Investing in real estate can be one of the most lucrative vehicles to build wealth and a financial foundation for you and your family. There are 2 main areas that will determine your success for your real estate investments. The first will be your ability to find GREAT deals and the second will be your ability to find funding for these deals. If you are able to accomplish the first step (finding great deals) then the second step, finding funding will be much easier.
A common theme we find among real estate investors or individuals looking to get into real estate is the lack of funds they have or the lack of ability to find funding. We want to let you know that one of the main reasons real estate can be so lucrative is because you can use other peoples funds to reach your goals.
Is it better to have some of your own cash to invest in real estate? Yes, but do you have to have your own money to begin investing in real estate or grow your real estate business? No.
No matter what real estate investing vehicle you decide to use, there are numerous strategies you can use to leverage your ability to invest in real estate.
With that being said, lets touch on, what we believe to be the 5 best ways to funds your next real estate investment.
1) Private Money Lenders - An individual who provides you a loan to fund your real estate investment.
This individual can be virtually anyone - from family members, friends, business associates or anybody who has money that would be willing to offer it to you for a return.
In our opinion private money lenders will be your best option to build or begin investing in real estate. With private money, there is not many qualifications or requirements needed, it is probably your least expensive option and the fastest way to obtain funds.
Why Would Someone Choose To Invest As A Private Money Lender
There are only so many investment vehicles people can put their money into and there are only so many that people are aware of or feel comfortable using. Individuals decide to put their money into the stock market but with the stock market they have no clue what their return will be. This is a much riskier investment because you are not in control of your money.
People also put their money their money into banks or low yielding investments, such as CD's or bonds. These investments are much less risky but the return on these investments barely earn enough interest to cover inflation.
When someone decides to invest their money being a private money lender they can earn both a high and consistent return in a short period of time. Their investment will be secured and will be collateralized by the property being loaned on. Typically a private money lender will charge anywhere from 8-12% with a balloon payment after a certain number of months. This means that after the terms for repayment, you will be required to pay back the principal (initial) payment after 6 months plus the interest of the loan.
How Much Will Private Money Lenders Loan On Your Real Estate Investment
This is a great question and will be different for every private money lender that you deal with. To keep your private money lenders investment protected, never let them loan more than 70-75% of the ARV of the properties value. If you are able to bring in deeply discounted properties, you should still be able to obtain funding for the complete purchase. On a good buy, you will be purchasing properties anywhere from 30-50% of the ARV.
Once again there is no rule to what percentage you should allow your private money lenders to lend on your properties. This will be completely up to the agreement that you two settle on. However, if your lenders know that you are looking out for their best interest, they will feel more comfortable investing with you on a consistent basis.
Private money is a great way to leverage your house flipping business and if you can prove that you can consistently pay back your investors within the agreed upon time frame, you should have no problem getting private money lenders on your team.
2) Hard Money Lenders - Financing that is obtained through a private business or individual for the purpose of investing in real estate. This is typically a short term loan that is secured by real estate.
This type of loan is conceptually similar to private money lending except the terms differ.
So how does Hard Money work?
Loan is based around the value of the property
Typically short term loans (6 - 36 months)
Interest payments will be higher than private money ( Typically 10 -16%)
Will contain loan points on purchase ( fees to get the loan)
Monthly payments of interest only or interest + principal payments
Balloon payments due at the end of the loan
Credit will not determine lending. Lending subject to investment or property value
When Should Hard Money Be Used To Fund Real Estate Investments
Hard money lending is not a good idea for every situation. If you are looking to purchase a primary residence and you have good credit, good income and you have never been through foreclosure then traditional lending will be best for you. Hard money lending is a good source of funding when you can not get a traditional loan, pay for properties in cash or get funding through private money lenders.
You should use hard money with caution and if you are just starting out and it is one of your first investments we recommend staying away from hard money. The reason for this is because this money can be expensive. It will cut down on your margins and if your are not efficient with your flips or investments and do not have systems in place, your investment can become very risky.
This is a quick and fast way to obtain funding. Funding can sometimes be obtained in around 10 days compared to traditional financing which can take anywhere from 45 - 90 days. This is the main reason that investors choose this medium for funding. If you are an experienced investor and work your investment in an efficient manner then hard money can be a lucrative way to do more deals and leverage your investment business.
As we spoke about earlier, hard money loans can become very expensive. Typically hard money lenders will lend up to 65-75% of the ARV of the property with interest rates teetering anywhere from 10-16%. They will also charge anywhere from 2-4 points (loan fee) on the total loan at closing. In some instances hard money lenders will also lend on the repairs of the project. At first glance, this sounds great for the real estate investor but with anything in life there is a catch. These loans will will require increased interest rates where hard money lenders will require anywhere from 16-20% on the loan, since they are taking on more risk.
So make sure you understand all of the terms required with a hard money loan. Know exactly how much money you will be required to pay and make sure your margins are large enough to cover these payments and still make a good profit. Use these loans with caution and before you decide to go this route, make sure you are comfortable with your investment skills.
3) Equity Partnerships - Funding obtained through an individual with a return based around the % of profit on the project. Typically individuals who will lend their funds and good credit to help finance your real estate deals.
