Need Money for Your Next Real Estate Investment?

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Money/Capital/Mulla is the life blood of being a real estate investor. Real Estate Investors need to develop two key skill sets as they enter the world of real estate investing:

  1. Get Good at Finding Deals and
  2. Get Great at Raising Money.

You can have a great deal but if you cannot raise money then you cannot take advantage of that deal. The first thing to understand are the different type of capital sources that you can access for raising money.

Two Categories of Money

Money comes in all shapes and sizes. The two major categories of money are debt and equity.

Debt 

Debt financing refers to money raised through some sort of loan, usually for a single purpose over a defined period of time, and usually secured by some sort of collateral. There are various types of debt financing options ranging from Fixed Rate Mortgages, Bridge & hard money funds, and owner carry-back loans. Since the real estate market crash of 2007, the debt markets have frozen and the equity requirements posed by lenders have risen. Hence it is important to understand the equity portion of the capital stack.

Equity

In today’s market, a real estate entrepreneur/investor should expect the equity component of  a deal to comprise 15 to 40 percent of the appraised value of the property, and likely higher for development deals and other projects considered  more risky. Equity capital is the cash money invested in the deal which can either be the investor’s own money or cash from third party capital investors: private equity, hedge funds, accredited and non-accredited investors. (Read more about how to legally raise money from these types equity sources). All of these sources provide funds in exchange for a portion of ownership, and therefore a share in the profits of the investment. Equity has the benefit of a long term capital source but it has costs associated with it which can include one or more of the following: giving up some control of your investment strategy, legal, accounting, and capital raising fees, which eat up at least three to five percent of the amount raised and equity investors will want a regular stream of information which can eat up your time to do more deals.

Real Estate investors need to strike the right balance between debt and equity financing by weighing the costs and benefits of each and making sure that you are structuring the best capital stack for the investment which benefits you and your equity investors over the investment horizon.

Different Types of Debt

  1. Conventional First Mortgage Debt: A conventional first mortgage loan is either a fixed or adjustable mortgage loan. A mortgage is typically given out by banks and pension funds (depending on the size of the loan) and a lien is placed on the asset as a security. Conventional debt is cheapest and lengthiest form of borrowing but it is also the least accessible and most time consuming source of debt capital.
  2. Second Mortgage or Junior Debt: Subordinated or “junior” debt (so named because it has only a secondary claim on assets in the event of a bankruptcy). These loans come at higher interest rates typically in the range of 8 to 12%, but they’re available from development agencies and private lenders.
  3. Asset Based Debt: An asset based debt can be a hard money loan. A hard money loan is a type of asset based loan through which a borrower receives funds secured by the value of  real estate with limited income and asset underwriting by the lender. Hard money loans are typically issued by private investors or companies. Interest rates are typically higher than junior debt and can be in the range of 11 to 14%.  Hard money loans are used for projects lasting from a few months to a couple of years hence they have a ballon risk associated with using them. So use them cautiously or else you may need to be creative to shield your investment against the “Evil” Hardmoney Lender.

Different Types of Equity

  1. Syndication of  Accredited and Non-Accredited Investor Cash: I parallel this source of equity to Angel Investors especially when it comes to flip or turn around type investments. Angel Investors are typically high net worth individuals (accredited investors) who collaborate with like-minded individuals to invest into the entrepreneur investment related business plan. That is where the similarities end as, unlike Angel Investor groups that exist for sector such as technology, bio-tech etc- there is no such thing within the real estate sector. Within the real estate sector, Real Estate Entrepreneur/Investors has to locate each of these “Angels”; get them to commit to invest; pool their funds into a special-purpose investment fund or LLC and then execute on the investment. This traditional process is now changing with the advent of crowd funding acceptance by the SEC which arose through the Jobs Act wherein funding portals such as PropertyPeers and Fundrise are becoming disruptive forces to the process.
  2. Institutional Equity: Private Equity Groups  and Hedge Funds fall into this category. Couple of things to keep in mind as you consider approaching this type of equity source:
    • Less than 10% of private equity funds will consider an equity investment of $1 million or less
    • Around 40% will consider an investment smaller than $5 million
    • Two-thirds are control investments and one third are non-control
  3. Self Directed IRA:  A self-directed IRA is technically no different than any other IRA (or 401k). A self directed IRA is unique because of the available investment options. Most IRA custodians, such as TD Ameritrade, Bank of America, Wells Fargo etc., only allow approved stocks, bonds, mutual funds and CDs.  However, a self directed IRA custodian, such as Equity Trust, Pensco Trust, and others allows those types of investments in addition to real estate, notes, private placements, tax lien certificates and much more. If you can locate this equity source and work with the capital investors through the initial setup process then you have the potential to lock in a longer term equity source.

It is important as a real estate investor to use a balanced mix of debt and equity sources to  achieve the highest net rate of return to your pocket with the least amount of acceptable risk to your equity capital investors.  That is capital budgeting, my fellow real estate investors.

