The one in which we almost start a real estate fund
Finding ways to come up with the money to purchase real estate results in career options you never thought possible (and that is saying something!)
Ahh, the imagination of children. It’s unlimited *stares into the distance with a faint smile* … This is where what could be a cute story ends very abruptly. Turns out, the imagination of young teenagers is equally unlimited but much less cute. At least that’s the conclusion I reach quickly when thinking back to my answers to the age-old question of “and what do you want to be when you grow up?”. There was a time when I’d say “foreign correspondent” which I still find somewhat shocking in its realness. My beloved grandfather was a journalist, so that part made sense. Add travel and you get a pretty awesome job, even by today’s standards. Sure, newspapers are dying and it probably isn’t quite as glamorous a gig as young me imagined. But this certainly wasn’t my most embarrassing or unrealistic answer given there was absolutely a time I thought both model or professional dancer were totally attainable careers. Don’t worry, I am cringing on my own behalf.
What I never thought I’d be when growing up? A real estate fund manager. Surprising, I know. Yet that almost happened just a few short decades after I sat stretching in jazz dance class, dreaming of auditioning on a stage in New York despite fully realising that my peers somehow seemed noticeably bendier, more musical and, I don’t know, just more like potential dancers. Let me tell you how I got there - almost becoming a real estate fund manager that is. Not jazz dance class.
When we initially started thinking about buying a house in 2012, very theoretically, that dream definitely felt less realistic than that of being a model (at the respective times of dreaming). We just didn’t think we had the funds. That didn’t turn out to be true - or needed, more specifically, because the financial structure we actually created was largely based on the fact that we were able to finance the purchasing price through a mortgage in its entirety. But for an uninitiated moment, we actually thought that raising funds from a larger group of family and friends would bring real benefits.
The first and most obvious one: more cash. We simply wanted to fundraise to have capital at our disposal - which we believed was the only way to even start looking for real estate
Secondly (though closely related): even if we had started with no money to our name, more cash in either case means better interest rates. Obviously. Pooling money from friends would have given us a bigger lever and better deals in talking to banks
In a non-money advantage: having a group invest together also seemed like a good idea in terms of the workload. Having more people on board meant shared responsibilities
And lastly, we definitely also thought that we’d solve a real problem for those we knew, doing them a favour by opening up an investment opportunity previously not available to everyone individually
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Suffice to say, my funds manager career was equally as short lived as the dancer slash modeling one. All died an unceremonious (but more than timely) death the moment I thought about what each of these scenarios would look like in real life. The latter for a whole list of reasons I probably don’t need to explain any further. And while we didn’t put a ton of research or resources into figuring out how a privately run fund between people that know each other would work (others have, though) - there’s two main reasons it didn’t seem like a fit for us after all:
Timing - a problem we encountered again and again down the line but was even more damning here. In order to fundraise, you need at least an idea of what you want to invest in. If you start looking, though, things you like will be off the market before you have even begun telling your potential co-investors. A weird chicken and egg situation that definitely doesn’t end in purchased property
Emotional - which we have discussed here. Doing business with friends and family might lead to conflicts best to be avoided. It really was the idea of complicating something unnecessarily that prompted us to more seriously look into mortgage conditions on our own and we ended up being just fine getting a mortgage through a bank with just the two of us
This is where I think we need to add a quick side step (I will spare all of us the ballet terminology despite the obvious pun-potential). Since we are still somehow on the topic of childhood … imagine this: Your mom gives you 10 Euros and a shopping list and sends you on your way to the supermarket. At the register, you realize that the price she assumed for all those items listed is much lower than what you actually have to pay, leaving you scrambling to come up with the difference while impatient shoppers all around you roll their eyes and wait. Clearly, it would be a good conversation to have with your Mom how she landed at this assumed (but too low) value for your groceries.
Congrats, you now understand what banks call “Beleihungswert” - which is the maximum value the bank attributes to any property about to be financed. These digits are of critical importance because they put a price tag on the security you offer, thus ultimately determining how much capital a bank is willing to loan to you, leaving you with a (sometimes quite significant) gap that you need to fill yourself. You would think this Beleihungswert or mortgage lending value (in English) is the same, no matter which bank you deal with - after all, your house doesn’t change whether bank manager A looks at it or whether bank manager B tries to put a price tag on the door. Sadly: wrong. Every bank has their own calculations - which is why it’s sensible (and our strong advice) to shop around when checking out mortgage conditions.
The underlying idea here is clear: the bank will try to limit their risk at all costs. Once you understand that it’s no surprise that the mortgage lending value probably is lower than what you will pay for the property, sometimes a whole lot lower in fact. The bank simply wants to ensure that they recover all their money should you default on your mortgage payments, no matter whether the market pays a high or lower price at that very moment in time, which is also why they try and factor in market developments of the next 30 years. Basically, this means that there’s three key numbers that are relevant to you (and the bank).
