Hi, Reader!

One of the most important parts of starting and growing a real estate portfolio is the ability to finance properties. When done correctly, financing properties can be beautiful. The investor receives all of the tax, cash flow, and appreciation benefits of the entire property, but they only have to bring a portion of the money. There is a lot to know about financing, and after financing 30+ properties I feel like I have some insight to offer others.

There are lots of creative ways to pay for properties - seller financing, syndicating, hard money, subject-to, etc. Those tactics have their place, but this is not about that creative stuff. There are plenty of places to learn about that stuff around the internet.

This is about financing real estate in the traditional way - with banks. It's simple but can be allusive at times. It's a particularly important topic to understand if you are considering quitting your W-2 to pursue real estate full time.

This is also not about financing large properties or institutional-level real estate. That's a different topic and one in which I am not experienced. This is about an average person wanting to finance cash-flowing real estate under $2m.

Let's get into it.

About that W-2 Job

Banks love it. There's no other way to say it. You might want to quit your W-2, but financing real estate will get 10x harder with no W-2 income. Not impossible, though. I'll outline more on this below in The Ideal Path, but a great strategy is to begin to build your real estate portfolio while you still have your W-2 job.

Owner User

Similar to W-2s, banks love owner users. Imagine a plumbing company looking for flex space or an accounting firm looking for office space. Similar to a personal residence, a bank sees reduced risk when the business itself will occupy the space. If you're a business owner, a great strategy is for the business to purchase a multi-unit property, occupy one space, and lease out the remaining spaces.

Relationships with Local Banks

This is the most important thing I will write today, so take those AirPods out and listen up. More important than your W-2, your net worth, the tenants, or anything else in this list is having a relationship with a local banker (preferably multiple). I'm not talking about the teller at Chase. I'm talking about the commercial loan officer at a local bank with only one or two branches. They make lending decisions right there, in that building. Their reason for existence is to lend to local businesses, like you. You have this person's email address. You have this person's cell phone number. You send this person a Christmas card. You know their spouse and children's names. Get it? While ultimate loan approvals might go to a "committee", that committee will put a lot of value in what this banker has to say about you. A few years ago, I got financing ON A VACANT OFFICE BUILDING! How did that happen? Because of the relationship with my banker. When your banker is in your court, anything is possible.

Reputation

This is a very close second to having a relationship with a local banker, so hopefully you're still paying attention. Developing a reputation of success is a sure-fire way of making lending easy. Of course, this means making money on deals. More importantly though, (because your lender may not even know if you make money on a deal), this means having your financial documents ready, easy to understand, and properly labeled. It's having these documents in a single digital folder; not sending a million attachments. It means making payments on time or early. It means providing annual tax and insurance documents to the lender without having to be asked. Earn a reputation of being business-savvy and easy to work with. As an example, after I proactively gave my updated tax returns to a lender, he told me, "I wish everyone was as easy to work with as you". That's the lender that financed the vacant office building.

Watch those Leases

Expiring leases can be a deal-killer. The lender wants to be certain they will be repaid. If there is risk a property will go vacant soon, this raises red flags with the lender. This is also why vacant properties are extremely difficult to finance.

I'm a value-add investor looking for industrial deals nation-wide. My ideal property is occupied with a great tenant that wants to stay long-term but has an expiring lease. If a lease expires in 6 months, it's very risky for the lender to approve me for a 5-year loan. How will they get paid if the property goes vacant? Think like a lender. At this point, I know if a lender will finance a property without even having to ask.

Net Worth and Liquidity

These are often the trump cards. How do you get financing if a property is vacant, has expiring leases, is in a shady part of town, doesn't cover expenses, or you have no experience? Just have a boatload of money, that's how! With these types of loans, you will undoubtedly need to sign a personal guarantee along with the loan. Meaning, if this particular deal goes south and you're unable to pay off the loan, the lender will go after your other assets to be made whole. If you have LLCs that own other assets, you might need to sign guarantees on behalf of those entities as well. You want a $1m loan and you have $5m sitting in the bank? No problem!

Co-Signer/ Key Principal

I've never personally done this before, but I know it's possible to pay someone to sign on a loan with you. This person is called a co-signer, or key principal. Without this person, you wouldn't be approved for the loan. In exchange for a check or equity in the property, this person will bring their net worth, balance sheet, and reputation to help get financing. For a great deal, it could be worth it and a win-win for everyone.

It's an Art

The fun thing about commercial financing is that, at this level, it's an art, not a science. All of the headings above are different levers that can be pulled to get a deal financed. Often times, there are no hard and fast rules to get lending. Beginner with no experience but got a deal? Bring in a key principal to sign with you. Plan on doing a bunch of deals in one market? Build a relationship with a local banker. These banks are in the business of lending. It's how they make money, so there is almost always a way.

The Ideal Path

I'll lay out a potential path to financing for an aspiring investor in the beginning stages of their real estate investing journey. It might be strangely similar to my own path. I share it because these principles have worked so well for me.

You have a W-2 job and you hope that one day you can quit to live on your real estate earnings. You have little or no experience in real estate but you find what you believe to be a good or great deal locally. You have money for a 25% down payment, and you'd like a bank to finance the rest. You research banks in the area and call a few that have only one or a few branches. You meet in-person with one or more bankers to explain your background, your business plan, and the deal. After reviewing your finances, one of the bankers says YES. You close the deal and believe this is the start of becoming a mogul.

You keep working your W-2 and you find another local deal. Since you have your banker's email address, you send him or her an email with a brief outline of the new deal and ask, Is this something you would consider lending on? Since you've established yourself as a reputable borrower, they'll likely say YES. You close the deal as your next step toward being a mogul.

You close more deals, but at some point, this bank is no longer an option for you. Maybe your contact leaves for a different bank, they raise rates, or they don't like a deal. Lucky for you, you now have a portfolio and a reputation. You create a website or a document outlining your track record of being a reputable borrower and take this to other local banks. Since banks are in the business of lending, one says YES. And now you have a relationship with another local bank. Send a Christmas card.

This real estate thing is taking off for you, and your monthly cash flow is growing. You believe it's time to quit your W-2 to pursue real estate full time. You know it's a risk, but it's a risk worth taking.

You find your next deal. Now, you have TWO bank contacts that you can take it to for lending. During the process, you explain to your banker that, since my real estate investing has been so successful, I was able to quit my job to work in real estate full-time! The banker has some questions but knows that since you've been such a reputable borrower and have such an impressive portfolio, they'll continue to lend to you. Your path to mogul-ness continues.

You won't always hear YES, and there will be some bumps along the way. Maybe you want to do really big deals or venture to new markets and new states where your banking relationships do not extend. Since you've built a portfolio, experience, and reputation, you'll undoubtedly figure it out.

THIS WEEK ON THE PODCAST

I talk with Stewart Heath, principal at Harvard Grace Capital. In this conversation, we discuss having a competitive advantage, why some types of office could make a great investment, and Stewart's 3 rules for investing.

Listen here on Apple Podcasts.

Listen here on Spotify.

Watch on Youtube.

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Curious about commercial real estate? Read The Top 6 Reasons to Invest in Non-Residential Commercial Real Estate. ​