An Investor Answers: Am I Using the Wrong Type of Money to Fund My Real Estate?
I often hear folks talking about how you don't need your own money to invest in real estate, and what they're really saying is that you just need other people's money (OPM). OPM can be from the bank, a hard money lender, or even someone privately, like a friend or family member who lends you the money, whether it's secured to real estate or not.
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What I don’t hear very often is someone suggesting what types of money an investor should use and when. Since real estate is a finance-driven business, this could have a big impact on the overall outcome of your investing.
In the beginning of my real estate investing career, I really didn’t know any of this, and I figured things out the hard way over a long period of time.
Looking back, though, a few preferred strategies of how to use various types of capital come to mind.
Private Money vs. the Banks
Although today I would use mostly private money (or private equity if it was for a big real estate project), there is still a time and place for using traditional bank financing (for example, when the terms are favorable).
When you first start out, traditional banks lend you money on financeable properties, and it makes good business sense to take advantage of this when you can. A regular bank will let you buy only so many doorways (e.g. 4-10), and once you’ve reached the cut off, they may only give you commercial loans going forward.
My advice would be to utilize this strategy with traditional financing if possible. In some of my recent articles, I primarily discussed doing this when buying properties owner-occupied or even as an investor.
If you’re trying to build a portfolio, you might as well maximize this, the reason being that down payment requirements are more favorable, the rates are lower, and homeowner insurance is much cheaper than a commercial policy.
But once you hit your number and commercial is the only way forward, then you are where you are. For me, it made more sense to head into private equity and larger commercial deals.
Using Private Equity
This just means you’ve graduated to a larger commercial project like apartments, where you raise capital from private investors for your down payment, closing costs, and any renovation money needed to improve and turn around the property.
Then in around 3 to 5 years, you can refinance or sell the property and take out your investors for a nice profit or to gain complete control over the apartment complex.
Fix and Flips
As for fix and flips, I usually recommend using private money or hard money until you have a better track record and a better money list.
I don’t like using my current equity (via lines of credit) for flips, as I deem this too risky and illiquid and prefer to use this for things like notes. If I have a good real estate deal, there’s usually plenty of money around to fund it.
Once I’m done with the rehab, now I usually sell for a nice profit, or I refinance out of private money with permanent commercial funding. If you build a good money list, you might even find enough private investors where you don’t need commercial bank money at all.
My one buddy uses a ten year balloon to sweeten the pot (by not having a long term note and mortgage, e.g. 30 years), and if he needs to, he can always replace that investor with another one quite easily without much notice. It’s usually easy to bring in another investor because there may have been several improvements over time, such as the property value going up, rent increasing, or maybe you owe less (if it wasn’t interest-only).
So what type of capital do you like to use, and when?
Let’s talk in the comments section!