Whether you’re new to purchasing, rehabbing and repositioning real estate as an investment opportunity, or you’re a more seasoned investor (in real estate or elsewhere) you need to answer one big question before you make your next purchase: Where’s the money coming from?
The answer? Either you have 100-percent equity to invest or you are going to have to put money down and arrange financing.
Put simply, it’s the cash needed to close a deal. Twenty to 25 percent of the agreed-upon price of a property is usually required up front. It helps to have a rich uncle (and I’m very open about the fact that having family in the business gave me a leg up), but when it comes to financing, there are other ways to skin a cat.
Other sources of personal equity:
As I’ve written before, there are sources of personal equity that are a bit higher in risk and require some out-of-the-box thinking.
- Borrow on margin: This practice — borrowing money against the value of stock you currently own at low interest in order to purchase more stock — is essentially investing with borrowed money. In this case, it’s investing in real estate rather than more stock.
Borrowing on the margin is also not, obviously, without risk; witness the case of one Joseph Campbell, who woke up one fine morning and found himself $106,445.56 in debt. While an investor can borrow up to 50 percent of a stock’s value, most financial advisors flinch at anything over 30 percent.
- Life insurance policies: You may borrow against your life insurance policy, provided it’s a whole-life policy (as opposed to a term policy) and the policy has accrued enough cash value. The advantages are that there is no credit check, no timetable for repayment and a low interest rate, but the death benefit can be reduced depending upon how much of the loan is repaid. The accrued interest can also cut into the value of the policy.
- Credit card/line of credit: With both, a set amount is loaned, and a time limit established for repayment. Typically a line of credit is based on a variable interest rate, so your loan rate will fluctuate on that basis.
Then, there’s the option of entering into a partnership.
Besides the obvious benefit of pooling financial resources, there are other potential plusses to such an arrangement. Partnering with those whose strengths might make up for your shortcomings can be particularly helpful — i.e., opposites not only attract, they can be a real advantage. With that in mind, there are a number of questions to consider before settling on a partner, not the least of which is, what is his or her financial situation?
Sources of Equity Outside Your Personal & Partner Funds
Again, I’ve covered this in detail in a previous post but briefly, these are some other options.
- Friends and relatives: How does one ask without alienating? That is the tricky part. And if an agreement is in fact reached, the next step in the process is a gift letter, in which the person sharing funds informs the mortgage company of the amount changing hands and makes assurances that it is in fact a gift, not a loan.
- Joint Ventures: Risk is shared by a group of individuals or companies, but the downside is clear: There is not nearly as much reward.
- Syndications: Similar to a joint venture, except the investors are often limited partners who have little say in how the company is run, and incur little risk.
- Institutional: Large entities building real estate empires.
Typically institutions finance 75 to 80 percent of the value of a property. The key questions to consider are interest rate (and whether the rate is variable or fixed), length of the loan, points and other potential fees, etc. The amount of financing you need will depend on the amount of equity you have. I recommend going for the minimal level, so about 20-percent, if possible.
- Small Banks: The loan-approval process is more streamlined and the staff often more constant, offering the chance to build relationships. The downside is that this institutions have legal lending limits.
- Large Banks: There is a greater lending capacity and more lending options than might be offered by smaller banks, but there is also more red tape.
- Recourse financing: Under this arrangement each of the borrowing entity’s principals — whether from a limited partnership or a limited liability corporation — personally guarantees any deficiency on the loan, in the event the investment falls through or there is a shortfall after liquidation.
- Mortgage Brokers: They can help you structure financing at the best possible rate. The key is finding the right broker with a proven track record and connections to various funding sources.
Bottom line: The money is out there. It is a matter of being nearly as creative with the financing as with the project itself.