Every property I have ever purchased has been with the help of a mortgage broker. After my recent trip, I have started to wonder why this is the case. The obvious answer is simply their access to cheaper capital. Brokers can secure rates 50 to 100 basis points (.5%-1%) lower than most local and national banks. Additionally, the terms tend to be more investor friendly, with longer amortization and no recourse. With all of these benefits, why would anyone consider going anywhere else?
The answers lie in two things: Technology and Relationships. The easiest explanation is simple disintermediation through technology. The Internet has opened the mortgage world to investors by allowing them to search many national and local bank rates, as well as, look across the country for the most aggressive mortgage lenders. The time will come (probably very soon, if not already) when some forward thinking investor will provide a site that connects investors and lenders in the same way mortgage brokers do now (think Lending Tree for Commercial Loans).
Additionally, looking at Brian Brady’s recent post, Interview: The XBroker, the industry seems poised for positive transparent change. This change will further allow disintermediation and provide investors unparalleled access lenders. Furthermore, increases in information will drive down pricing. I have consistently been quoted prices in the 1% (of loan value) range for broker services, which can be fairly steep as a percentage of closing cost when purchasing properties in the $500,000 to $1,000,000 range. I would love to see this come down to 50 to 75 basis points (sorry to the brokers out there, but business is business).
The less obvious answer is relationship building. I probably mention that real estate is a relationship business in 90% of my post because I really believe this. This concept is no different when working with banks. The value of the relationship, however, is not apparent right away. Most banks have specific lending criteria and will only be able to offer certain terms based on their risk assessment model. This fact alone keeps mortgage brokers employed. What investors fail to realize, however, is that banks have latitude in other aspects of lending; I want to specifically address foreclosure here.
No investor goes into a property thinking it will be foreclosed, but it happens. The catch is that banks can choose when to foreclose and they can even choose to offer bridge loans instead. Enter the investor relationship. While the relationship is not solely responsible for these decisions, it helps tremendously. Properties that show good fundamentals with a cash gap are prime opportunities for bridge financing. This financing is almost always easier (and cheaper) to get from the original lending institution because they have the most to gain or lose from foreclosure. Having a strong past relationship with the lending institution increases the likelihood of workout financing and decreases the likelihood of foreclosure.
So what should the investor do with this information? Consider this information like a real option. If you do a lot of investing in one market and have a good relationship with a commercial bank, first, make sure you are getting their best rates. Then, consider the market cycles. When the market is strong this real option will probably have little value because the risk of foreclosure is very low. However, as the risk of the investment goes up (or as market fundamentals decline), this option becomes more valuable.
Financing is one of many tools that real estate investors have in their arsenal. There are clear times when it is appropriate to go for the best rate and terms possible, but do not always assume this is the case. A good relationship with a strong commercial lender has value as well. While that value will fluctuate by market condition, it should always be considered when vetting financing alternatives.
Brian Brady says:
“I have consistently been quoted prices in the 1% (of loan value) range for broker services, which can be fairly steep as a percentage of closing cost when purchasing properties in the $500,000 to $1,000,000 range. I would love to see this come down to 50 to 75 basis points (sorry to the brokers out there, but business is business). ”
Michael:
You are the exception rather than the rule. My guess is that you come to the broker with a full understanding of the loan process, the mountain of paperwork neatly compiled, and a rational understanding about DSCR.
Why shouldn’t you be rewarded for saving a mortgage broker tons of time? My suggestion to you would be to develop a strong relationship with a national mortgage broker who has a real understanding of the properties you purchase and negotiate a fee for each transaction upfront.
A mortgage broker offers three things:
(1) expertise about the loan programs available
(2) access to wholesale rates for capital
(3) a system to insure a smooth loan transaction
If you can provide one or two of those components of the service offering (namely 1 and 3), you should pay less than those who need them
January 31, 2007 — 9:16 am
Chris says:
I agree about creating a relationship with whoever does your lending. My uncle lost a big commercial property in the late 80’s and the bank worked with him. They didn’t want to foreclose and he was able to pay nothing on the note (about $5M) for a year. He still does business with them to this day.
Relationships count for a lot, and everything is always negotiable.
January 31, 2007 — 11:30 am
Jeff Brown says:
Since by necessity I must work in different states, my brokers need to be able to lend everywhere. The more business I do in multiple states, the more I pare down lenders.
My prediction is by the end of this year 80% of my clients’ loans will originate from one broker.
Good post Michael, and thanks for the cogent comment Brian.
January 31, 2007 — 11:58 am
Agusto says:
Mikel,
How did the mortgage brokers that you have a realtionship with react to your thoughts about cutting their commissions in half? I have a feeling that if you do that you’re going to be doing alot more shopping for rates and your relationship will suffer.
Hey Brian,
How are you going build expertise about the loan programs available and ensure a smooth loan transition if you don’t have access to wholesale lenders? Humm I wonder why mortgage brokers have access to cheaper capital.
I guess it might not be so bad if a mortgage broker was paid too simply offer access to wholesale lenders similar to the discount realtors that you pay to give you access to MLS and you sell the home yourself.
January 31, 2007 — 3:54 pm
Michael Cook says:
Agusto brings up a good point when he asks how mortgage brokers will react to my suggestion of a price cut. I have two responses to this.
First, I do a lot of deals. If the deal is a plain vanilla deal with minimal work on both sides, I expect (and most of the time get) a discount because of my relationship. In the past I bought all of my properties through one broker. He got a great deal of business and was not oppose to cutting the fee on a straight forward deal. That being said, I was also willing to pay a bit more if the deal required harder to obtain financing.
Second, its about being choiceful. There is no rule to say that you cant have a mortgage broker relationship and a bank relationship. If you are an investor you should certainly have both. Investors who buy multiple properties per year can certainly give good business to both sources. My suggestions is to choose wisely when considering your options. If a property is higher risk, dont go with a bank you are unfamiliar with to save 50 basis points. Take the deal to your local bank, pay the slightly higher interest rate, and take comfort in the fact that if things go bad you have an ally.
January 31, 2007 — 4:14 pm
Brian Brady says:
Humm I wonder why mortgage brokers have access to cheaper capital.
We are compensated to originate and package the loan. Mortgage brokers originate over 65% of the residential loans and over 30% of the commercial loans. Lenders offer the wholesale pricing to a broker so they can either
)a) mark it up to retail pricing a borrower would get at the bank (much like a retailer of, say, shoes)
One could deal with a discount mortgage broker and get access to the wholesale rates. Or just negotiate a “volume discount” as Michael suggests. I’m no slave to the 1% model if a borrower delivers me 3-4 loans annually and knows what he/she wants.
January 31, 2007 — 7:21 pm
Brian Brady says:
post script:
Michael:
Disintermediation in mortgages seems to be a 10 year old thought. Priceline and Costco thought they would elimate the mortgage broker. Alas, the wholesale lenders who participated in the technology found that the quality of the loan package was lacking and stoped passing on wholesale rates to a borrower who couldn’t deliver the proper package.
The there’s the expertise and knowledge that comes from using a broker. Good ones are irreplaceable
January 31, 2007 — 7:25 pm