Going behind the scenes for lenders on real estate property

Published in the API Magazine – December 2006 issue on Pages 75 – 76. Most borrowers like the reassurance of having detailed knowledge of their lending institution and its financial reputation. Taking one step back, you first need to determine your level of understanding of the business of money exchange. There’s a significant difference in the risks associated with borrowing and investing and the information you should be aware of in each case.

Mortgage Shopping
There’s a lot more involved in selecting a mortgage than merely enquiring about interest rate and product flexibilities. Past articles have covered the intricacies of these topics, but how important is it to understand your real estate lender’s business?

A real estate lender’s reputation is an important criterion you should consider when taking out a loan for a real estate investment property. If you’re using a broker, they’ll usually have an opinion on the real estate lender. This opinion will often cover such things as credit policy, processing efficiency and in some cases, effectiveness in resolving disputes.

Particularly in the case of a real estate lender, you know nothing about, a little research is needed on your part to determine how long the lender has been in business for real estate investment lending and their ability to provide a consistent product.

Ask about the interest rate offered. Is it a special rate or a standard rate? This is more relevant when you’re considering a fixed rate product. There are some real estate lenders who may have a special rate advertised at the time you’re looking for a loan on your property but this rate may change significantly afterwards. It may well be a good deal to start with but when the fixed rate period is over, it may be a different matter.

Variable rate interest for real estate properties isn’t totally reliable either. Most institutions move their variable rate in line with the Reserve Bank cash rate. However, it’s not a rule that’s set in concrete and your bank lender can certainly change the interest rate, even when there’s no official cash rate adjustment. Ask about their policy on this. Is the variable interest loan written with a specific margin to reference rate (such as a standard variable) or is it unlinked?

Service: Mild, Medium or Hot?
In many cases service is a major factor when shopping for the right loan. Matching your needs with a big institution practices can be relatively easy.

With an unknown lender, however, you simply need to be a little more inquisitive. Is the service they provide perfect? Before you make up your mind, look outside the square.

Ask yourself, will they continue to provide good service after the sale, or will it grind to a halt once you sign on the dotted line? And does the company employ enough people to answer your queries in the future? A small company previously unknown to you is not necessarily to be dismissed, particularly if it meets your loan criteria.

Investing: a different kettle of fish
Many of us invest cash in the forms of term deposits, online accounts, cash management trusts, shares or managed funds. Here, the fundamental rule of investing is king – risk-return equation.

It’s usually easy to see the trade-off between the interest rate paid and the company’s financial background, especially on term deposit and debenture products. You’ll quite often see a 3 or 4 per cent gap on interest rate paid on term deposits by major banks and debenture products from small investment companies.

When considering putting your hard-earned cash into an investment company, you need to be more astute about the institution and its financial reputation. Ask yourself about the company’s ability to pay interest promised, as well as the principal when needed by you.

The newspapers may report the current cash rate of 6.25 per cent (at the time of writing), yet your company can offer an attractive 9 or 10 per cent. You should expect a higher level of risk associated with this type of investment.

It may be that your money is invested into mezzanine funds which banks are unwilling to lend against. In the unfortunate event of the investment company going belly-up, you must realise that banks have first claim against the assets, with you, as a private investor, coming in on the secondary level.

Security versus Reputation
As we can see, different assessments are required when you’re investing your cash and borrowing some funds for your property. Most mortgage originators securitise their loans so most of their assets are transferable if the real estate lender goes out of business for whatever reason. They’ll simply sell off their loan portfolio to another lender or investor (such as an insurance company or mortgage trust) or secure their portfolio as a mortgage-backed security (MBS).

MBS is an asset-backed security whose cash flows are backed by the principal and interest payment of a set of mortgages. These payments are typically made monthly over the lifetime of the underlying loans.

When your loan is administered by a new lender, they may reconsider the products structure and may offer you a new product as a substitute for your current product. This can become a hassle for you if there are significant changes in pricing and flexibilities of the new product offered. However, the mortgage lending arena in Australia is highly regulated, with many areas of legislation ensuring the rights of the consumer are met.

As an overall, when we look at security versus reputation, we clearly see that major banks offer both. Even though you may not be sure about a lender’s security, you can’t afford not to research the lending institution’s reputation.

Excuses, excuses when it comes to real estate investing …

When it comes to property real estate investment, it really is true that “anyone can do it”. Is it time to challenge some of your erroneous beliefs? Story by Michaela Ryan written for the December edition of the Australian real estate magazine called API.

I can’t afford to invest in a real estate property at the moment. Because I’m a single parent. A student. A low income earner. I’m single. I have four kids. Do any of these sound familiar? For just about every excusive you might think of, API has at one stage or another profiled a real estate investor to prove you wrong. Whether it’s your first property or your fifth, there are practical ways to overcome any obstacles you think are standing in your way. API regularly presents techniques for investing when you mightn’t have much home equity, cash flow or time. The scope of this article isn’t the practical things you can do, but the mental shift you need to make in order to succeed in property real estate investing.

Last month, we looked at some positive beliefs that tend to lead to success. Now it’s time to consider whether there are any negative beliefs standing in your way.

What is a belief?

Behavioural science expert Philippa Bond, CEO of Inform Training and Research, says beliefs aren’t substantial facts, although people mistakenly think they are.

“A belief is usually formed by anywhere between one or three experiences that occur, that the individual looks back on retrospectively and then formulates a belief based on (those incidences),” she explains. For example, Bond suggests a person might hear that everyone else is getting a much better return on their real estate property investment. Then they might have a bad experience with tenants. And they might go on to purchase another dud property or real estate investment. So any or all of these incidents might lead them to form a belief that they’re no good at property investing. Making a link between the events, they think that their belief is a fact.

