Three Hurdles in the New Era of Investing

Lenders are clamping down with strict title seasoning guidelines, appraisal guidelines and borrower requirements designed to protect their interests…and make the art of property flipping a little more difficult.

Because housing is a necessity, strong demand for real estate is always present. The declining market we’re in was not caused by a sudden decrease in demand for housing. It was caused by banks and mortgage lenders becoming increasingly reluctant in the past two years to do what they are supposed to be doing: lending money to would-be homeowners. Real estate investors have fewer people to sell to right now because so few homebuyers can get financed to buy a house. That’s why many real estate investors are having trouble making money right now. Their viable exit strategies for converting their marketable home’s equity into cash are greatly diminished. Its not that their potential buyers don’t want to buy a home right now, they simply don’t have the means to obtain financing.

Because mortgage lenders are so reluctant to lend, people are forced to either put up mega down payments to qualify for a loan on a house, or buy a house with their own cash. Not many people can exercise either of these options at this point in time. Over time, loan guidelines for buyers will become more flexible, allowing people will come out and buy houses again. This will eventually raise prices as available houses start to get bought up again. The important thing to remember is that overall demand for housing relates closely to available loan products and credit guidelines for would-be home buyers at any given time.  When the market starts to correct again, investors will be amazed at how easy it is to make large profits every month because potential buyers will be able to obtain financing with relative ease again. Nevertheless, it is important as an investor to have exit strategies that work in any market. If an investor or seller can make it in this market, they can dominate in better markets.

So as long as banks won’t lend as freely as in years past, does that mean sellers and real estate investors are out of luck until times improve? For those that don’t have the right information, the answer is yes. But the answer is much different for certain sellers and investors who relentlessly search for new ways to buy and sell real estate for profit. For them, making money is not so difficult right now. Listed below are three troubling obstacles for current sellers and investors combined with information on how to evade them. These obstacles affect all sellers and investors right now, but also apply to a lesser extent no matter what type of market presides. These three obstacles apply to any person that wants to buy property to renovate and sell at wholesale or retail prices, or buy, refinance then hold property as rental.

The Three Main Obstacles Today’s Sellers and Investors Face

1. Title seasoning refers to the length of time an individual holds title to a particular house. Title seasoning guidelines are set by all mortgage lenders and change based on market conditions. These guidelines are one of the greatest obstacles that any seller can face – especially in today’s market. The concept of seller title seasoning guidelines can be summarized simply by stating that most conventional mortgage lenders want a property owner to hold title to a particular property for approximately 1 year before that owner sells that property for profit or exercises a cash out refinance. Seasoning guidelines protect mortgage lenders from lending too much money against a property that a seller or investor intends to make a profit on. FHA seasoning guidelines are not as strict, but 90 days on title as the owner is the prerequisite to sell to an owner occupant buyer who qualifies for an FHA loan.

How long an individual has held title to a particular property before selling or cash out refinancing is important to potential lenders. They feel that lending money to a buyer for a property that a seller has increased the price of is risky. This makes sense; would you want to lend money against a home that was bought for $50K and then weeks later is being sold or refinanced for $110K? On deals like this, banks and mortgage lenders ask themselves: What could justify such a huge gain in value and how much does this equity stripped house stand to make the owner who is trying to sell or refinance it? Remember that if the house goes into foreclosure after the house is sold or refinanced, the lender will be under-collateralized while the investor who refinanced or former owner makes away with a big cash profit. This scenario plagues banks.

Owners or cash out refinance candidates who have been homeowners for less than a year on any given subject property are going to need to show potential lenders proof of the improvements that were made to that subject house. This is called a value justification (which shows the potential lender that the home will indeed collateralize the loan an investor or buyer seeks) and can be done through the loan officer handling the loan file. If a seller or cash out refinance loan candidate just can’t seem to close their deal due to a term of ownership that falls short of lender seasoning requirements, then they need to be prepared to lease their home until the house becomes “seasoned”.

2. Appraisals are being scrutinized by mortgage lenders more than ever before. Lenders that have survived the recent foreclosure crisis have figured out that the practice of over lending to unqualified borrowers caused former banks and mortgage lenders to bite the dust. This has unfortunately caused today’s remaining lenders to scrutinize appraisals and “chop” appraised values down to protect their interests against lending too much money to any given borrower.

The whole concept of a flip is to buy low and sell at a higher price to a buyer in proportion to the highest appraised value a real estate investor is able to get on their subject home. Having a home appraise as high as possible to create a better looking deal attracts potential buyers. During the mortgage boom, investors would choose an appraiser who could get suspiciously high values for the homes they were flipping. Some investors had a legitimate claim to seeking higher than average values on homes they sold because they did great renovation jobs. Other investors committed blatant fraud and bribed appraisers to come in too high on homes they were selling. Once again, mortgage lenders are aware of this issue and will do anything to avoid lending money on homes that seem to have an appraised value that is high.

The practice of investors controlling an appraiser’s point of view from a value standpoint isn’t happening too often anymore because of stiff, lender imposed appraisal guidelines. All mortgage lenders are now controlling the appraisal valuation process by outsourcing appraisals through large appraisal firms; thus investors have no control over their home’s appraised values. Investors who want to buy and sell property for profit absolutely have to buy the very best deals and pass on the rest. Anyone planning to flip a house need to survive an estimated 25-50% reduction in any given home’s value based on an anonymous appraiser’s valuation – and still be able to make a profit when it comes time to sell. The best option is to pick areas to invest in that are in high demand. In other words: stay out of marginal areas with many foreclosures.

Before purchasing a home, it is wise to get proof of several comparable sold homes within ½ mile of the home to be purchased, that also possesses a similar build style and similar square footage. Any comparable homes sold outside of 6 months and/or across major thoroughfares from the neighborhood of the home to be purchased should be considered invalid. Do not buy in areas with a lot of foreclosures as appraisers are being instructed by lenders to use multiple foreclosures as comparables in any given subject house’s appraisal. What’s worse, many appraisers use these foreclosure comps and compare them to the house being sold or refinanced – no matter how ugly these foreclosure homes may look. This obviously destroys the value that a seller or investor thinks they can get

3. A potential buyer’s “lendability”. Credit scores, employment history, a 2 year residence history with provable on time rent or mortgage payments, annual income and how much money a potential buyer has in the bank are items that are now being heavily scrutinized by lenders – much more than ever before. Banks issuing conventional loans are only lending to extremely good credit borrowers (usually 680+ credit scores) in good financial standing with low debt to income ratios. FHA lenders are more lenient and are able to do sub prime (under 600 credit scores) loans still. All lenders want “full doc” borrowers, meaning every buyer has to show their current pay stubs, last 2 year’s W-2’s (or last 2 years tax returns if self employed), and their last 2 months bank statements before a lender will considering structuring a mortgage for them. Borrowers must have a debt to income ratio (DTI) of <50% to qualify. In other words, all monthly debt payments displayed on the credit report of a potential home buyer have to equal or be less than half of their gross monthly income. Even if the borrower can supply this information and qualify, there are always the title seasoning guidelines and new appraisal guidelines increasing the chances of a deal or property flip blowing up. Stated income/asset loans and no documentation loans are gone, so developing relationships with several reputable loan officers and mortgage brokers is wise for those who wish to be on the cutting edge of new loan products – increasing the chances that a potential buyer can receive a loan to close the deal.