashcards
What is a lease?
A contract by which one party conveys property to another for a specific time, usually in return for a periodic payment.
What is a balloon payment? And what kinds of ballon payments are there?
A balloon payment is a payment that is a lump sum of the borrowed money left over after paying the amortized payments up to the agreed upon “loan term”. (Loan terms are generally anywhere from 3-10 years in CRE, in our strategy we don’t do less than 5.5 years)
Types:
* 54321 or a 12345 - payments increase or decrease annually over loan term
* Flat - specific payment after loan term
* 1 time first year balloon payment (+1%point)
* Variable balloon payment based on interest rates
What’s the difference between loan term and loan amortization? And how does a balloon payment come in to play with these two in CRE?
Normally in residential RE you’ll see a 30 year fixed rate mortgage term and a 30 year amortization (payback) period. (you don’t have to pay back your loan for 30 years and you pay consecutively over 30 years)
BUT… in CRE it’s a little bit different. In CRE you’ll generally see a 3-10 year loan term (much shorter than residential). Since there’s a shorter payback window that means there’s going to be higher monthly payments.
Which generally would concern investors in terms of cashflow.
So… what CRE lenders will do is separate the the amortization period and the loan term… so you could have a 5.5 year loan term but with an amortization period of 30 years and only need to make payments as if you were paying it back monthly over 30 years (ie. A much lower monthly payment than 5.5 years) but THEN owe the loan in full after the 5.5 years.
Thus this lump sum after the loan term is called the “balloon payment”.
How do you pay off the balloon payment?
It can be payed off by:
* selling the property
* using cash out refinance proceeds
What’s a “lease to own”? And why would someone want this?
A contract that combines elements of a traditional lease agreement with an option to purchase. This is an interesting option for those who want to “try before they buy” or even a way for people to claim dibs to a property until they can purchase.
What is a Deferral?
A postponement of an action or event (Ex. Differed interest, differed profit, differed down payment)
What is a “subject-to”?
Buying a property “subject” to the existing mortgage. While little is transferred to the “buyer”, the existing mortgage stays in place where the buyer takes over the payments.
What is an “option”?
A contract that offers the buyer the “right”, but not the “obligation”, to buy a property at an agreed upon price during a certain period of time or on a specific date. (Ex. lease to own is a type of option)
What is a moratorium?
An authorized period of delay in the performance of a legal obligation or the payment of a debt. (Grace period)
Why would a seller want to do your creative financing deal?
- you have the ability to close fast (as soon as 1 week) when the average close for CRE is 120 days
- If you fail to make one payment he gets the property plus all the value/occupancy you’ve put into it.
- He’s motivated to sell because he needs the cash/satisfy debt payments or wants to quickly invest in a different opportunity
- Tax benefits to the seller because he doesn’t have to pay out the IRS all at once in one year vs smaller amounts over a stretched period of time. https://youtu.be/zoFPUSTs2pEw
What are the 4 main offers to make to close?
- Cash Lowball of 30-40% of asking.
- 40-10-60 | 50-50 deal purchase, you give him 40 he breaks you off 10 on the backend and he carry’s back 60.
- 70-10-30 | 80-20 deal refinance, seller gets 1st position on mortgage and you make the payments to him. You pay him 70 upfront he pays you 10 on the backend and carry’s 30 on the backend.
- 20-70-10-30 | 80-20 purchase, seller makes the down payment and he gets the 70 at closing and breaks you off the 10 on the backend and carry’s 30 on the backend
- all carry backs are 5.5 year ballon notes (principal only)
What is the debt service coverage ratio? (DSCR)
Formula that will tell you if there is enough cashflow to service the loan and also get the green light from the lender.
NOI âž— Debt Payments đźź° DSCR
The DSCR must be at least 10% and in some cases at least 20%.
What is the gross operating income? (GOI)
The total income from rents (occupied +paying) and other fees and incomes associated with property. (Similar to gross scheduled income but minus the vacancies and credit loss)
GSI - Vacancies - Credit loss + other revenues đźź° GOI
What is a credit loss?
