Of all the subjects discussed in regard to real estate, money is THE subject that appears most often, and is critical to every deal. I do not claim to be an expert on this subject, but will share with you lessons from our experiences. We have been developing real estate projects for 30 years.
Over that time, we have developed projects ranging from single family residential single homes, residential subdivisions, office buildings, small office parks, PUD’s, medical/dental clinics, office/retail condominiums, etc. The bulk of our projects were built as “spec” buildings, meaning we had no buyer/tenant lined up ahead of time, meaning more risk for lenders. Due to that, we often used hard money lenders.
When the market crashed the area where we lived was hard hit. We decided to sell our assets, pay off our lenders, and relocate to southern California, knowing it always rebounds first. We were right. However; because property is valued much higher here, we are again looking for lenders and partners to work with. Though some of our past lenders decided to move their money with us, we have been exploring various options that will allow us to raise the funds needed to develop new projects.
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It’s All About Balance
The more money costs, the better the profit margins need to be. Whether you are buying a house to fix and flip, or we are building a project from the ground up, it’s necessary to know exactly what it’s going to cost. Those costs include the cost of financing, as it can make or break a deal. The more risk a deal has, the more you pay for money. However; there is a huge variation on what is charged in points, fees, interest, etc. Just because someone will loan you the money, doesn’t mean that the deal will be able to sustain the fees, etc. Never be so desperate to put a deal together that you take whatever money you can get, just to put a deal together.
On a small fix/flip, there probably isn’t enough profit to justify 100% financing, at a high interest rate, and points from a mortgage broker, in most instances. However; there are areas of the country that are appreciating, where there’s a strong economy, and solid growth, that may allow that, but it’s rare. An unsuccessful deal will set you back much further than taking the time to find a lender with terms you can live with. If you can’t, drop the deal and move on to another, and work on what is necessary for you to become more fundable.
Money VS Risk
When lending out money, lenders are looking at several factors. Depending upon the type of lender, their experience and comfort level, they weight these differently.
- Cash available from borrower to put into the deal
- Type of property that will be used for security
- Value of the property
- Location of the property; and economic viability of the area
- Credit score of borrower (not as important for Hard Money Lenders)
- Experience of borrower
- Exit strategy (Once you have the money, how will it be paid back
Be realistic of what your situation is, and what lenders look at. Don’t take things personal. Listen to feedback. If you are weak in an area, try to compensate in another, etc. If you can’t compensate for the lenders concerns on your own, you may need to bring in someone else on the deal that can. Keep an open mind. Remember, a piece of the pie is better than no pie at all! Build your foundation.
Types of Loans:
- Conventional loans (from banks, credit unions, savings & loan, etc.)
- Private loans (borrowed from those you know and have a relationship with)
- Hard Money Loans (Funds can come from a variety of places, usually placed through a mortgage broker that lends out private clients money)
Other Funding Sources
- Joint Venture Partnerships – Financial partner joining with either a developer, flipper, investor. The financial partner puts up all, or part, of the financing in exchange for a percentage of the profits when the property is sold or refinanced. There’s a variety of ways in which this can be done, with various partners adding value in different ways, etc.
- Syndications – A group of investors that fund real estate or other projects in return for a percentage of the profits, or can be paid a set return on their initial loan, etc.
- Trading equity in your land or property into a real estate deal or project, in exchange for being paid when the project sells. You can also invest your equity as a down payment for an interest in the completed project.
- If you are a buy/hold investor, you can provide financing of a deal in return being allowed to purchase a unit, lot, etc. at below market value upon completion, etc.
I know, because I have read on BP, about all the creative ways others have funded real estate deals, and I hope you’ll share with us. Tel us what has worked the best, and those that didn’t turn out so great. Also, enlighten me if I have misstated any of the funding types I mentioned, or you can add to it.
Photo Credit: josemanuelerre