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Following our last post, Small Vineyard Business Plan, was the topic of financing the vineyard. Today we will cover the types of loans and pros and cons. This is an area where I am not a complete expert but will endeavor to share what we learned. However, financing is highly variable and each lender has their own criteria. This is where an experienced commercial realtor or contacts you make at other local vineyards and wineries can really provide value.
Differences between Vineyard & Residential
During our evaluation we found the following differences between purchasing a typical first or second home and purchasing a second home + vineyard:
- Acreage: conventional loans via Fannie/Freddie have provisions on what constitutes a residence. In particular it must first and foremost be a residence as its primary use and it must be similar to nearby residences. This means if the property you want to purchase is 10+ acres and most nearby residences are all under 1 acre then it may not qualify as a residence and instead as a farm.
- Vines: via the same qualifiers as above a conventional residential loan cannot loan on a commercial/income producing farm. That means if you want a residential loan on a vineyard + house property the appraiser cannot assign any value to vineyard and cannot include any income produced by it when assessing whether or not you can afford it.
- Distance from Civilization: I am not sure about all of the details on this one but all of the banks and insurance providers asked about it. Even though our property was only 5 miles from town it almost prevented us from getting home owners insurance until our agent ‘found a loop hole’. Sometimes I just don’t want to see how the sausage is made…
- Rentals: this one seemed to be bank specific. Some banks were ok with having a rental unit or renting the property out part time and others disqualified it.
- Down Payment: 35% for a second home (10-20% for primary)
- Interest Rate: typically the same or 0.25% higher than prevailing mortgage rates for primary homes.
- Terms: the same as a primary home mortgage, typically 15/30 year fixed or a 5/1 or 7/1 ARM.
- Lender Types:
- National Bank & Resale to Fannie/Freddie: these include banks like Wells Fargo, Bank of America, etc. These banks have very strict qualifying criteria because they package up your loan and typically sell it to Fannie Mae or Freddie Mac. They can usually offer a better interest rate.
- Local Bank and Portfolio Loan: A locally owned and operated bank like Heritage Oaks Bank in Paso Robles or Saco Biddeford Savings in Maine. These banks have their own money that they lend and therefore they can decide on their own criteria. This allows them to include a vineyard, extra acreage, etc.
- Down Payment: 50% if you have not previously owned a farm and cannot show multiple years of commercial experience. 35% for qualified commercial growers.
- Interest Rate: typically the same or 0.5% to 1% higher than prevailing mortgage rates for primary homes.
- Terms: the majority of the commercial loans we looked at were ARMs.
- Lender Types: these can include Agricultural lenders or specialty banks like Silicon Valley Bank (SVB) and their Wine Division.
When you go to qualify for the loan banks will always want to be sure you aren’t stretching beyond your means. This usually means that your Debt to Income ratio must be under ~43%. Thus you have two options:
- You are a Baller: congratulations you are inherently wealthy, have great income, low expenses and can afford a second home even if you generate no income off of it!
- Income from Property:
- Farming: if you have a contract in place to purchase your fruit for a set amount then a commercial lender and some local lenders with a portfolio loan will count ~75% of this as income.
- Rentals: to count rental income you usually need to have a yearly lease in place or documented proof that there have been multiple years of short term rentals and income. Lenders will typically count ~75% of this as income.
Let’s assume your debt to income checks out and you can afford to pay the monthly financing costs (plus farming costs covered in Small Vineyard Business Plan). Now you will need to pay for the 35%-50% downpayment. What are your options?
- You are a Baller: you were employee 100 at Google and just sold off some stock or you are an oil baron who invented fracking. Being wealthy with a ton of free cash continues to be the easiest approach
- Friends and Family are Ballers: your friends or family worked at Google or in Oil and are willing to lend you money. Be aware of this approach though as they will likely want to spend additional quality friend and family time at the vineyard and may have opinions on how to decorate the house or operate the vineyard that may not jive with your own preferences.
- Hard Money: if you watch Flip or Flop on HGTV, this is the shady guy who will loan you money at a very high interest rate. This is typically best for short term loans where you will be able to refinance it within a few months.
- 1031 Exchange: you purchased a different investment property before, operated it successfully, sold it for a profit. You can now purchase a more expensive property and use the proceeds tax free.
- Home Equity Loan on Primary Residence: if you purchased a property in California between 2009 and 2013 at the bottom of the housing market you likely have built enough equity in your home to buy a McMansion in Texas or a vineyard downpayment. Credit Unions are a great option and typically offer home equity lines of credit up to 90% the value of your primary home on a 15 year note and ~3.5% interest rate. The benefit of this option is you can also use the line of credit for the farming portions and working capital.
All of these options can drastically restrict the type of vineyard + house properties you can buy. Think of these scenarios and the impact:
- House with land suitable for vines: if the house was owner occupied this means you cannot count any income from rentals or farming. You will need to owner finance planting the vines yourself. This means a lot of cash… 35% downpayment, $5k to $40k per acre planting costs, and then 3 years of farming without income. Good news is that you can likely do a standard residential loan.
- House with vineyard: You have options here. If your personal income is high then you could still do a residential loan with a 35% downpayment and not count the vineyard income. Or, you could do a portfolio loan with 35% downpayment, count the vineyard income, but pay a slightly higher interest rate.
- Vineyard with no House: you better have a lot of cash and time on hand. You will need to purchase the land via a construction loan. The valuation will likely not place any value on the vineyard so you will need to pay for that with cash on hand. Then you will need to do approvals for building etc.
- House + Rental Units with vineyard: this was our situation. A purchase price of $1.135m and a commercial appraisal of $1.135m. However, the residential appraisal came in a few hundred thousand less than the purchase price because for a residence they don’t count the full value of a commercial vineyard.
- Conventional Residential Loan: the loan limit for SLO is $561k so that would mean a downpayment of $574k + closing costs. Income from the vineyard and rentals could not be counted. The prevailing interest rate for a 7/1 ARM was about 3.375%. However, this type of loan had a low likelihood of satisfying the Fannie/Freddie criteria above due to the income producing vineyard and rentals.
- Portfolio Residential Loan: would be 35% down but on an appraisal of only $950k or so. That means a loan of about $625k at a prevailing interest rate of 3.8%. That means a downpayment of $510,000
- Commercial Loan: would be 50% down but on the whole value of the property at $1.135 resulting in a $567k loan and a $567k downpayment. The prevailing interest rate was around 3.875%.
As you can see there are a lot of factors that go into financing a house + vineyard and it is dependent on the amount of cash you have on hand or access to, your personal income, the rental income, the farming income, and the type of loan you would like. I am sure there are many more options and it would be great to hear about them in the comments section.
Julie and I will be down at the vineyard Thursday evening for the Hospice Du Rhone seminars. Unfortunately we will be assessing our first major setback – FROST! This was one of the primary dangers we observed in our Small Vineyard Business Plan and we hit it. Stay tuned for pictures and commentary from the vineyard coming next week!