Five Ways To Finance One-To-Four Unit Real Estate Investments

Real estate has always been an important part of the investment market but today the new emphasis is on smaller properties with one-to-four units. The logic behind small …

Real estate has always been an important part of the investment market but today the new emphasis is on smaller properties with one-to-four units.

The logic behind small investment properties is clear:

First, in many markets, large numbers of candidate properties and eager renters are available.

Second, interest rates today are low by historic standards.

Third, first-time homebuyers are a disappearing species who in many cases are either renting or living with Mom and Dad. According to the National Association of Realtors, first-time purchasers in April represented just 30 percent of all existing home buyers, down from the 40 percent or so the industry likes to see.

Zillow says home buying should be very tempting for qualified tenants because today "the typical renter should expect to spend about 30 percent of his or her income on the median rental home, up from 25 percent historically. Home buyers, on the other hand – thanks largely to low mortgage interest rates and home values that remain below their recent peaks in many areas — should expect to spend just 15 percent of their income on a mortgage, down from 21 percent historically."

The catch is that huge numbers of potential first-time buyers cannot enter the marketplace because of lagging incomes. Simply put, they’re not financially qualified and rising rents make saving increasingly difficult, meaning many are stuck in the rental world. The Pew Research Center says 51 percent of us were in the middle class as of 2013 — down from 61 percent in 1970 — while the Census Bureau notes that real household incomes were 8.7 percent lower than in 1999.

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Taken together these trends have created a clear demand for investment property. Several Wall Street firms have entered the buy-to-rent (BTR) business in a big way, purchasing single-family homes rather than apartment complexes or high-rise rental properties. As an example, Blackstone Group’s Invitation Homes reports that it owns more than 45,000 single-family properties.

"What’s interesting about the buy-to-rent business is that you don’t have to be a financial giant to play," said Rick Sharga, executive vice president at "This is a market which traditionally has been dominated by small, local investors seeking cash flow and gradual appreciation, not only year-to-year but also in many cases from generation-to-generation. Even with the entry of institutional investors into the field in recent years, there’s still plenty of opportunity for individuals looking for one-to-four unit properties.”

One of the reasons why small investment properties are so attractive is that lenders do not view such homes in the same way that they see commercial real estate such as stores, warehouses and apartment properties. Properties with one-to-four units are relatively easy to finance and therefore relatively easy to acquire.

In basic terms there are five ways to finance investment property with one-to-four units.

Cash — No fuss, no muss, just write a check and you’re done. There are no worries about lenders, points, fees, interest rates, paperwork, lost paperwork or more paperwork. No less important, buying for cash may give investors a substantial marketplace advantage, the ability to buy at discount in situations where owners want to sell as quickly as possible.

FHA — You cannot buy investment real estate with FHA-backed loans if the entire property is rented. However, the FHA has a provision which works very well for entry-level investors: It will finance properties with two-to-four units under the condition that one of the properties is occupied as a prime residence by the borrower.

The FHA program is attractive because borrowers can purchase with 3.5 percent down, far less than typical investor programs require. Also, the interest rate may be surprisingly-low: Ellie Mae reports that in April the typical FHA borrower paid 3.989 percent to finance versus 4.151 percent for the conventional borrower.

VA — The VA does not finance investment properties, but there’s one circumstance where a VA-backed mortgage can be used for refinancing. According to the VA, for an Interest Rate Reduction Refinance Loan (IRRRL), government language for a VA refinance, "the occupancy requirement for an IRRRL is different from other VA loans. For an IRRRL you need only certify that you previously occupied the home."

Translation: If you bought a home with VA financing as a prime residence and converted the property for use as a rental then you may qualify for a VA refinance.

Conventional Mortgages — We usually think of conventional loans as financing with a 80/20 mortgage — you put up 20 percent of the sale price plus closing costs and the lender will put up 80 percent of the sale price.

With conventional financing for an investment property look for at least 20 percent down and a somewhat higher interest rate (because investment properties are thought to represent more risk). You may also find that the loan application standards are different: for instance, you may need two years of rental management experience if you want to use rental income to qualify for the loan, gift money may not be allowed, and lenders will routinely knock off 25 percent of the rental income for vacancies and maintenance. Lender standards vary widely so be sure to shop around.

Investors — Some real estate buyers finance their properties with funds from investors, family members and friends, either with a group ownership, through loans or a combination of both. New loan products – specifically created for small investors who want to buy and rent one-to-four unit properties, are also available from large institutional investors and hedge funds.

The terms and conditions related to these arrangements vary but any involvement with private financing or joint ownership should automatically require the use of an attorney by each participant to make sure that both parties interests are protected.


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