The list above is far from exhaustive and I would love to get your thoughts/ideas on other sources of either debt and equity that can be utilized to finance a real estate purchase or rehab. Share your thoughts in the comments below as that is how we will all get better by having a free flow of information  So please leave me a comment and I promise to comment back.

Photo: Shelly S

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About Author

Ankit Duggal(G+) is the Investment Director of a New Jersey Income Operating & Consulting Company . Ankit is a seasoned value investor who enjoys achieving a zen through surfing, hot yoga, and snowboarding.

18 Comments

      • Ankit, Great info!! Look forward to more from you. I was fortunate enough to be able to barrow from my Dad, but in return he got around twenty 3 to 31/2 year payout rentals worth twice what he invested. So i guess you could say i cheated a lil, but paid my way in the long run. He’s a retired pharmacist, since he owned his own pharmacy, he had plenty of capital, but no retirement income. So it worked out well for both of us. I would be weak at raising money, so like to learn as much as possible. Thanks…

        • Bobby

          The first round of raising money is always Friends and Family. You helped your dad make a great return on his idle capital so props on doing that. We are all weak in something until we are thrust into it head first then slowly we all become experienced within that something. So I look forward to providing some more clarity to this topic based on my past experiences. What one thing would you like me to focus on in terms of raising capital in my post for next week?

          Ankit

        • Nice Brandon. I agree with you that it is a great win-win. Would you take money from any other family member? As some people wont take money from other family members given that if something goes wrong in the investment then that has a potential to create a strain on the family relationship.

        • Ankit, thank you for asking… But i honestly wouldn’t know were to begin a post on the subject. I think Jeff, Brandon or yourself, would be allot more qualified for that. I traded my percentage of the houses, for the down payment and Dads signature on a 36 unit Apt complex, nine months ago. It took me around 7 mnths to bring them from 60% occ to over 90%. So i’m just now beginning to generate a decent income while paying the six year note. Wth the economy the way it is and were i’m at financially (kinda starting over) i’m leaning towards land, 80 to 120 acres, were i’ll also live. I’m shooting for owner financing with large down payment. I’m planning to start investing again in a couple years, thats when i might try raising money, to buy a large apt complex. Or, may follow Brandons plan and trade up..

  1. This is my biggest issue right now. I have used seller financing but need to find access to funds outside of the banking system. I need a private money lender of some sort. I only have 5 properties as a buy ( fix up) and hold investor, so it is just that start up capital for the initial purchase before I can make the improvements and then back into traditional financing. I don’t market for finding houses but the way I run my business, the passion in which I speak about my business and word of mouth has lead several potential deals my way lately but with limited funds I have limited options….

    I look forward to your future posts.

    • Kyle
      That is a common problem that most investors face. You need to setup and start a private investor marketing program wherein you are trying to have lunch or dinner with potential private lenders who can help grow your real estate portfolio and make passive returns. The best place to find them is to ask your current friends and family and if they are not interested then ask them for a referral. Real Estate and Money Raising is a contact sport so make a potential lenders list from your current network and start having some lunches/dinners.

      • Sound advice. I do talk with family and friends. I think I could pull together enough for a purchase but I might have to cobble it togher. I think that will be my main goal for 2013. That is to develope a firm list of friends and family private money lenders.

        Do you have any experience with subscription private money lists online? I seen a couple for $95/m but am leary of the idea but enticed by the ease?

        • I think thats a great goal. In terms of my experience, I do not have any specific experiences but it could be a useful tool. Even with that director you will need to market to that list and build rapport with those lenders before they will give you funds. Now they should be more aimable to investing into real estate given that they have done it before as that is why you are getting there names from this list. So make marketing to private lenders a key goal of yours for 2013.

  2. Ankit, what do you suggest for first-time home buyers? Conventional loans all seem to require 20% down, which can take YEARS to save up for. What options are there for people that need down payment assistance (but without getting gauged either)? Are there different parts of NJ that lenders will be sympathetic/lax toward, and perhaps allow the 5% to 10% down instead?

  3. Hi Ankit,

    My husband and I are looking to begin Real Estate Investing starting with Multi-family properties in NJ. We are overwelmed with all the information there is to know but are defintely learning. Can you recommend the best financing for a beginning investor – one that will protect our assets if possible? Have you came across any tax benefits with Real Estate?

  4. Hello Ankit and great post. I currently own 19 units and have two interested investors for a 48 bed student housing property. I also am operating a property management firm/inspection company, that to date, manages my properties only. I am trying to use the investors so I put in less of my money, but don’t know the best way to package this for everyone.

    The property is about $990k so I am looking for about $125K from each of the two investors. That leaves a small balance for me to put in to close. I’m not sure what is fair to ask for on an equity deal? Initially I thought it would be fair to do a 1/3 split between us on ownership even though I didn’t contribute the same amount upfront. My basis for this is finding the deal and managing the property. However, some people I discussed this with felt that wasn’t reasonable.

    What do you think about a this and any suggestions? Thanks!

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