We love leverage. Like leveraging geoarbitrage and renting our homes out on AirBnB while we travel, or leveraging the school community to create a carpool for our kids. Heck, you may even find us leveraging an extra long wrench when changing a tire.
In real estate, leverage is one of the top reasons we can grow our wealth. This leverage comes in the form of financing a property. With many debt products on the market, it is essential for us to understand how these will impact our expenses and ultimately the returns on any property we evaluate.
Why We Love Debt In Real Estate Investing
As one of the major expenses of any real estate property, the type of loan – or debt – used to acquire a property can greatly impact cash flow amounts. We love that our tenants help us pay this expense while we maintain ownership of the asset. But if our interest rate is higher, more of the property’s income will go back to the bank, rather than into each of our distribution checks.
This is why we love fixed-rate, assumable loans in a higher interest rate environment, such as a HUD loan.
A HUD 223(f) loan is a multifamily financing vehicle that is insured by the FHA® and provides the lowest-cost source of non-recourse, fixed-rate financing.
Before we look into each of these advantages, let’s get a misconception out of the way.
Misconceptions of HUD Loans
The Department of Housing and Urban Development, known as HUD, has typically been associated with affordable housing or Section 8 developments. However, HUD offers many different programs and products to improve and develop our Nation’s communities.
While HUD does support many low-income developments, many average, or unrestricted, multifamily projects also have been financed under this program. This includes construction loans to build multifamily finance projects that we can then purchase.
If a developer uses this type of financing to construct a property, we may be able to assume that loan – or take it over with the same terms. This could include a lower interest rate than currently available out on the market.
Benefits of HUD Multifamily Loans
The advantages of this type of HUD loan includes longer amortization periods, lower interest rates, fixed-terms, non-recourse debt, and the potential to be fully assumable. Basically, everything that can be harder to find in a high interest rate market.
First, longer amortization periods mean payments typically remain lower and cash flow higher throughout the life of an investment.
Second, fixed rates reduce vulnerability of rates increasing – and thus requiring more income to go toward debt in the future. Fixed rates also eliminate big balloon payments often required at the end of other loan periods. HUD offers one of the only fixed-rate new construction loans on the market today, with up to a 40-yr period.
Third, non-recourse debt means that the bank can only use specified assets as collateral, typically the asset being purchased. This means that they can not try to seize any other properties owned by the operator or investors of these properties.
Finally, these types of HUD loans have the potential to be fully assumable by a new owner. This means that we can leverage potentially lower interest rates secured at the time the seller purchased or developed the property. If higher interest rates or non-fixed rates can’t be found in the current market, securing an assumable loan can be like finding a treasure in a shipwreck.
Finding Favorable Debt in Today’s Market
In today’s higher interest rate debt market, favorable financing is hard to find. Deals that would otherwise provide favorable returns may be too risky using higher interest or non-fixed rate debt.
Finding this type of HUD loan can decrease risk of future rate hikes because the fixed rate prevents changes in the interest rate paid to the bank every month. We won’t ever be surprised with a bigger expense than expected with fixed rate loans. This means that we can keep more cash flow in the pockets of the investors – instead of the bank.
Now that’s the kind of leverage we love to get behind.
Investing your funds in real estate is a great way to diversify your portfolio and build wealth for the future. Although there are some risks involved, the potential rewards far outweigh them.
Here at Goodegg Investments, we are all about helping you build sustainable and long-term wealth so you can build a stable nest egg while also making an impact in the world.
If you’re ready to invest right now, whether with your personal funds, through an entity, or through a self-directed 401(k) or IRA, we invite you to check out our open deals page to learn more about our current or upcoming opportunities.
If you’re not yet ready to invest but are curious about how all of this works, we invite you to dip your toe in the water with us through our free 7-day email course – Passive Real Estate Investing 101 – or to get a free hardcover copy of our book – Investing For Good.