Originally published in the November issue of REI Ink Magazine, DLP Lending CEO & Founder Don Wenner discusses how to succeed in today’s climate by employing real estate investing strategies that allow you to capitalize on opportunities fast.
Uncertainty haunts the real estate market today.
According to Redfin data, the median home sale price jumped 13% from September 2019 to September 2020. However, investors remain concerned that the economic damage caused by the COVID-19 pandemic will eventually spill over into the housing industry.
One does not have to look too far for warning signs. A simple Google search will lead you to articles about an ‘overheated, bubbly market’. Additional articles discuss the divide occurring in the market, with rural and suburban single-family homes rising while multi-family and commercial real estate decline.
We have not seen anything like the COVID-19 pandemic before. We do not know where it is leading. And this has made Wall Street and independent investors hesitant and even fearful when it comes to the housing market.
How should you respond? The best thing an investor can do is focus on what they can control. Opportunities are out there in this market, and investors can continue to grow during these uncertain times. Specifically, what needs to be done is to take control of your access to capital.
Get Pre-Qualified So You Can Be Greedy When Others Are Fearful
We have all heard the Warren Buffet quote: “Be fearful when others are greedy and greedy only when others are fearful.”
Well, people are fearful right now. So, the opportunity for real estate investment is now. However, this does not mean investors should get aggressive. Stay conservative while making sure to jump on opportunities. Given the nature of this pandemic, you may have to adjust where you invest to best capitalize on opportunities.
For instance, low housing supply continues to drive home prices up. As of August 2020, the monthly supply of houses dipped to 4.0 according to Federal Reserve research. This means it would only take four months to sell all the homes currently listed for sale.
Knowing this, investors may discover through their analysis that better returns can be achieved through new home construction projects or fix-and-flip projects. There is a demand for more inventory. The investors who help provide more inventory stand to gain the most.
To take advantage of such opportunities, investors must prepare capital well in advance. Get pre-qualified as soon as possible. Investors cannot take advantage of a good deal if they do not have the capital ready.
What investors must do is partner with a real estate lender before doing market research and going after deals. With tightening borrower requirements and more conservative underwriting, loans are taking longer to process. Investors need to be 100% sure they have the cash on hand to complete the deal.
In this market, the early bird gets the worm if they have the cash on hand. The first step is to find a source of capital and establish a solid relationship with that lender.
Be Conservative When Making Assumptions
Investors know that there are opportunities out there and how important it is to have a capital partner. However, financing during these uncertain times can be difficult. Real estate investors need to be conservative when making assumptions and should plan for the following:
- Longer processing times
- Higher rates
- Higher reserve requirements
- Reduced leverage
Lenders have taken these precautions to mitigate risks. For example, on a deal today, a loan may take a few weeks longer to process, require 6-12 months of future payments, and have an interest rate that is 0.5% higher. Borrowers and investors must respond and prepare accordingly.
Also, investors must be conservative with more than loan terms. Any deal analysis should be conservative as well. In 2020, lenders have reduced as-is and after-repair-values by 5-15%, which is why fix-and-flip investors should calculate this into their deal analysis. Also, plan for higher cap rates, higher delinquencies, lower occupancy, and less rent growth.
By taking a conservative approach to penciling out deals, investors insulate and protect themselves from external risks. This increases the likelihood that the deal will be successful. It could even turn out much better than projected.
Know Where Your Lender Gets Capital
Observing the success of fix-and-flip investors, Wall Street has entered the private lending game over the past decade. They have done so by providing lines of credit to lenders. Wall Street’s involvement has also led to the securitization of private real estate loans.
Why does this matter to real estate entrepreneurs? It matters because many lenders’ capital is tied to Wall Street. If you work with one of those lenders, you do not have full control over when and how you can access capital.
For example, before the Coronavirus pandemic, private lenders had been originating loans and selling them to Wall Street at a 2-3% premium. Given the current risks, Wall Street will not pay that premium anymore. As a result, these lenders have had to stop or greatly reduce their lending since Wall Street is not providing funds. This has left many real estate investors stranded and unable to capitalize on opportunities. Always know how your lender is funded. If your lender works with Wall Street, market swings can directly impact your ability to access financing. That takes the investor out of the driver’s seat.
Build the Right Culture
Let’s return to Buffett’s quote: “Be fearful when others are greedy and greedy only when others are fearful.”
The current real estate market may have many investors worried, but great opportunities are out there. To win in this environment, investors must take control of their access to capital. Control hinges on finding the right capital partner, getting pre-qualified, using a conservative approach to deals, and having a good internal culture and quality processes in place within your organization.
Now is not the time to sit and wait. It is time to act! With the right capital and the right team, investors can get ahead of the game.