18 Ways to Finance Real Estate Projects
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There are many reasons to invest in real estate. The three most common types of loans you can use for funding a real estate investment property are conventional bank loans, hard money loans, and home equity loans.
Real estate property financing can take several forms. Choosing the wrong kind of funding can impact the success of your investment.
Understand the requirements of each type of funding and how the various alternatives work before approaching an investor or lender.
There are a few ways to finance real estate property investments.
Finding the money to take advantage of an investment opportunity does not have to be an obstacle if you know where to look.
Real estate is one of the most preferred methods of investing since it provides good returns but also cushions the investor from inflation.
No matter how much cash you have on hand, investing in real estate is possible.
Some of the most innovative ways of funding real estate include;
Bank loans are heavily collateralized and involve a lengthy due diligence process.
Most real estate developers get funding from a bank or an institutionalized lender.
Loan interest rates are determined by market forces, or controlled by regulatory authorities.
A conventional bank loan requires a good personal credit score and credit history to get approved.
Most lenders also review a borrowers' income and assets.
A borrower must be able to show that they can afford their existing mortgage, and the monthly loan payments on the real estate property.
Future rental income is not factored into the debt-to-income calculations.
Most lenders expect borrowers to have at least 6 months of cash set aside to cover mortgage repayment obligations.
This is the most common form of financing for real estate property developments.
Even though interest rates for private residences are much higher, bank loans tends to have lower interest rates than private loans.
Financing your real estate project through a bank loan can maximize your potential profit based on how much cash you have available for a down payment.
Banks have a much longer approval process and strict lending profiles than private lenders.
They only provide a certain percentage of development funding usually 50% - 70% of the cost of construction.
A bank loan is often charged on the property title, and the borrower cannot seek funding from other banks.
Private lenders are more flexible than traditional lending institutions. If a private lender sees a good investment opportunity, they can advance loans to invest in the opportunity.
The lenders are not institutionalized or licensed to lend money. They give loans with the intentions of earning a return.
A private lender is easier to meet and make a profit by lending money to real estate investors who increase the value of their investment properties.
Loan amounts from private lenders are usually small. Private lenders tend to have higher interest rates than banks.
Presales are early sales made before completion of a real estate development project.
The financing obtained from buyers reduce the capital required to fund the project development.
Project developers sell their real estate projects early on to cover their capital requirements.
Buyers can get a property at a discount, and can benefit from potential capital gains.
Real estate investors can take advantage of capital appreciation of properties that are sold off-plan.
They are readily accessible for development projects with good sales, and have no cost of capital. Sales may be unpredictable and also unreliable.
Potential homeowners can also opt to buy a property before it is actually developed.
The real estate property investor can pay for the property in instalments or in full.
This is a business arrangement in which two or more parties come together to develop a real estate project by pooling funds and resources.
Joint ventures in real estate combine real estate development expertise and funding potential of a property developer, with the land owner’s contribution in the form of land.
This can be in the form of preferred stock, or as debt, and is meant to bridge the financial gap between senior debt and the investor’s equity.
An entity provides subordinated financing to a real estate development.
The financing is junior to a bank loan, and gets paid only after the bank but before equity investors.
Mezzanine financing has an investment horizon of 1-3 years and is a favorable option for real estate development companies with restrictive cash flows.
It is also flexible but acquisition of the loan can be a lengthy process. The funds are unsecured and have high costs.
You may have to relinquish some control over your property and risk double taxation.
This involves various funding options issued by a private firm to finance real estate projects.
They include project notes, real estate-backed medium-term notes and other high yield loan notes.
The solutions are packaged by investment professionals to enable real estate investors access a return supported by the performance of real estate in the market.
This form of financing is easily accessible compared to debt financing.
Structured products have proven to be useful in funding real estate development projects.
Structured notes tend to deliver higher returns to investors. They provide principal protection, coupled with an above-average yield return.
The notes are traded in private equity markets to qualified investors through private equity managers. They are quite indispensable in the real estate sector.
