Jimmy Moncrief is a bank credit officer, real estate investor and member of Real Estate Mogul. As a banking industry insider, he’s contributing a series of lessons providing fellow Moguls with a rare glimpse behind the banking curtain, including some surprising insights and very savvy tactics we can all deploy to enjoy better, more favorable options for investor financing with banks. Enjoy…
If you did the homework from my last lesson, you know I’m all about having a capital plan. Most investors I’ve met haven’t really understood the importance or power of having this in place, but as both a banking industry insider and a real estate investor myself…trust me, it matters.
I’m about to give you a peek behind the kimono and share some really stealthy strategies I’ve seen savvy investors use with banks to get them to do things you’d never imagine they actually would do.
Currently, I’m en-route to Utah for a guys’ ski trip this week. It’s amazing to me how people let others not only influence their plans, but dictate their plans. For instance, I meticulously packed last night so I could fit everything in my carry-on so I could save myself $50 round-trip and not have Delta lose my bags. Win/Win.
Of course the plane was full and they announced they were going to “require” everybody in my seating zone to check their bags to their final destination. I of course didn’t move, because when I have a plan, I execute the plan. I promise you don’t want to be a hurdle when I’m executing my plan.
Anyway, like a herd of sheep, people flocked to check in their bags. Even people in another zone checked their bags. I get on the plane and of course there is plenty of room, which is actually not even the point.
How is this related to real estate investing? A couple of ways, but I’m only going to focus on one:
Lies You’ve Been Told about Lending
I’m not going to regurgitate all the crap that you’ve already heard. It’s actually not crap, its straight-up lies.
Lies like:
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Your loan has to be at 80% LTV, appraisal or your purchase price, whichever is lower;
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Minimum credit score of 650;
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Prior 2 years of rent-rolls, etc…
Lies, I tell ya!
As a banker, this is what I have seen with my own eyes:
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Guy with a 580-credit score gets a $1.2 mm property;
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120% LTV HELOCs with a 3.5% interest rate;
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My personal favorite: a guy got a -2% loan.
You read that right – he got the bank to approve a negative interest rate loan. If you are thinking this is some small $20k loan, think again. It was a $2 mm loan.
Time Out
Ok at this point I need you to break and do 2 things:
First, know this: I would never willingly share this on any old public website. RealEstateMogul.com is a private, members-only arena, and you're paying for the privilege of learning information many are never privy to. So please keep this in the family – don’t share it with your beer-drinking buddies because they think they “want to get into real estate someday.”
Second thing: At this point, if you haven’t already, you really need to go watch my previous video lesson. If you don’t, you may well be totally lost in understanding the principles of negotiating with your lender that I’m about to lay out for you.
Negotiating Principles
Every situation is different, that’s why you need to learn the principles of negotiating with your lender, rather than just trying to copycat somebody else’s situation.
Here are a few scenarios to consider:
Scenario 1: The Bad Credit Negotiation Strategy
So every bank (and most types of lending institutions) has some kind of “minimum credit score” in their credit policy, right?
The credit score was created so lending institutions could give a quick “yes” or “no” without having to train tellers and the like to actually underwrite. However, I say that credit scores are the absolute dumbest thing that has happened to the underwriting world in the modern century.
Why?
Because underwriting decisions are based almost entirely on this single number – a number which gives no bearing whatsoever to (i) your income, (ii) your cash flow, (iii) your net worth, (iv) your liquidity, etc.
As someone who has been lending money for the past 10 years, I can tell you that I have seen every-type of messed-up credit score scenario you can think of. Without going off the rails, I’ll give you some details to the example I gave above. How did a guy with a 580-credit score get a $1.2 million property? Oh, and did I mention that he didn’t put any money down and he got a rate that was 100-basis points cheaper than the banks “floor interest rate.”
First he said: Well why is my credit score that low? Digging in the details he had some crazy $80K credit-card balance, which was actually a corporate AMEX card that was reporting on his personal credit. (This is standard. Did you know that about 90% of credit reports have mistakes?)
Then he said: Since this is clearly a mistake and not indicative of my personal credit, I think the bank should make an exception. And it did!
So the principle here is, when your dumb credit score is an issue, you can often look deeper into it, find a “good reason why” you should get an exception, then make your case. If you’re dealing with an actual person – a brain that can make decisions on the other end (like smaller banks, portfolio lenders, etc.) they’re often quite pliable in scenarios like this. Meaning, just like our man here, you can negotiate an exception to your credit-score based assessment.
Bonus: How did he get into the property with no money down? Well, the property was a foreclosure and had previously appraised for $4.4 million. He paid for an updated appraisal and it came back at $3.7 million. Therefore, the bank was still in at less than 50% LTV.
Which is a nice transition to the next negotiation strategy...
Scenario 2: High LTV Negotiation Strategy
We’ve all heard that you have to be at 80% LTV for a bank or credit union to be interested, right? Instead of just fighting this, understand why that is....
Banks have to report all loans above 85% LTV to the FDIC or OCC. It’s called a Part-365 exception. And no bank wants to do this. So what are you to do?
Keep the bank at 80% LTV. But bring in some other banks…
You want your primary bank to be in an 80% LTV position, so you get a nice cheap rate and they don’t have an exception. However, you want another bank (someone fighting for your business - if you don’t have banks fighting for your business you haven’t watched the previous lesson) to give you an unsecured line of credit.