Purchasing price: This is, duh, what you pay (or in the case of a new building: the building costs)
Fair market value: what the bank determines the property to be worth, independent of what you actually paid. Legally, it can’t be more than the purchasing price
Mortgage lending value: the discounted market value, this is what the bank will agree to finance
In numbers, this means that you need to discount your purchasing price not once, but twice to get to the mortgage lending value (or Beleihungswert): Firstly, what the bank determines the property can be worth will most likely be lower than what you paid - because you were willing to pay a premium for a certain location for example. The bank is a little more objective, a little cooler (and more conservative) in their estimation. From that number, banks will subtract an additional amount simply for safety reasons - weirdly referenced as “haircut” even in financial publications - or “Sicherheitsabschlag” in German. As a rule of thumb, what you can expect is a loan offer of about 80% of the market value. While all lenders have their proprietary calculations, this safety discount will be based on one of three general methods, either taking into account the value of the real assets, the capitalized earnings potential or a comparative value method. This is where I draw my google line, though, guys. Too confusing and not important enough - but linking here so that you can read more if you feel so inclined.
To bring it home with some numbers, this is what an example could look like:
Purchasing price: 200.000 EUR
Bank assumed market value: 146.000 EUR
Safety discount or “haircut” of 80 % on market value gives you the mortgage lending value: 116.800 EUR
Your delta: 83.200 EUR
All these very theoretical concepts and calculations will feel painfully real the moment you actually have to come up with the difference between the property price at current market value and the mortgage lending value. This gap in money, called Blankoanteil, you need to fill, somehow and in addition to the purchasing costs like taxes and fees. Which is also why it’s super important to understand and discuss with banks the moment you start negotiating.
There’s another reason why you need to pay attention to this calculation, at least if you are planning to build out a real estate portfolio - or even purchase a family home later in life when you have already made a property investment in the past: Banks will not only look at each individual property to be financed but also your overall financial situation. If the Blankoanteil of several of your properties is relatively large the credit exposure - and subsequent risk - add up, making it less likely for you to get a mortgage at all. Not to get too strained on the childhood imagery - but your whole tower of building blocks comes tumbling down. You will have achieved the opposite of building out a portfolio of assets that can act as securities - you will have actually diminished your credit score through too much risk. In our case, for example we were fortunate to get a loan on 100% of the purchase price (don't forget there's two of us which also means twice the income and twice the credit score), meaning our delta was small. So in that very moment - awesome, only the additional purchasing costs to be paid. In the future, though: ugh. Risk.
So, how DO you pay the difference? In order to actually come up with the capital the bank won’t lend you, what are your options?
The obvious one: save money until you have enough to fill the gap. Depending on every individual financial situation, this is the safest but probably most long-term option
As mentioned above: Negotiate with the bank. The higher you can get them to set the mortgage lending value the better. This can be a real lever - but banks also can be real inflexible :/
Fundraise: That’s where our real estate fund idea came in. If you have ways to somehow unearth capital through a family loan, early inheritance or other scenarios - go for that!
Crowdsource: StartUps have identified the Blankoanteil as a problem to be solved. Through crowdfunding, they raise money to be invested in real estate, promising decent returns for those investing. Pretty unlikely, though, that small private projects would qualify plus experts are not convinced. Interesting idea (which is why we list it here) but very likely not relevant. Sorry!
Buy less: In this case, that means to find a smaller, cheaper property to start out. Not the most glamorous but probably the most sensible advice (and the route that we took)
So what’s the takeaway from all this complicated inside baseball (or better: inside bank) stuff you ask? I think it has to be something like this:
Getting a mortgage that covers 100% of your purchasing price isn’t possible unless you provide additional securities beyond the property itself. In our case those were two really good credit scores.
Realistically, when you discuss mortgage conditions with your bank they will very likely not make an outward differentiation between what they have determined to be the mortgage lending value and the Blankoanteil. Both are theoretical / arithmetic concepts behind the scenes. You will be presented with a number and not learn how that sausage was made. That’s why we think it’s important for you to understand this background.
Lastly, even if you can come up with the money to pay the gap between what the bank determines as the mortgage lending value and the purchase price - make sure you understand the long term implications of too much credit exposure if you plan on buying more than one property eventually. In that regard, our real estate fund idea wouldn’t have helped. It’s not about somehow, somewhere finding the money to get started. That’s, almost, the easy part. The hard part is to find a way to “make it on your own”. Buying cheap, generating cash flow, repaying your mortgage quickly and building assets and securities - that’s the way.
Turns out, if your Mom sends you into supermarket hell and your allowance is only 2 Euro a month, you will be hard pressed to come up with some cash. The same is true in the grown up world. At least, these days, we are a little bit more realistic about what we can or can not do? That has to count for something, no?
Next time, on Rente aus Stein: a look at all the terrible things that can go wrong (and did!) when renting out real estate. Prepare to be shuddering.
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Disclaimer: We are not lawyers (sadly) and as such can’t give you legal and/or tax advice. We are simply telling our story in the hope that it’s inspiring to you.