“The Four L Test” may help you simplify the complex world of real estate investing and finance. It’s a formula I’ve followed for years.
Where is the property located? As the saying goes, real estate is really just about three things: “Location, Location, and Location.”
That’s why the same 2,000 square-foot house located in California near the ocean costs over $1 million more than when located in the Midwest. Location.
How is the current job market in your area? Are the unemployment or underemployment rates in the high double-digits?
If so, the rental and resale markets may not be as stable as in other areas where the job markets are more robust.
Again, this has a huge impact on the location.
Historically, residential properties (1 to 4 units) were much easier to finance than any other type of real estate. Today, some commercial real estate loans may be easier to qualify for and fund due to more flexible non-governmental mortgage lending options.
When considering whether to purchase a property, you need to know what sort of financing is readily available for that type of property. If you’re having trouble qualifying for a loan for a certain type of property, then future buyers for your property may have challenges qualifying for loans as well.
In spite of the much higher percentage of all-cash buyers in recent years, more individual investors typically rely on third-party bank financing in order to purchase properties.
Homes loans are typically easier to qualify for than land loans, apartment building, or commercial loans, and are more flexible for much higher leveraged loan amounts.
For example, many lenders today prefer to make land loans only up to only 40% – 50% loan-to-value (LTV) partly due to the perceived risk of land. Most apartment lenders may only lend up to 65% to 75% LTV, depending upon the income and expense history of the property.
You need to find out what type of money is available to get you into the deal and what type of money is available to get you out of the deal when you eventually sell.
Historically, it’s access to the supply of capital (easy or not so easy) that is the driving force behind a “Boom” or “Bust” housing market. In more flexible lending times, which include lower interest rates and easier loan underwriting guidelines, home and rental prices usually increase much higher than during periods with much higher interest rates and less access to capital.
Many of the factors within the “Lendability” category cross over into this category. How high of a LTV may an investor qualify for on the property type he’s seeking to purchase?
Owner-occupied residential properties may be preferred by mortgage lenders up to 97% to 100% LTV for certain types of government-backed properties. Non-owner-occupied properties, however, may only qualify for 65% to 75% LTV loans.
Since the onset of “The Credit Crisis” the Summer of 2007, a high percentage of 100% LTV programs have disappeared. With the higher loan amounts for more highly leverage mortgages, can you still afford to make the monthly payment?
On the other hand, a property acquired with 0% to 5% down may appreciate 5%, 10%, 15%, or 20%+ per year in a strong market, which will provide the investor with incredibly leveraged high cash-on-cash annual returns.
How quickly can I get my money out of the property in a sluggish economy, like we had for the past six or seven years? If I am in need of cash within a relatively short period of time, can I expect to sell the property within 1, 3, 6, or even 12 months?
Residential properties usually sell faster in most regions since there are more buyers available for those types of properties rather than non-residential property buyers who may be in search of multi-family apartments, retail shopping centers, or office buildings.
In today’s world of real estate and financing, it’s important to have as many different types of financing options available to both acquire and sell a property, including:
- Third-party bank loans
- Private money financing
- Creative seller financing, such as Contracts for Deeds, Lease Options to Purchase, All Inclusive Deeds of Trust (AITDs)
The “Four L Test” may be summed up in one word – Financing. Financing is the most important element associated with real estate. Financing gets me into and out of any and all real estate transactions.
For better or for worse, money does make the world go ‘round. So today’s savvy investors should seek to learn as many different investment and lending strategies by applying the “4 L Test” in order to prosper.