The 2007/2008 housing crash and subsequent recession marked two of the most profound economic events of the new century. It led to a number of important changes in the financial sector, including stricter underwriting rules for institutional lenders. The rules impact real estate investors as much as anyone else.
Real estate investors have unique needs when it comes to lending. Oftentimes, their needs make traditional financing unfeasible, at least for acquisition purposes. Traditional lending is still doable for refinancing and other needs. But for acquiring new properties, traditional financing is less-than-desirable.
You are the most profound ways real estate investors are impacted by the stricter underwriting rules:
1. They Are Driven to Hard Money
While hard money has always been a good vehicle for funding new property acquisitions, it became the preferred choice among investors following the housing crash and recession. This is not a bad thing, by the way. Hard money is actually a better tool for getting acquisitions done.
Investors have been driven to hard money because the stricter underwriting rules make it more difficult to arrange new loans in a timely manner. That is a problem in commercial real estate. Investors cannot make money if they need to wait on banks for months. Private lenders, like Salt Lake City’s Actium Lending, can approve and fund loans in a matter of days.
2. They Face Lower LTVs
Next, stricter underwriting requirements include lower loan-to-value (LTV) ratios. Institutional lenders can no longer lend as much as they would on a property acquisition. Lower LTVs on the lender’s part mean higher down payments on the investor’s part. An investor needs to bring more money to the table to get a deal done.
Lower LTVs can inhibit an investor with a large portfolio from leveraging existing assets to stimulate growth. In simple terms, more cash is tied up in acquisitions giving an investor fewer resources for other needs.
3. They Face Higher Debt Service Ratios
While the stricter underwriting requirements have lowered LTVs, they have increased debt service coverage ratios (DSCRs). DSCR describes an investor’s rental income relative to his debt payments. Stricter underwriting requirements force lenders to demonstrate higher rental income to get the best possible rates and terms on new loans.
For an investor with a sizable portfolio and a high volume of outstanding loans, this is problematic. Even if an investor poses no risk of default, he still has trouble securing new loans because equity in existing properties is not as high. The result is slower growth. New properties cannot be added to the investor’s portfolio as quickly as he would like.
4. Stricter Document Requirements
Stricter underwriting rules translate into stricter document requirements among lenders. Institutional lenders require a lot more documentation than they used to. Unfortunately, investors are unable to supply many of the documents that lenders require.
An institutional lender often requires proof of income. However, investors who make their entire living in property do not have traditional income. Their income is realized from capital gains. That cannot be documented with a W-2. So it’s a lot tougher for full-time investors to meet documentation requirements.
Stricter underwriting requirements impact investors in a number of other ways. The common thread is that all the impacts add up to a situation in which it’s more difficult than ever before to fund new acquisitions with traditional financing. It is no wonder so many investors now look to hard money for acquisitions then turn to traditional lending to refinance. It’s the only way they can get deals done so they can move on to making money.
