One of the biggest questions I receive from new real estate investors after they get an idea of how they want to invest is what is the best way for me to fund my deal?
When starting out most new real estate investors who have the funds might use their own funds to buy that rental property or flip property or whatever, but then all their funds are tied up and when another great deal comes along, they have to pass it up because all their current funds are tied up.
For example, I have a friend right now that found a great rental property and used his own funds to purchase this property and renovate. Then along comes another killer deal. Because his model is to pay cash, he has to scramble to find other funding to do this killer deal or pass it up.
The next method new investors use depends on their investing model. Those who are going to acquire buy and hold rentals, usually go to a local small town bank and make a down payment and purchase the rental property with a mortgage. This is actually a great model, however depending on the investors cash funds and banking rules, eventually they can’t buy any more. This could be because they run out of cash for the 30% down payment or because they hit the limit on the number of homes a bank will make loans on to one person for investment purposes.
There are quite a few other options that will depend on the reason for investing and the individual investor’s resources. These options range from your own liquid funds, to your own retirement funds, your own credit, other people’s money, other people’s credit and even the deal itself.
This article is to take a VERY BRIEF LOOK at a new investors options.
Liquid Funding: This is money that the new real estate investor has available that is not tied up in a retirement account such as a 401k or an IRA or Pension, cash that you can actually access to spend however the investor would like. If the investor has a large sum available, say over $250,000 this could be a great resource for doing a few wholesale flips or rehab flips in a year. However, if the model is to buy and hold for rental, then this would only go so far, maybe 2 or 3 houses and then they can’t buy any more.
Own Credit: The next resource if the new investors own credit and there are a bunch of options here.
Purchase Money Loan: This one is used to buy and hold a real estate investment. It assumes the property is in good living condition and does not need any repairs. This loan will require at least 30% down and usually a certain amount of money in reserves in case the rental goes vacant or needs a major repair, the amount of reserves will depending again on the experience of the investor and also the condition of the home.
Rehab Loan: This type of loan is sometimes offered by the smaller local banks as well as by hard money lenders. This loan is for the purchase and renovation of a home that needs fixed up. These could be loans used to buy rehab and flip a house. Or it could be used in combination with a purchase money loan to buy, rehab, rent up and then refinance to a purchase money loan.
The Rehab loan usually involves the deal itself meeting certain criteria for the lender, as well as good (not stellar) credit on behalf of the borrower, quite often it must be made in the name of a corporation, not an individual. Typically it cost the investor a minimum of 2 to 5 percentage points and 10 to 15 % interest. The loan is generally only for 6 months, possibly 9 months and may or may not require a down payment.
Combo: Some smaller banks have been known to offer a Rehab to Permanent Loan that has all the characteristics of a Rehab Loan that once the property is finished converts to a permanent loan with a lower interest rate and then amortized over a longer period of time.
Home Equity Line of Credit: This is just what it sounds like. If the real estate investor owns his own home and there is sufficient equity in the home, that equity can be used as collateral for a revolving line of credit. For a first time closing costs, the line of credit can be set up and then the money borrowed and paid back over and over again.
Great tool to use to buy, renovate and the sell or finance back out for long term hold. Would only use in situations where the plan is to get the line of credit money back on 6 to 9 months, not for a permanent loan on a long term hold.
Many new investors as well as some of the more experienced ones do not know that retirement funds can be used to invest in real estate. This is a huge area where investors sometimes never utilize. Because of many of the tax advantages, using this type of funding can save $1000, even $100,000 in taxes making it that much easier to build up a retirement nest egg.
All of the retirement vehicles like IRAs, Roth IRAs, 401(k)s, Coverdale Education Savings Accounts, Health Savings Accounts and maybe a few others can be set up with special qualified custodians and then be used to invest directly in whatever type of real estate investment the investor might want to do.
This is a whole month long course in itself, so be sure to get educated about Retirement Funds and many of the custodians have numerous articles, vidoes and webinars on the subject to get you educated.
Insurance Plans: There are life insurance plans that combine a term life insurance policy with a savings plan. That savings plan can earn interest, and with the right company it can be invested in real estate, or it could be used to borrow against for investing. Some Real Estate Investors like to use this as an investment vehicle for retirement because the profits made by investing within this plan has tax benefits. This is by far not my specialty and I have no experience in this model, but it may be something to investigate.
Investment Funds: Other investor may also find that they have funds invested in mutual funds or stocks and bonds at a brokerage account that they could cash out for money for their investment. But rather than cash out, they opt to get a line of credit using these investment funds for collateral and basically borrow their own money for a few percentage points in interest over whatever the fund is paying.
Private Partners: Most new investors do not start here, they aspire to get to this point where they invest with other people’s money or credit. This can be as simple as one person or company lending money to the investor for a flat interest rate, interest and points (like the hard money scenario), equity share or as complicated as a combination points, interest and equity share.
Using private partners is also an entire training class all by itself, but at the bare minimum we want you to make sure if you are using a private partner that you both agree in writing before the transaction to all terms and a definition of profit if you will be splitting profit. And you make sure to secure the partners funds invested with the correct documentation.
The Deal Itself: There are also ways that the deal itself could provide the funding. For example, when you get into larger apartments or commercial properties, a loan can often be obtained, non-recourse meaning the only thing the lender can do if the borrower stops paying is foreclose on the house, and the loan is based on the merits of the investment and the cash flow from the investment and not based at all on the borrower or the borrower’s credit.
However, what we mostly see when a deal funds itself is when the investor is being creative with a highly motivated and desperate seller OR with a seller who just no longer wants the property and does not need the cash up front.
So for example if a buy and hold investor finds a rental property from another investor, the other investor might finance the deal. Or a retiring landlord might owner finance rental properties to a new investor. Or a homeowner who has a free and clear house, has already moved to Florida to retire, wants to sell a house here but does not need the cash, understands interest and has a rapport with the investor buyer . . this owner might owner finance. Or a homeowner who can no longer afford their home and the upkeep might let an investor take over their mortgage payments on the home, just to get out from under them.
No matter how you go about getting your transaction funded you are going to want to take the time to present yourself and your transaction to make sure the numbers work. So for each deal take time to note why you would be investing, your strategy, the money needed for purchase, the money and time needed for renovations if any, the money and time needed to get it rented and potential profits. If there are renovations also work out a scope of work and a budget. Then present your deal to yourself to make sure it works. Then make sure you have the needed funds or reserves. Then if you are going to use OPM, you have a funding plan to present them.