That’s the strategy: If you need more than 80-85% LTV, get two banks involved at LTVs that make them each feel comfortable and make sure one of them is fighting to get your business.
Do you think this is a small-time strategy that only works with small to medium size loans? Nope, the big guys do this as part of their key strategy, too. Who are the big guys? Well, the main one I pay attention to is Berkshire Hathaway (i.e. Warren Buffet’s group). (By the way, I’ve been reading his annual reports since I was 12. Nope, not that much of a nerd, just ambitious.)
In his latest annual report, he talks about his purchase of Heinz with 3G Capital Partners. He stated that 3G was the operating partner and he was the financial backing. Did Warren Buffett just stroke a check for the whole thing? No. He got a bank loan for the vast majority of the buyout. However, the banks wanted skin in the game so Berkshire Hathaway loaned the buy-out holding company preferred stock, where Berkshire Hathaway gets 12% interest, plus preferred equity.
I’ll get into some details later on improving your capital structure for your real estate company, but for now, just know that you have to get multiple financial partners for each layer of the capital structure if you want to grow big and fast.
In the most recent Forbes 400, one of the newcomers stated: If you wait until you have enough money, you will never do it.
Scenario 3: Low Interest Rate Loan Strategy
Everybody wants the lowest interest rate, right? As bankers, we often refer to these interest-rate focused investors as rate whores – someone who just wants to go cheap, cheap, cheap, no matter what the costs.
Pay attention to the latter section of the last sentence – no matter what the cost?
Firstly, I want you to understand that getting the lowest rate doesn’t mean it’s the best financing strategy for you. What on earth do I mean by that? Let me give you a real-world example that I saw firsthand just a few months ago.
A friend of mine owns several bookstores and he’s tired of dealing with all of the employees so he’s going balls-to-the-walls buying multifamily properties.
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He found 5 triplexes in foreclosure that he was going to buy for $85,000 apiece.
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They were all rented out for $600/month per unit.
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My bank offered him 6.5%.
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BB&T offered him 3.5%.
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He went with BB&T.
Four months later I asked how the triplexes were working out. He said: “Weeeeell, we haven’t actually closed yet.”
“What?!” I replied with shock in my tone.
He said: “Getting a loan with BB&T is like getting a colonoscopy, probably worse actually because they keep coming back asking for more.”
Do the math real quick on the cash flow he missed out on by closing 3 months later. You got it…ouch.
So my point in sharing this story is to understand that going with the absolute cheapest interest rate isn’t always 100% the best decision – there are other factors at play that you need to consider that can and often should impact your decision.
With that said, let’s get into how to get a cheap rate…
Let’s first talk about what’s scaring the crap out of bank CFOs right now: RATES. That’s right, record-low interest rates to be precise. They don’t want to make a ton of loans right now because when rates rise, they will have their capital tied up with low-rate loans.
How do you fix this? Offer to pay a completely variable rate.
Give this a try. If you offer this to your banker after they’ve given you some kind of fixed-rate offer and you can’t get a 100-basis point discount right off the bat, then go ahead and quit trying to invest in real estate…with bank loans anyway.
Other things you can offer for a crazy-low rate:
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Offer to bring your deposits over and put them in a non-interest bearing account.
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Offer some referrals.
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Offer to let them keep this loan even though a competing bank is offering a 100-basis point lower rate.
Here’s possibly my favorite lending negotiation story ever – this happened many moons ago when I was just learning underwriting for a big top-10 bank:
In this world, everybody just does what they’re told. Most people are just sheep = SHEEPLE. This is great news for you. You just need to learn how to be a shepherd.
Big banks just do what the policy tells them to do and they aren’t really interested in anything else. The client in this story was in the manufacturing business, but before this he was in banking, so he knew the rules and knew how to work them in his favor.
Here’s the deal: Pretty much all banks have some kind of cash-secured rate, which is usually 2% above the CD rate. If you pledge a portfolio of bonds stocks, etc. you get a guaranteed rate of let’s say 3.5%.
So what did this guy do? He took some excess cash he had and invested them in a portfolio of municipal bonds (i.e. tax-free interest) that yielded 5.5%. The bank had a rate of 3.5% for loans secured with municipal bonds. Also, note he will write off his interest expense for tax purposes. The tax-equivalent interest rate is more like 2.7%.
Therefore, the guy literally got paid by the bank to get this loan.
Wrap it up
At this point in the lesson, most people give a summary of all the points above. I’m not going to do that. Instead I’m going to leave you with something I once heard Preston Ely say at an event. He was going through a deal in which he was the major underdog and said something along the lines of this:
“I don’t need this deal, if you don’t want to do this right now on these terms, I’m out.”
Then he added: “Always be in control, even if you have to walk away.”
- Jimmy Moncrief
Define your competitive strengths on what you offer financial partners.
List 10 non-bank lenders and investors – note, don’t contact them yet, my next lesson is how I got a private money loan at 2% interest!
Start organizing your financial information for deals in a presentation format. You will more than likely need this in the future and it’s better to go ahead and build it while you have time before you have the deal, so your stakeholders take you more seriously and you have more negotiating power.