In this blog, we will explore 12 benefits of an SBLOC specifically in real estate transactions.
- 12 Benefits to an SBLOC in Real Estate
- Clear Creek Conclusion
A securities-based line of credit (SBLOC) allows an entrepreneur or investor to open up a line of credit using a portfolio of securities as collateral.
For example, an entrepreneur is trying to buy a $2,000,000 home for their family, and they find a great opportunity in Mill Valley and use an SBLOC to generate cash, quickly closing the deal. The entrepreneur leverages their investment portfolio at Pershing to borrow the $2,000,000 to purchase the house. Within 30 days of the purchase, they get a hybrid mortgage to repay the SBLOC.
This can work for investors as well. If an investor found an amazing residential investment but needed $500,000 for the down payment, they could leverage an SBLOC to access the cash and secure the property.
In general, securities-based loans have variable interest rates, no payback terms on the principal, interest-only payments, and no loan fees. They are extremely flexible, could potentially help to lower the overall cost, and the money can be used to purchase just about anything besides more securities.
SBLOCs do carry risks. If the value of the portfolio decreases there could be a collateral call that requires the owner of the pledged account to contribute assets. The lender reserves the right to liquidate any of the pledged securities to satisfy a collateral call. The lender can also change the terms of the loan to impose stricter collateral requirements. If the borrower defaults on the line of credit, the lender can force the sale of the assets within the pledge account to satisfy the laon.
SBLOCs are not for everyone but in the right circumstances can be a great option to finance real estate. To learn more about SBLOCs, check out our blog, “What is a Securities-Based Line of Credit?”.
Let’s dive into more of the benefits of an SBLOC in real estate.
12 Benefits to an SBLOC in Real Estate
Quick Access to Cash
SBLOCs allow very quick access to cash. It can take less than a week to establish the line of credit and once established, money can be accessed the same day a request is submitted.
In highly competitive real estate markets, like real estate, speedy access to cash can be critical in securing a deal.
If a client calls me before 3 pm (PST) and requests $1,000,000 in cash, I can have the cash in their account that day. Some lenders also provide checks that can be written against the line of credit, allowing you to use it whenever you need it.
Almost all security-based lines of credit are interest-only.
Interest-only payments allow for extreme flexibility and cash management when approaching real estate projects.
For example, if you are a real estate investor and want to secure bridge financing for a 10-unit apartment complex, you could leverage an SBLOC and pay interest only until you secure a long-term financing option.
Lower Cost of Capital
In certain circumstances, an SBLOC can provide access to a relatively lower cost of capital.
Interest rates on SBLOCs are typically variable (although you can get fixed rates).
Institutions like TD Ameritrade and Pershing (BNY Mellon) use some version of the Secured Overnight Financing Rate (SOFR) or Federal Funds Target Rate plus a spread.
The spreads vary between lenders but are typically between 1.25% to 5% depending upon the size of the approved line of credit.
An example, for a $2,000,000 line of credit at Pershing, an entrepreneur might pay the Fed Funds Target plus 1.75%.
Lending firms vary widely on the interest rate they charge on the loan. The good news for real estate developers, entrepreneurs, or large investors is that the bigger the line of credit, the more lenders will compete with one another to get the business.
Independent financial advisors have an advantage over broker deals in that they can float the potential loan to different lenders allowing for a competitive bidding process to lower the cost of capital even more and potentially sweeten the terms.
Potentially Defer Taxes
One of the biggest advantages of an SBLOC is that a real estate investor doesn’t have to sell the securities within the portfolio to raise the cash and can potentially avoid the capital gains taxes associated with the sale.
The advantage of this is that the deferred taxes can continue to grow with the portfolio over time, meaning greater potential wealth creation.
The exception is that if for whatever reason, there is a collateral call on the line of credit, then an individual might be required to sell securities that have capital gains associated with them.
There are ways to manage a collateral call, check out our blog on 10 Risks to SBLOCs and How to Manage Them.
Simple Underwriting Process
The underwriting process for an SBLOC can be much simpler than traditional financing.
Because this is a collateral line of credit and the lender already holds the collateral, they generally do not require things like bank statements, tax returns, business plans, etc.
