Primer on Banks and why they aren't all the same

[Michael Worley]

I enjoy reading Bigger Pockets and listening to the podcasts. I’m also a bit of numbers geek naturally so I try to break down things to the basic arithmetic most of the time.

What I have found is that there is an abundance of talk in real estate investing forums or in REI clubs about certain aspects of REI (50% rule, construction discussions, LLC vs. S Corp vs. Individual titling, etc.) but there are also shortages of informed discussions on the big picture of financing the properties.

I look at investing as having 4 major sections that have to be understood to invest effectively.

1. Site selection – broadly speaking which properties to buy (lots of discussion regarding this here and other places) – encompasses property, construction/rehab costs, and the decision points along the way
2. Funding the project – what type of capital stack to use (people love the jargon don’t they!) how and where to source the funding (more on this in a minute)
3. Project Management / Ongoing Operations of the property during the hold period (flip or cash flow, both are included in this section)
4. Exit strategy – even if you plan on holding the property for an extended period, that’s included in the exit strategy section

I think section 1 gets a lot of air time as does section 3. For the scope of this discussion we’ll omit those sections and focus primarily on section 2 with some discussion on section 4.

I’m a banker. I work for a community bank (often referred to here as a portfolio lender). I used to work for a large bank which did not portfolio their loans. What I want to discuss here is a beginning primer on how all banks are not the same.

Banking is a complex industry and it takes years to really understand it, even if you work in banking.

When funding a project there are multiple phases of the projects lifespan. Stages can include but are not limited to acquisition, rehab/construction phase, lease up and stabilization. Each phase has a different type of funding, and each type of funding has different funding sources that prefer to fund that phase.

In the initial acquisition phase of a deal, it could be that you're buying raw land with the intent to develop it. Many banks have no interest in raw land funding (it's very risky to lend money on an asset that provides no revenue). Some banks however will fund law deals at say 60% LTV/LTC. During the next phase which might include construction or rehab of a building/house it's not uncommon to get constructing/temporary financing. After the construction is done, during lease up/stabilization, it's common to get ‘mini-perm' financing which is around 3 years or so on average. After that phase it's common to get permanent financing (longer terms and amortization schedules).

An investor needs to know that all banks are not interested in financing the same stages.

An example would be that a hard money lender might be the best option for the acquisition of land. A portfolio lender is a good option for the construction / mini perm financing stages. A money center bank (think BofA, Chase, Wells) is a good place to go to for permanent financing. Permanent financing is almost always done by a bank that doesn’t portfolio their loans (they aggregate them to Fannie/Freddie, sell them MBS pools, Sell them to mortgage REITS, etc.).

The question often comes up about when to use a portfolio lender or when to seek Fannie/Freddie financing (which in reality just means go to a money center bank/aggregator because you don’t go to Fannie directly for a loan). If an investor knows which phase of the funding project that they are at, it’s a good indication of which type of bank to seek out.

This post is already in the TL;DR category but there is much more to discuss on this topic. The scope of this post is just to begin a discussion about this important aspect of investing.