These partners typically do not have the time or knowledge to complete an investment deal so in return they offer their finances to get involved in the game.
These partnerships can be another great way to leverage your real estate investing business and increase your ability to complete more deals.
With any loan, the primary concern of any lender is ensuring a high return on investment. In this specific situation, typically you will be able to obtain all the money needed on the purchase of the property and repairs.
With this specific type of funding you will be paying your funding partner a percentage of the total profit made from the investment. The percentage that will be due when the property closes will depend on the equity partner you have. Some equity partners will require a 50-50, while others will take a 70-30 split. Each equity partner will have different requirements.
These types of loans will work both for long term buy and holds and short term fix and flips. Your equity partner will take a percent ownership in whichever vehicle you decide to use. There investment will be secured by the profit or cash flow that is generated and in the insurance on the property. These equity partners want to participate on the upside of the investment rather that requiring a set interest return on their money. This means that they are taking on a little more risk to obtain a higher return.
In order to obtain this type of lending, you will need to be organized and have good idea of all the numbers on this specific project upfront. If you are organized and can explain the return that your equity partner should expect, you will be more likely to obtain this type of funding. If you are able to make your partner feel comfortable and explain to them the benefits of this transaction and ownership you will be far more likely to obtain equity funding.
4) Conventional Lending - A government loan that is not insured by a government agency. They follow the loan amount regulations set by Fannie and Freddie Mac.
Each bank or lender will offer different terms, interest rates and fees. A conventional mortgage is beneficial for individuals with good credit, solid income and not a lot of debt. The maximum number of allowable, simultaneously financed properties is 10, although not all banks and lending institutions will lend on this many properties.
If you are looking to use conventional lending for real estate investment purposes your terms may differ if you were using this vehicle on a primary residence. Banks and lending institutions may require higher down payments such as 30% because they feel it is a riskier loan. If you are looking to leverage your rental property portfolio, conventional lending may be a good vehicle.
Not all lending institutions and banks are created the same. Some banks and lenders only prefer to work with homeowners working on financing their primary residence while there are other lenders that prefer or will work with real estate investors. If you want to use conventional lending to finance your projects, we suggest doing your research and finding a lender that has worked and likes to work with real estate investors.
In these circumstances sometimes it will be better to work with a direct lender rather than a mortgage broker. The main difference between the two is that a mortgage broker will shop around your financial profile while a direct lender will be the institution actually financing the loan.
Typically for mortgages 1 through 4, lenders will require a credit score of about 620 and 6 months of cash reserves required for each property. If you investing in a single family property on properties 1-4, you should expect a typical down payment of about 20%. On properties with 2-4 units, a down payment of 25% will be required for your first 4 properties being mortgaged.
If you are looking for some more information on lending requirements, this post does a good job of explaining what lenders will look at when evaluating your investment.
5) IRA's & 401K's - These are long term savings account that offer tax advantages if you comply with IRS standards. Not all financial institutions will not allow you to invest in real estate with your IRA and 401K due to increased paperwork, the IRS does not forbid using these vehicles to invest.
So can you use your IRA or 401K to invest in real estate? The short answer is yes, as long as your turn your traditional 401K or IRA into a self directed 401K or self directed IRA. To learn more about self directed IRA's and 401K's, this blog post does a good job of explaining the rules and requirements necessary to accomplish this.
Many individuals have become very disappointed with the unpredictability of returns from investing in the stock market. Therefore more and more people are educating themselves on how to pull money from these investment vehicles and push them into real estate.
In regards to your 401K, you will basically be borrowing from your 401K to purchase real property and your repayment terms will differ depending on your specific requirements. Typically you will be able to borrow $50,000 or 50% of the total value of your 401K.
So you can potentially borrow $50,000 to purchase a rental property and you will be required to pay back YOURSELF depending on the specific interest payment requirements. Each money you will pay interest into your 401K from your regular pay check.
Be aware that if you quit or lose your job then you will be required to pay this loan off in full at the time of the job loss. So if you do not plan on staying at your job for long or think that you may be getting fired sometime in the near future then really consider if this option is right for you.
So if you have some money saved up in your 401K or IRA accounts and want to borrow from these accounts to invest in real estate, be sure you do your homework and further educate yourself on the process. Be aware of all the requirements and guidelines involved in this transaction and vehicle being used to fund your next real estate investment.
Real Estate Investment Funding Wrapped Up
Whether you choose to fix and flip or build a long term portfolio, there are several different strategies to fund your next real estate investment. Just understand the requirements and terms for each funding vehicle and make sure the particular investment at hand will fit under the funding medium chosen. Each funding vehicle offers specific pros and cons depending on your specific situation and niche. So make sure you further educate yourself on each funding strategy and be sure that you are comfortable moving forward to invest in real estate.
In the comment section below, let us know which strategy you have had the most success with and let us know if you have an alternative strategies to raise money or fund your real estate investment deals.
If you are a investor looking for deeply discounted properties in Syracuse and surrounding areas then be sure to sign up to join our cash buyers team. You will receive first dibs to all our leads that receive and we will work together to help build your real estate portfolio.
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