Portfolio/Commercial Financing - Term & LOC-Pro's & Con's & Strategy

Portfolio financing in this context can be considered any loan where a bank will retain the ownership and the servicing of the note internally. The terms will both be used interchangeably. Some times portfolio financing can be called commercial financing since smaller banks and regional banks often times portfolio these commercial loans and or notes on their own books. These bank will sometimes own the note for the full duration of the term (till maturity). The notes often times will balloon or be due at the end of the term so the borrower will have to refinance or payoff the note at the end.

Conventional financing is a loan that is generally originated, funded, closed, and then resold to secondary markets. They tend to be resold immediately after closing and sometimes held for less than 1 year and resold to the secondary markets. Sometimes both the servicing rights and the note are sold and often times if the bank has a servicing department, only the note will be sold while servicing is retained by the originating bank.

The first part to know when to use portfolio financing is to know the pro's and con's of the option. 

Pro's of portfolio financing: unlimited financed properties, ease of processing, low documentation relative to conventional, and flexible underwriting and terms in many areas, and will help you vet the deal since commercial/portfolio lenders focus on cash flow and if the property is not a viable candidate you will know right away

Con's of portfolio financing: generally higher rate than conventional, adverse clauses, covenants, and terms in the note , term tends not to be a full 30 years (amortization might be 20-30 years), may pay 1-2 points depending on relationship with bank, if the portfolio loan is a line of credit or LOC it may be annually renewable meaning you'll have to send in tax returns or financials to make sure your financial condition still merits keeping the line open.

Its good to use both conventional financing and portfolio financing for REI till all conventional options are maxed out (10 financed properties). After the 10th 1-4 unit residential property is purchased with financing only primary residences are allowed after that point so this is the point where investors are generally only left with portfolio financing as the only option left.

Portfolio financing is often times underwritten similar to apartment or commercial real estate so by utilizing this type of financing you'll be preparing your self to possibly take the next step from residential into commercial or multi-family real estate since the loan underwriting is similar.

A lot of times these portfolio term loans have line of credit components that are very beneficial as well similar to a HELOC or home equity line of credit, a portfolio or commercial LOC or line of credit acts in similar and different ways also.

The revolving interest only nature is similar however commercial line's of credit are a bit different in that they can range from 5 - 10 year fixed interest rate with 5 -10 year term as opposed to the typical prime rate + Margin that is typically used to determine rates on typical residential HELOC's. The key is that the rate doesn't fluctuate from month to month with some portfolio LOC's (not all) and you can plan and use the LOC's for acquisitions of future properties, rehabs, or other business purposes when potential deals arise. The LOC's allow you a higher degree of deal speed.

A Strategy we've utilized is to setup LOC's with the newly created equity that we've generated instead of selling the property and realizing a tax impact since selling short term can cause taxes of upwards to 50%+ (depending on the state) while selling after 12 months can cause long term capital gains of nearly 24% (20% top bracket + 3.9% obama care tax) depending on your income bracket. So the thought process is that if you were going to lose 20-50% anyways we mind as well keep the cash flowing asset and setup a line of credit up to 80% (what we would have "netted," anyway if we sold) of the property's new market value and avoid losing the 20% idle equity above this 80% loan position.

There of course are options to 1031 and delay the capital gains taxes all together but that requires a deal that is more viable then selling the current asset and this option is reserved as a arrow in the quiver for future options.