How to Fund Your Real Estate Investments


01 Sep
01Sep

 

It is no secret that real estate investing is one of the greatest avenues to build long term wealth for yourself, your family, and future generations. The challenge that most investors face, especially inexperienced investors, is raising the capital needed for their investments. What this article will do is highlight several available options that you can use to fund your real estate investments.

The most obvious source of capital for investors is their own personal assets, but in the case of new investors, or investors with limited personal resources, the next best option is other people's money (OPM). Whether you believe in leveraging your personal assets (cash, savings, lines of credit) or other people's assets, you will need to know where the money is coming from and how you can access it.

For Fix & Flippers, liquid capital is essential to purchase projects with cash. Cash is King when it comes to real estate investing. When we first started, our capital was not liquid, which made it challenging to acquire properties and close in less than 30 days. As cash buyers, your capital needs to be available almost immediately for the transaction to close on time, sometimes in as little as 7 days. Most of our cash was diversified into different asset classes like, stocks, bonds, retirement accounts, checking, savings, life insurance, and so on. Instead of liquidating our personal assets to start buying real estate for investment purposes, we decided to leverage OPM and pay a fair return back to our investors, while making a tidy profit.

MONEY SOURCES: OPM & PERSONAL

HARD MONEY

The first and most expensive type of OPM is hard money. Hard money is institutional funding that is approved for fix & flippers to buy and renovate homes. Your traditional bank will not finance these types of transactions in most cases. Hard money has both positives and negatives, but it is the easiest source of capital if you need to quickly close on a deal. Let's start with the positives:

  • Fast turnaround - sometimes in 7 days or less!
  • Your personal credit usually is not a major factor in the loan, so a credit score under 600 can still qualify with the right deal.
  • Hard money lenders can usually fund up to 90% of the purchase (for experienced investors) and 100% of the renovation costs. For inexperienced investors, those terms may look different - 60% of purchase and 100% of renovation costs.
  • Purely asset based lending - their money is secured through the asset and not based on personal credit.

Now onto the negatives:

  • Hard money generally has high interest rates - 8% to 18% - new investors often pay over 12% interest while seasoned investors enjoy lower rates.
  • High fees - 2 to 5 points per transaction.
  • The hard money lender may require an appraisal that can slow down funding.
  • High holding costs on your project due to interest rates.
  • Construction draw fees - $200 to $500 per draw.
  • Most of the time, you cannot purchase the asset and cover renovation costs without having your own capital involved - 60% purchase requires you to bring the additional 40%.
  • May require personal guarantees.

Hard money has pros and cons, just like all lending options. But if you have a great deal, it is worth paying the higher costs for the money. For example, if your purchase price is $250,000 and your renovation costs are $120,000, but the ARV is $599,000, hard money is a great option because there is plenty of equity available in the deal to cover the high interest and fees.

LINES OF CREDIT

Lines of credit are a great way to fund your real estate transactions. There are many different lines of credit that real estate investors can access in order to fund their deals. Credit lines often have low interest and reasonable terms, which can save you money throughout the project by eliminating fees and high interest costs associated with hard money. Lines of credit may still require some fees to open the line, but the interest rates are generally lower than hard money.

Lines of credit include:

  • Business lines of credit.
  • Personal lines of credit.
  • Home Equity Lines of Credit (HELOC).
  • Securities Backed Lines of Credit (SBLOC).
  • Cash advances on credit cards (NOT RECOMMENDED)!

Positives:

  • Built-in flexibility.
  • Open-end credit account, meaning you can borrow, repay, and borrow again without needing to pay the fees to start the credit line.
  • You only pay interest on the amount you borrow and not the total line.
  • Can be secured or unsecured - unsecured lines generally have higher interest.

Negatives:

  • Unsecured credit lines have higher interest rates and require a high credit score.
  • Interest rates are generally variable.
  • Penalties for late fees are severe.
  • Misuse of the funds will hurt your credit score.
  • Maintenance fees - monthly or annual.

RETIREMENT ACCOUNTS

Retirement accounts are a great source of capital for real estate investing. The 2 main types of retirement accounts that allow for real estate investing are Self Directed IRA's and Solo 401k's. Many investors choose their retirement account to invest in real estate because of the ease of use and the flexibility the account offers. Not only can you invest in real estate, but you can also invest in precious metals, notes, tax liens, cryptocurrencies, private equity investments, crowdfunded real estate investments, etc.

Positives:

  • One of the main reasons why investors choose to use a retirement account, over other investment accounts, is the tax benefits that are associated with this type of investment vehicle. Unlike flipping with personal capital, hard money, credit lines, or other loans, retirement accounts defer taxes on the profit until you take qualified distributions at retirement. So if you make $100,000 on a transaction, you will not be losing 20% to 40% of your profit in taxes. Rather, your full profit is returned to your account to continue to gain interest and reinvest in more deals.
  • You can accumulate rental properties with your retirement account, and that profit, too, is deferred from taxes.
  • You are not restricted to use the funds only to purchase real estate, you can use the funds to cover renovation costs as well.
  • Build and preserve long term wealth.

Negatives

  • You cannot buy investments for personal use, so you cannot "house hack" or "live in flip."
  • IRS restrictions with strict guidelines that must be followed.
  • You cannot take the profits of the investment out for personal use, the money must stay in the retirement account and cannot be drawn upon if you are not at retirement age.

PRIVATE MONEY

Private Money is a loan given to a real estate investor from a private individual, and that money is secured with a hard asset. Private money investors are secured with a first or second lien position on a property, and they are an excellent source for real estate investors to fund their deals. At JSJ, we use private money on more than 90% of our transactions. There are several key elements to private money that make it so beneficial to us as real estate investors.

Positives:

  • You do not need to deal with a bank or any other institutional lender, which speeds up the process.
  • No fees!
  • Gives you, as the investor, a leg up on your competition because you have money available right away to purchase the property CASH.

Negatives:

  • Private money lenders generally expect a higher rate of return.
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