Don’t Fall Into the Rate Shopping Trap – Here’s Why
Rate shopping is one of the biggest traps that business owners can fall into. This is when you spend time looking for the lowest rates possible, instead of focusing on what really matters – the quality of service you receive. Just because a company offers low rates doesn't mean they are the best option for your business.
I’ve seen it time and time again. Small business owners frantically search for the best rates, coupons, and deals available. They think that by lowering their costs they will improve their business’s bottom line. But in reality, this is often not the case. In fact, chasing lower rates can actually have a negative impact on your business.
I'm aware that what I'm about to say might not be well-liked or even acceptable. But I think many seasoned investors will find my advice on selecting the lender—or lenders—you'll work with helpful.
How am I aware? Because in addition to being a co-founder of a loan business, I have completed hundreds of successful investments.
So here's what I'm saying: An investor shouldn't base their decision on a lender's rates alone. I am aware that this method is frequently taught, but I strongly object. Why? Read on.
What Might Be More Essential Than a Lender's Rates?
Yes, rates are crucial, but in terms of importance, I believe they should rank third or lower on your priority list.
If you want to invest for the long term, you will advance more quickly if you:
1. Select lenders that are moreover investors.
2. Select lenders with trustworthy capital.
To be completely honest, these points replicate two of the main marketing strategies used by my lending company, but that is not the reason I am bringing it up here.
I say this because, having worked in a number of market environments as both an investor and a lender, I have seen the significant impact that these two factors may have on an investment's strategy and capacity to expand. These two factors have a considerably greater impact on individual investors than the tiny variations in loan rates.
The latter: When it comes to choosing a service provider for your business, rate shopping should not be the first priority. Companies that offer extremely low rates are often cutting corners on quality of service or customer support. This means you could end up spending more time and money trying to make up for the lack of quality than if you had just chosen a more expensive provider with better service.
It is also important to look at the entire package when evaluating providers. You need to consider things like customer support, technology, and any additional services they offer. It may be worth paying a bit more for a provider that offers extra features such as online tools or support services. These can save you money in the long run by making your business more efficient.
Lenders As Investors
You need a lender who has a deep understanding of your industry. Why? Because lenders who are business-minded and are knowledgeable about the real estate industry can assist you in gaining access to financing and expanding your portfolio by using both conventional and novel methods.
These lenders have a different perspective than other lenders, weigh risks and rewards more carefully, and identify potential hazards in projects based on their extensive investing expertise rather than just the figures on a spreadsheet.
You are well aware of how crucial it is to assemble a staff with knowledge and experience. What a difference it would make if you had a lender who was a crucial member of your investing team rather than just someone you contacted when you needed money.
Good Bank Relationship
Lenders had to be investors in order to recognize the developer's team's potential and executional skills. You must be willing to learn with this customer because you are also investors and you are able to visit the market area, interact with the staff, and witness their goals in person. All of this made it feasible for you to become confident enough to team up with developers and make a significant entry into a developing market that otherwise would not have been conceivable.
Many seasoned investors are willing to pay higher rates in order to obtain additional leverage, which is something they look for when raising funds. Working with us was favorable for the developer since loan exposure is higher with an alternative lender than the bank, and he wanted more leverage to join the new market so he could have a bigger impact.
We were aware that even the most seasoned builders would not have been able to predict what happened during Covid, the supply problems that followed, as well as the sharp increase in loan rates. Investor required a lender who was knowledgeable about the impact that commodity and labor costs were having on his circumstances and who could work with him to devise innovative ways to use what he had previously established to put him back in a position where he could continue to move forward.
We must feel the pain as investors and lenders. We were all involved in this, and together, we solved the problem. We were able to creatively structure the agreement for the investor because alternative lenders can offer significant leverage. We permitted this investor to recoup a portion of the imputed equity he had built up in the project up to that point and changed his construction budget to account for the increased cost of completion. As a result, the investor was able to continue purchasing real estate and yet have the necessary working money to finish his projects.
Relationships are more important than your rates.
Having a lender that understands investing on your real estate team is a major advantage if you are a new investor. You need a lender who is prepared to discuss your proforma in detail and co-underwrite your deals with you in order to assess the viability of your venture.
For new investors, this is a priceless service that can make the difference between making a smart decision and one that backfires. You get absolutely no benefit from what can be one of your most valuable resources if you are not working with a lender who is willing to collaborate with you on this level.
When it comes to resources, your lender should be able to connect you with reputable architects, dependable contractors, reputable lawyers, respectable title companies, and reputable real estate agents, among many other professionals.
https://www.jacobsandco.com/agents/ Is here to help.