One of the key things a lender will review is the portfolio of assets in the pledge account or accounts. The portfolio will determine how big of a line of credit you can have access to.
For example, a lender like Pershing might lend 70% of the market value of qualified equity, mutual funds, and investment-grade bonds and up to 90% on U.S. Treasury securities.
Each lender has different advance rates and depending upon the entrepreneur’s investment strategy and portfolio holdings will determine what lender might be the best fit.
Soft Credit Checks
Lenders vary on if they will require a credit check.
Many lenders either do not require a credit check at all or do a soft check. However, there are a few that do require hard credit checks.
The advantage of working with an independent financial advisor because they have access to multiple lenders giving entrepreneurs and investors a wide range of loan terms, including working with a lender who won’t do a hard credit check.
No Loan Fees
Again, all lenders are different,l but many lenders do not charge application, origination, closing, underwriting, or annual fees.
Depending upon the size of your line of credit and the use of the funds, an SBLOC could save you $10,000s of thousands of dollars in fees.
No loan fees help lower the SBLOC’s overall cost.
Quick Approval Process
Because the SBLOC is a loan on collateral already held at an institution, the approval process can be quick.
You can have a securities-based line of credit approved in a few days or less. Some Lenders can take 1 – 2 weeks.
Once the account is approved and the line of credit opened, the cash can be deposited into your desired bank account within 24 hours or even the same day.
Lending on Multiple Pledge Accounts
There are some uniquely focused lenders who allow a line of credit to be based on multiple accounts.
This can be advantageous to an investor who might have multiple accounts they are wanting to pledge.
This can help if you need a larger line of credit, want to further protect against a collateral call, or want to lower your cost of capital through lower interest rates on a bigger line of credit.
Don’t have to own the Pledge Accounts
The individual who uses the line of credit does not have to be the pledger of the accounts.
For example, if the entrepreneur’s family has a trust set up, the owner of the trust could take out an SBLOC and let the entrepreneur use the funds.
This could be an option for helping children and grandchildren buy a house or if a real estate entrepreneur is seeking investment from close family and friends.
Keep current investment strategy
One of the key benefits of a securities-based line of credit is that the owner of the pledge accounts does not have to interrupt their investment strategy nor do they have to miss out on potential market gains.
Let’s look at a super simplified example. An investor has a trust account worth $5,000,000 and is currently earning 6% a year on the investments. An opportunity for a real estate deal comes up with a projected return of 15%. The investor could leverage an SBLOC paying 3% to finance the deal and still earn the 6% on the entire $5,000,000 in the trust account. They could potentially earn 7% on their entire trust account and the return on the real estate deal less the cost of the SBLOC.
Great Bridge Financing Option
While I know some investors who borrow long-term from their SBLOCs, the vast majority of funds are used short-term. Long-term use of an SBLOC exposes the borrower to higher interest rate risk and the longer it is held, the larger the overall loan cost will be.
Bridge financing is a popular use for these funds, especially in real estate. If an individual needs additional cash to enhance the property or even manage construction costs, an SBLOC can provide speed and flexibility.
For example, let’s say a small business owner wants to buy a new building for their business in Boise ID, and finds the perfect opportunity. The problem is that they have not sold their current building yet and do not have the liquidity for a down payment. They could leverage an SBLOC to free up liquidity for a downpayment for the new building and repay it once their old building sells.
Another example might be buying a property in a short sale. An SBLOC could be used to provide the short-term financing needed to buy the property and even pay for improvements that might need to be made before a lender will lend on the property.
A few things to keep in mind when using an SBLOC for bridge financing are: how will you exit the bridge loan and pay back the SBLOC, what is the estimated cost of the loan, what is the exposure to interest rate risk, and what is the LTV on the property.
Clear Creek Conclusion
SBLOCs have some very clear benefits for real estate investors over traditional financing methods.
SBLOCs can lower the cost of capital, provide quick access to liquidity, provide flexible terms that meet the unique requirements of a client’s situation and bring some additional strengths to acquiring real estate in a competitive market.
If you have any questions about SBLOCs in real estate or in general, please reach out to our office. We would be happy to discuss them.
About the Author: Located North of San Francisco, Jason specializes in financial planning, investment management, and tax strategies for families across the west coast.