By Jorge Vazquez, CEO of Graystone Investment Group
Today, I want to address a critical topic for real estate investors. Just moments ago, I had a conversation with an investor who asked, “Can I buy distressed properties with conventional lending?” My answer is simple: this strategy is flawed, and here’s why.
Understanding Distressed and Off-Market Properties
When we talk about distressed or off-market properties, we refer to properties that are not listed on the MLS. These properties often come to investors through wholesalers, who are able to secure deals at lower prices due to one primary factor: speed. The sellers of these properties are often facing financial emergencies and need to close quickly. This is where companies like Graystone and other wholesalers step in, offering rapid closings—sometimes in as little as two or three weeks.
This speed is the leverage that allows us to purchase these properties at a discounted rate. Sellers in distress don’t have time to wait for a conventional buyer to navigate the often lengthy process of securing traditional financing, which can take 30 to 45 days or longer. That’s why distressed sellers are willing to sell at a discount. They need liquidity, and they need it now.
The Flaw in Conventional Lending for Distressed Sales
Conventional lending is not designed for speed. A traditional loan typically requires 30 to 45 days to close, which directly conflicts with the needs of distressed sellers who want to close quickly. If you’re waiting for conventional loan approval, you’ll likely miss out on the best off-market deals, which demand quick action.
Additionally, when you buy a property conventionally, especially through the MLS, you’re often paying top dollar for a property already improved or rehabilitated by someone else. The previous owner has put in the time and effort to repair the property and then capture that equity. Essentially, you’re buying the equity they’ve created rather than building it yourself.
In contrast, when you buy distressed properties with speed and private financing, you have the opportunity to build equity through repairs and improvements.
Private Lending: A Better Solution
Many investors shy away from private lending because of the higher interest rates, often around 10%. However, this concern is misplaced when you take a long-term perspective. Let’s break down the math.
Suppose you purchase a distressed property using private lending with a 10% interest rate for one year. After making repairs and increasing the property’s value, you refinance into a conventional loan at 5-6% for the remaining 29 years. Over the 30-year life of the loan, the average interest rate is barely impacted by the short-term high interest from private lending.
When you compare this to the conventional option of locking in a 5-6% rate from the start, you realize that the savings from buying the distressed property at a lower price far outweigh the cost of one year of higher interest. The key is building your equity.
Conventional Lending Comes with Extra Costs
In addition to slower closing times, conventional loans come with a host of extra costs and requirements. For example:
- Full Appraisal: You’ll need to pay for an appraisal, which could cost $500 or more.
- Four-Point Inspection: You’ll need to ensure that major systems (roof, electrical, plumbing, HVAC) are in top condition, which adds time and expense.
- Insurance: Conventional loans require full insurance coverage based on the property’s value, which can triple your insurance costs compared to the minimal insurance required for private lending.
Moreover, the amortization schedule on a conventional loan means that in the first few years, you’re mostly paying interest, not principal. So while you may think you’re building equity, it’s minimal at the start of the loan term.
The Value of Speed and Flexibility
Let’s consider two scenarios to illustrate why private lending for distressed properties makes more sense than conventional loans.
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Scenario 1 – Conventional Lending: You find a property on the MLS, secure a conventional loan, and close in 30-45 days. You pay a higher price because someone else has already made the improvements and captured the equity. You also pay for inspections, appraisals, and full insurance and begin with minimal equity.
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Scenario 2 – Private Lending for Distressed Property: You secure a distressed property through private lending and close within two weeks. You pay less for the property because you’re promising speed. Over the next six months to a year, you improve the property, build equity, and refinance into a conventional loan at a lower rate. You save on inspections, appraisals, and insurance, and you’ve captured far more equity by doing the work yourself.
The difference in the acquisition price is significant—often $20,000 to $40,000 less for a distressed property. That’s equity in your pocket that wouldn’t be there if you took the conventional route.
Conclusion: Choose Speed Over Comfort
If your investment strategy is to buy only properties that qualify for conventional lending from the start, you’re setting yourself up for failure. It’s difficult to find distressed properties that meet all the requirements for conventional loans, and even when you do, you’ll pay a premium for them.
Instead, consider using private lending to move quickly and secure off-market deals. This approach allows you to build equity through repairs and improvements, and then refinance into a conventional loan when the time is right.
As I always say: “You invest, we do the rest.”