Lost revenue from an occupied unit with a tenant who has not paid rent on time (or an unoccupied unit with potential for monetization)
What is gross scheduled income? (GSI)
The total potential income from all units being rented out at current market rate prices.
Rental income from occupied units âž• Vacant units slated income đźź° GSI
What are the ways a property’s equity can “increase” or “decrease”?
It can increase if:
* you pay off your mortgage, as you pay off your mortgage or as you increase the size of payment
* it just sits there and on average RE appreciates about 4.5-5% per year (in the US)
* you rent out the property to exponentially pay off the mortgage
* make valuable improvements to the property
* add new revenue streams
It can decrease if:
* Renovation costs exceed your mortgage payments/don’t add value to the property.
What is usable equity?
Lenders only offer a specific LTV to use your equity if you’re not selling the property. It can be as high as 80%.
(If using the second mortgage method)
If you were to do a cash out refi or sell the property you could access the whole thing.
What is a second mortgage? What is it also known as?
Also known as:
* a note or carrying paper, a carry back (seller financing)
* an equity loan
* an equity line of credit
* a piggyback mortgage
Is a second mortgage that allows you to leverage the equity of your property without affecting your original loan terms. It generally comes at a higher interest rate due to the lender being in “2nd position” of being paid out behind the OG mortgage lender should there be a foreclosure.
These can come in the form of a equity loan which is generally a fixed interest loan and is an upfront lump sum or a equity line of credit which is like a credit card for your equity position that allows you to utilize whatever percentage you need. These usually come with variable interest rates based on fed rates.
Or the second mortgage can be created by a seller to create credit for a buyer to purchase a property from him. This is beneficial for the seller as they get to sell and cash out on they’re property + less capital gains tax and the buyer gets more favorable loan terms than he would at a bank and generally a lower upfront cost to buy the asset.
What is a CAP rate? (capitalization rate)
Cap rate đźź° NOI âž— Market Value of property
CAP RATES ARE DRIVEN BY THE
EXPECTED INCOME UPSIDE OF
THE DEAL BEING ANALYZED
Low cap rate = lower initial yield
High cap rate = higher (potential) initial yield
Why do property owners take out a second mortgage?
- Avoid paying loan prepayment fees with refinancing or paying off their mortgage in general.
- Leverage their equity while keeping their original mortgage loan terms.
- To avoid having to pay private mortgage insurance. (If you borrow more that 80% of the property value to purchase you may have to pay PMI but splitting it up with a 2nd mortgage can avoid that)
- Avoid having to pay jumbo loan interest rates by splitting it up with a 2nd mortgage.
What should you ask for to get the real numbers on any NYC property?
Ask for the Department of Housings income and expenses report and the schedule E
What is a Schedule E and a Schedule C?
Schedule E and C is a tax form that rental property owners have to file showing the REAL #’s for a property’s income and expenses. The schedule C is specifically for property’s with a retail/business element such as a hotel or a retail store etc.
What is equity?
The value of the property minus what you owe on it.
How does real estate influence your net worth?
Your equity adds to your net worth
What is a cash out refinance?
It is a restructuring of your mortgage that allows you to obtain different terms and also cash out on any equity you have in a property. It’s generally a fixed pretty low interest rate and requires you to pull all equity out of the property.
What is an equity line of credit? (Or HELOC for residential)
Is a revolving line of credit collateralized against the equity in your property. It’s a type of second mortgage that allows you to use what ever percentage you need to use out of your equity position generally at a variable interest rate based on current fed rates. General are free and fast to set up. There are some hybrid equity lines or credit that do provide fixed interest rates.
What are “operating expenses”?
All expenses associated with running the property: utilities, property taxes, insurance, and routine maintenance.
Doesn’t include: income tax, mortgage payments and capital expenditures.
What is net operating income? (NOI)
NOI đźź° Gross income âž– expenses
Doesn’t include debt servicing
What are closing costs in CRE?
Loan costs:
Loan fees, Insurance, and interest reserves (0.5% - 1.5% of the loan)
Appraisal: $2500
Titling cost: title search, and title insurance.
Legal costs:
Recordation taxes, transfer taxes.
Commission:
Paying our realtor: 1-3%
