I’ll be honest: I was lucky, as I come from a family that has long been established in real estate. As a third generation real estate investor, I could draw on existing resources: capital, equity, and hard-won expertise and networks.
Still, not all hope is lost. Plenty of my colleagues are entrepreneurs with little-to-no prior experience in the field (and certainly no family help). As a result, I know of very few other industries with such a high portion of self-made business people who started with nothing.
For those of you aiming to make your fortune in real estate, here are some tips and techniques for wrangling loans (and thus, equity)–one of the most elusive (yet essential) aspects of the business.
What is equity–and why is it important?
There are two types of real estate investment: debt and equity.
In debt investment, you are, in essence, lending money to the property owner or the deal sponsor–which resembles bonds. The difference is that the property itself secures the loan, and in lieu of interest (which would be paid to a traditional lender), investors receive a fixed rate of return. At the end of the repayment period, investors will receive their money back.
In equity investment, on the other hand, you are the owner of the property, either in part or full; for instance, if you put down $40,000 towards a $400,000 piece of property, you own 10 percent. In equity investment, you’ve already put down money in any given real estate transaction–so you are the one who stands to gain (or lose) should conditions change.
Throughout my years of experience, I have this to say: I have never known or seen a real estate investor (or at least those with multi-million dollar portfolios) who hasn’t invested hard equity in properties. Never.
Getting equity–without going broke
Don’t be dissuaded if you don’t have equity. At the risk of repeating a cliche, it’s true that where there is a will, there is a way. Obtaining equity doesn’t have to wreck your bank account or your credit score. In fact, there are a number of strategies for first-time investors (or those with less capital) to get started.
Home equity loans
For those of you who already own your homes, you may consider a home equity loan. Basically, in a home equity loan, you’re borrowing a large amount of money against the value of your home; in essence, it’s a second type of mortgage. Home equity loans are convenient, have low interest, and more importantly, are easy to qualify for–especially if you have bad credit. Lenders will feel comfortable fronting you a considerable amount of capital, because the loan is secured by your home.
There is one big downside: you may lose your home if you default on payment, or even miss a single installment. It may also be tempting to tap into your home equity for a cycle of borrowing and spending, or to borrow more money than your house is worth: don’t do it. Both approaches are just a path to bankruptcy.
Borrow on Margin from a Brokerage Account
If you have a healthy stock portfolio with a fairly diverse range of holdings–as well as a healthy appetite for risk–then you may want to consider borrowing from your brokerage account. In this, you would draw a portion of the cash value, and use it to buy equity. The advantage of this approach is that interest rates may be lower than comparable loans; the downside, however, is that margin loans are subject to the whims of the market. In that case, you may have to sell off some of your assets in order to make up for the shortfall.
Credit Card Lines of Credit
This approach is risky, but it can be done. I strongly recommend against this, however, given the considerable downsides: credit card debt is no laughing matter, and a poor credit score can destroy your financial health, leading to high interest rates, requirements for security deposits, and even difficulties getting approved for apartments. Still, I do know several top-notch investors who made their initial fortunes from credit cards; one of them has his office on Chicago’s LaSalle Street today.
In the next installment, we’ll discuss the advantages of working with a partner, as well as more complex legal structures, such as joint ventures and syndications.