The belief is not a fact, as it would be easy to do some learning and research and become quite good at property investments and real estate. But they never find this out, because their beliefs puts an end to their property investing. Alternatively, they keep investing, but all the time they’re telling themselves that they’re no good at it. “The pre-disposition of that belief being validated increases enormously,” Bond says.

How can you change a belief?

Bond says in order to change a belief, you need to think through its consequences. If the consequences are unsatisfactory enough, you might be prompted to change the belief.

So if you currently believe “I won’t ever be wealthy”, what are the consequences of that belief going to be? Perhaps you won’t ever develop a savings or investment plan. That might mean in 10 years’ time you’ll still be living in your current apartment or home. It might mean yuou’ll never get to take your family overseas. And in 30 years’ time you might be retiring to live on the pension – without a great quality of life.

If you’re spooked by any of the consequences, you’ll probably change your mindset. You might start to believe that you actually can be wealthy. There are plenty of practical things you can do to build your wealth. But until you alter that limiting belief, you’re never going to get off the ground. Now let’s look at some other examples of beliefs you might need to challenge when it comes to investing in property and real estate.

1. I can’t afford to invest“Some people say, ‘I can’t really afford it.” Says John McGrath. CEO of McGrath Estate Agents and author of You Inc. “The reality is you could have a lot more home equity than you think in your first property, and you might be able to borrow against it.” He adds, “Funnily enough, I think it’s as much about your belief and your strategy as it is about your financial capacity. I know people that are earning $50,000 or $60,000 a year that have bought two properties and real estate investments over the last six or seven years. And I know people that are earning $250,000 and they still have no assets or real estate investments.

“It’s not necessarily about how much you earn, it’s about how much you have the ability to save and how disciplined you are in your approach to your financial affairs.”

2. Property real estate is so unaffordable these days
If you listen to certain sections of the media on real estate and property, you’ll believe that property ownership is out of reach for most Australians and North Americans.

“it’s a very interesting psychological barrier – this ridiculous word called ‘affordability’,” says Bond. She suggests that affordability doesn’t actually mean anything; it’s only relative to your net worth, and your ability to access money. So the first thing you might need to do is define what affordable means to you. “Something that’s affordable has nothing to do with the price. Whether something is affordable or not has got everything to do with a cost benefit analysis,” Bond argues.

In other words, you don’t need to get a ‘bargain’ in order for a real estate property to be affordable. “If the return on the investment real estate property is going to be strong enough, and you have access to the funds for that property, then it’s affordable to you.”

3. Property homes can’t go up any more
McGrath regularly hears people say they don’t believe property real estate prices can go up any more. He recalls hearing the same thing 20 years ago when he was starting out in the real estate business. At an open inspection for a studio apartment in Centennial Park, he overheard someone say, “This is like a tiny room. How in the future will anyone pay more than $15,000 or $20,000 for a studio apartment?”

“Of course today that’s probably worth $220,000 or $240,000 for the same apartment. And someone walking in there today might be inclined to say the same thing,” he says. “I think you’ve just got to follow the trends, see that there are certain real estate assets – predominantly I think it’s real estate property and blue chip shares – that over a period of time have had a very consistent growth cycle that is dependable. There are some things that have faltered – I think you can buy risky shares. I think you can buy risky property. But if you stick with well located property and blue chip stocks, I thin you’re guaranteed the same cycle that generations before have enjoyed.”

4. Property’s too difficult to liquidate
Bond says many people believe that real estate property investments takes much more time and money to sell than other types of investments. She challenges this belief by saying, “(If) the contacts are in place, you can turn over a real estate property at a party! You get an exchange (of contracts) the next day. You then demand a 10 per cent release on the deposit … which gives you instant cash there and then.

“But if you have a managed fund, it can take anywhere between 14 days and 21 days to be able to get your money out.” “The shortest property settlement in real estate is going to be 30 days. But even it if goes up to 60 days, you’ve got it locked in by a legal contract real estate which is very difficult to get out of.”

This is only hypothetical, of course, and Bond isn’t arguing that real estate property is any better or worse than a managed fund. However, she makes the point that property investments can be liquidated (turned into money) a lot faster than many people would imagine. If a vendor is ambitious about getting a high price, then it might take a long time to sell a property or real estate investment home. But that’s a problem that’s easily avoided by keeping realistic price expectations from the start.

5. I don’t pick the best properties or real estate
Bond is impatient with people who believe that they aren’t good at choosing decent real estate. “If you don’t pick the best properties, it’s because you’re lazy,” she says. “There are so many magazines, so many reports. It’s so easy to pick the right properties and investments in real estate markets. You’ve just got to do your research. “(Someone might argue) ‘Yes but I don’t want to pay for the median price reports’. Well-pick the wrong properties then!”

Where to from here?

If you think through the consequences of any of these beliefs, they don’t auger well for your success in property investments in real estate. However, you can turn them around whenever you like. John McGrath suggests, “Use (your limiting beliefs) as a catalyst for developing specific solutions that help you move forward.”

“So if something concerns me or I don’t get a great feeling about it, it doesn’t always mean I won’t go forward on it. It often means, I’ll just ask myself the question, ‘what is it about this particular strategy or transaction that I’m uncomfortable with?’ And (I’ll” sit down on my own or with my advisors and say, ‘how can I get beyond this?’ “Sometimes there’s no solution and you’re better to not go ahead. But a lot of the time you’ll find there is (a solution),” McGrath says.

For example, if you believe you couldn’t cope with an interest rate rise in real estate, the solution would be to lock into a fixed rate home mortgage. Or if you believe you can’t afford another real estate property investment, you might resolve to see a lender to find out how much you can borrow. That way you can act based on the facts, not beliefs.