Structured funding notes are invested heavily in asset classes such as real estate, and are easily accessible as a means of financing for real estate developers.
Real Estate Investment Trusts (REITS)
This often involves buying shares in a company that has converted physical real estate assets into a liquid investable product.
REITs can be public markets tradable or privately placed.
You can get a mortgage insured by the FHA if it is your first housing investment.
With a down payment of just 3.5 percent, you can buy a multifamily property, live in one of the units and rent out the other units.
You can get rental income on the property while you hold it. The bank grants multi-family mortgages to borrowers from $500,000 to $7 million at up to 75% loan-to-value (LTV).
Hard Money Loans
Hard money loans can help you secure a real estate investment deal quickly. They are a flexible financing option even with the high interest rates.
Though not a sustainable long term option, it is a valuable resource if you need to close a deal quickly. The interest rates are higher than traditional loans.
Hard money loans relies on a hard asset which is the property. This loan is a short-term and provides funds until either the house can be sold, or a more traditional funding can be secured.
Hard money loans can get approved in as little as 7 days. Borrowers can get funding to buy and repair a real estate property with little upfront cost.
It is a great option for fix-and-flip real estate investors.
Buy To Rent
Buy to rent is an asset based mortgage based primarily on the rental income from the property.
It is a great funding alternative for startup real estate investors and businesses.
Investors can get up to 80% LTV for an acquisition or up to 75% for a refinancing. Interest rates ranges from 6.5% to 8.5%.
There are no limits to the number of properties an investor can finance with buy to rent. The loans are flexible than traditional loans.
Family and Friends
You can finance a real estate investment project through contributions from family and friends.
This option requires no start-up capital. Family members or friends can pool funds together and buy a property.
Trust Deed Investing
This is getting funding from a private lender and using the property’s trust deed as collateral. You agree to lending terms you must meet.
If you do not, the private lender can foreclose on the property. Real estate investors are using this approach to finance deals.
They offer 8% to 10% APR to lenders to invest in deals with high yield. This strategy protects investors against recession.
Hybrid financing mixes traditional payment schedule of a mortgage with equity for the lender.
You may pay a higher rate or give up some control in the investment property.
If the deal make sense, you will end up with a good option to fund your real estate project.
Fix and Flip Financing
A fix-and-flip loan is a short-term loan that allows the borrower to complete renovations on a property so the property can be sold quickly.
Fix-and-flip loans are hard money loans secured by the property itself. Hard money lenders specialize in these kinds of loans.
While lenders may still consider credit history and income, the primary focus is on the property's profitability.
The home's estimated after-repair value (ARV) is used to gauge whether you can repay the loan.
Funding can be approved within days. Interest rates can go as high as 18% depending on the lender.
Repayment period may be short and can last less than a year. Origination fees and closing costs may also be higher.
Home Equity Loans
You can use your home equity or cash-out refinance to secure an investment property.
It is possible to borrow up to 80% of the home's equity value to use towards the purchase of a property.
With a HELOC, you can borrow against the home equity the same as you would with a credit card. Monthly payments are often interest only.
The rate is usually variable and can increase if the prime rate changes. A cash-out refinance has a fixed rate and may extend the life of your existing mortgage.
A longer loan term could mean paying more in interest for the primary residence.
Paying cash upfront for a property can enable you to acquire a property at a discount.
It also saves you a lot of money in interest expenses when compared to private, hard-money, or conventional loans.
Though buying a property in cash is a safer approach, it may limit your potential gains.
Paying cash can lessen the leverage that your money can give if you choose other financing options.
Paying with cash provides security and stability. It also may reduce your potential returns on the property invested in.
Senior debt is borrowed money that a company must prioritize during payment in case of liquidation.
Hard assets are used as collateral for the loan that has a specified period within which it must be paid back.
The loan requires a collateral and is less risky. It also attracts relatively low-interest rates of 10% to 16%.
It is prone to the volatility of financial policies from lending institutions.
You can save money to invest in a real estate project. Savings leverage the power of compounding.
A real estate investor can count on savings to fund a real estate investment.