Many investors have simply chosen the option that offers the lowest rate of capital access. They consistently seek out the lowest price and treat loans like commodities.
However, some investors who go about approaching lenders in this manner and who do not have solid, ongoing connections with lenders who have consistent capital are encountering significant project obstacles in our shifting market.
Many investors have called us in recent months whose lenders have either temporarily ceased their loan pulls or have completely disappeared.
This happened because some lenders lacked the liquidity to sustain changes in the market (and others are simply brokers masquerading as lenders). Lenders who had the depth on their own balance sheets to support the loans made to real estate investors as a result of Wall Street's recent decision to stop purchasing retail lenders' loans had to temporarily or permanently halt lending. Even leaving buyers and sellers at the closing table, some lenders!
You need lenders with stable capital, which means they have the wherewithal to support you even if circumstances become even more unexpected, more than before.
Find lenders with a wide variety of loan options in addition to making sure they have dependable cash. It's crucial to know that the lender you've spent time cultivating a connection with can help you transition from a 1-4 unit multifamily house to a 1-30 unit apartment complex.
Most seasoned investors actually maintain contacts with multiple lenders; this isn't so they can compete on interest rates, but rather so they can take advantage of the various products they offer, some of which may be more advantageous as you advance in expertise. (A lender's product selection is heavily influenced by the capital that appears on their balance sheet and their connections to institutional investors.)
Whichever lender you decide on, treat them as essential components of your ecosystem rather than as commodities. The most prosperous investors see their lenders as trusted members of their inner circle who can provide them with the vital information and tools they need to succeed.
How important are rates really?
Don't get me wrong. Rates are not unimportant; they are simply not the most crucial factor when selecting a lender, especially when you take into account how moving more rapidly with non-bank loans can enable you to use your money more efficiently.
Here is a mathematical example to show this:
The Deal: Fix and flip project that takes five months to complete.
Purchase Price: $375K
Rehab Cost: $100K
Total Project Cost: $475K
After Repair Value: $575K
LTC (Loan to Cost): Assuming all lenders are lending at 85% LTC*
Loan Amount: $403,750
Bank loan: 7% interest-only loan payment is $2,355/month x 5 months = $11,775.
Alternative loan: 9.5% interest-only loan payment is $3,196/month x 5 months= $15,980.
Cost comparison: Alternative loan costs $841 more/month in interest ($4,205 over 5 months).
You can close an alternative loan in three weeks as opposed to a bank loan in two months, which increases the velocity of your money. Theoretically, two of these projects could be finished in 11.5 months with an alternative loan and two of these projects could be completed in 14 months with a bank loan, all other things being equal, for the sake of simplicity in illustrating this point.
Alternative loan profit = $100K/project x 2 = $200K – $8,410 (the additional alternative loan interest versus a bank loan)/11.5 months = $16,660/month
Bank loan profit = $100K/project x 2 = $200K/14 months = $14,286/month
In this scenario, the additional profit you gain by using an alternative loan versus a bank loan, after factoring in the higher alternative loan rate, is $2,374/month.
*The additional benefit of higher leverage: The above example does not take into account the added benefit you gain by getting higher leverage from an alternative lender (85%) versus the typical bank’s leverage (75%). For simplicity in this example, we used an LTC of 85% for both. This is one more factor to consider, as less money out of your pocket means you have more to put down on your next project.
Long-Held Assumptions in Institutional Lending: A Challenge
The loan industry as a whole is evolving.
It is time for us, as investors and lenders, to question some of the tenets of the established institutional lending structures. One of these presumptions is how investors should decide which lenders will be the best fit for them in a variety of scenarios.
Your investments will have an advantage in the long term if you choose your lender more heavily based on their track record of successful investments and their capacity to provide cash than just their rates.
Finally,make sure you do some research on the company before signing a contract. Read reviews and ask around to make sure they have a good reputation for customer service and quality of work. You don't want to be stuck with a provider who takes forever to respond or doesn't deliver on their promises.
Rate shopping is tempting, but it’s not always the best way to find the right provider for your business. Look for quality of service and customer support when evaluating providers, as well as any additional features or services they offer. Do some research to make sure you are getting a good deal and don't be afraid to ask around for advice. By taking the time to evaluate all of your options, you can ensure that you get the best possible service for your business.
Now that you know why rate shopping isn’t always the best strategy, it's time to start looking for the right provider for your business needs.
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JACOBS & CO. REAL ESTATE, LLC.
12923 Fitzwater Dr. Nokesville, VA 20155
(703) 594-3800 | jacobsandco.com