Agency vs. banks

We’re working with a reader of this blog to secure our first-ever loan from Freddie Mac, a so-called agency lender, on a project we recently stabilized.

Previously, our experience with loans has been with banks.

Back when I was first starting out, every broker warned me to avoid the agency lender and stick to banks, because the agency guys were so much harder to deal with.

Turns out… they were right!

Freddie has amazing terms; they’re effectively unbeatable by banks. But they put you through the ringer in a way that banks just don’t do.

Here’s hoping we get this thing closed!

A pretty large appraisal discrepancy

Apologies for the lack of posts these last couple of days.

Today, I got word that an appraisal hit at the contract on price ($850,000) on a deal one of our agents is working on.

That wouldn’t be such a big deal, except that another appraiser for a different bank recently appraised the exact same property at $700,000.

That’s a ~18% difference in value… not some kind of rounding error.

What’s going on here?

Well, these kind of appraisal discrepancies tend to occur with properties with some of all of the following characteristics:

  1. Located in an emerging neighborhood – When a neighborhood starts to change, it’s very difficult to comp out rents. You will find gentrifying tenants renting renovated units for 30-50% more than “market” rate units on the same street.
  2. Rent controlled comps – Appraisers naturally look to the MLS to comp rents. However, they are often unaware of rent control, leading them to base their estimates of “market” on controlled, sub-market rents.
  3. Property type which is rare for the neighborhood – If you are buying, say, a 4plex on in an area dominated by single family homes, the appraiser is going to have trouble finding relevant comparable transaction. (Ironically, you’re probably making a good deal, especially if the area has been down-zoned so that no one else can build 4plexes)

Unfortunately for the first buyer, the first appraiser fell victim to all of the above. Fortunately for second buyer, the second appraiser did not.

Progress on the refi front

On Friday, a loan broker who reads this blog secured for us a letter of intent (LOI) from a bank for a refi of a project we just stabilized.

We’re all-into the deal for just under $2.8MM and the LOI calls for the bank to loan us that amount via a cash-out refinancing.

Now, going from an LOI to a closed loan is not always so easy, so I don’t want to give you the impression that this is a done deal… it’s not, by any means.

But I do want to explain why this is such a cool development for our business.

If we can buy a building, renovate it, lease all the units, and the get a loan which allows us to take out all of the capital invested after +/- 12 months, then the return on the capital invested is pretty amazing.

Why? Well, return on investment is calculated by dividing the profit by the amount invested. If you get all your capital back but still own the building (and it cashflows!), then you’re dividing by zero… a mathematical impossibility.

I don’t want to give you the impression that we’re able to do this on every deal… we executed this one very well, but we also got some help from the market (because rents ended up being higher than expected).

Still, it’s pretty cool, right?

What’s going on today

Just in case anyone thinks what we do is glamorous, thought I’d give you guys a sense for what I’m working on today.

Am working on securing four different loans:

  • Refi of a stabilized property so we can return ~70-80% of the capital invested to our investors
  • Two bridge / construction loans
  • One line of credit for Adaptive, itself

Am removing contingencies on a six unit deal and reviewing the diligence on a 16 unit deal we inspected late last week.

And, to top it all off, am arranging to pay the guy whose garage we moved for his time “supervising” (because everyone always wants a taste).

An irritating refinancing issue

Have just begun the process of refinancing 201 N Ave 55, a 12 unit property we renovated and recently stabilized.

Thought I’d share with you an irritating issue I’m running into, so that you aren’t surprised when it happens to you.

Let me begin by giving you some sample numbers. These aren’t actuals for the building, because I don’t want to give my competitors my real numbers, but they will serve well enough to illustrate the point.

The numbers:

  • Acquired for $2MM
  • Renovated for $500k
  • So, all-in for $2.5MM
  • New rent roll of $250,000
  • Stabilized valuation (in my opinion) of 12.5x GRM = $3,125,000

My starting point for a refinancing is to ask the bank for 65% of the new valuation, or $2,031,250.

Their counter is that, since the property has only been stable for a few months, they’ll only do 65% of my cost, or $1,625,000. Or, I can wait for a year, and then they’ll go off appraised value.

Can you see how irritating this is? At $1,625,000, they’re only at 52% LTV against my value… which is way too little leverage to lock in for 7 years (during which there will presumably be rent growth).

I can understand the bank not wanting to cash me all the way out (eg loan me $2.5MM). But 65% of cost is ridiculous.

Fortunately, I have good relationships with 2-3 banks who I think will see past this nonesense and look more at the value of the building and less at my costs.