Part of my growth as a real estate investor has come in understanding the many various ways I can use OPM (other people’s money) to grow MOP (haha, not that we use this term, but… MY OWN PORTFOLIO!). There are a million ways (well, close to it anyway) that you can fund real estate deals.
OPM is such a vital part of growing your portfolio that it’s crucial you understand how to see deals in different ways. For this post we are going to spend some time thinking about rental deals and different ways you can structure them with the use of OPM for YOP (your own portfolio).
How to Purchase Real Estate With No (or Low) Money!
One of the biggest struggles that many new investors have is in coming up with the money to purchase their first real estate properties. Well, BiggerPockets can help with that too. The Book on Investing in Real Estate with No (and Low) Money Down can give you the tools you need to get started in real estate, even if you don’t have tons of cash lying around.
4 Ways to Use Hard Money & Private Financing for Your Rental Business
1. Hard/Private Money Front-End Finance
If you are buying a property that is in need of a lot of work, you may need to be a cash buyer, or at least not need to have a financing contingency in your offer. We use hard money all the time to buy our rental properties. This is very useful because we are able to buy whatever deals we want to, whether they are cash only purchases or not.
Another great reason for using this kind of transaction is because you won’t need to go through a long, drawn out process with the bank, between appraisals and an inspection (which most likely will kill your deal if there is a lot of work or it doesn’t meet traditional financing criteria). The hard or private money lender will generally lend on the value of the property, its ARV (after repair value), or what it will rent for.
Related: 8 Things The Real Estate Experts Won’t Tell You About Hard Money
Remember, in this kind of scenario, your costs of money will be lower because you are bringing the rehab costs to the deal, or at least part of them. So you are paying less for the financing because it’s a lower loan amount, but you ARE bringing money out of your pocket for the rehab. If it’s a $30k purchase and $10k to rehab, you need to be prepared to have the cash to pay as the work is completed.
2. Hard/Private Money Upfront Finance Including Rehab Funds
This idea goes along with option number one. If you are buying a house with LTVs that meet the hard money/private lender criteria, and especially once you have had several of these under your belt, have your numbers down and have established a relationship and trust with your lender, you can get nearly all or all of your funds needed for the rehab upfront with no money out of pocket.
For me, I send a spreadsheet with the approximate costs for the purchase, holding, and rehab, and these funds are available for me after closing to complete the rehab on the property. Every lender works a little differently, and it’s important to understand how each party works in the transaction upfront.
Think through and talk through each other’s expectations, costs, timeframe, and above all, exit strategy for the funds to be repaid.
So you’ve gone through and put together a totally awesome rental house, gotten everything together, the rehab and make ready work are done, the house is ready to rent or already rented… what do you do now?
Unless you are paying cash afterwards, you need to be able to have back end financing for your deal. There are a few routes you can go with the financing; again, just be prepared to know how to move from the short term funds to the long term funds. Here are two examples of what I use:
3. Hard Money Front-End/Private Money Back-End Financing
In this scenario I use the hard money upfront, funding nearly all or all of the upfront costs of the rehab. This way I have control of the house and get the rehab done with little or no money out of my pocket. Once the rehab is done and the house is ready to rent or already rented (lenders love to see the house rehab well done and the house rented), you let your back-end lender know you’re ready.
One of the people I use looks at a CMA and wants the basic rent of the area, a workup of the property, and its projected cash flow after all expenses. Another one knows the area pretty well, wants to know what we are all in for, what the ARV is, and that’s pretty much it.
Some lenders want to see a full or drive-by appraisal of the property. Each lender is a bit different; just know what they are looking for, and prepare your property, your pocketbook, and your efforts for whatever they are asking for.
So, let’s say the back-end lender funds up to 65% LTV, and our ARV is $70k. That means the lender will loan up to $45,500. Let’s say we are all in our property for $48,000, including our hard money costs, so we would need to bring the closing costs of the second transaction (if it’s a full closing with title insurance, etc.), plus the difference of the hard money loan.
(For the example, I am not adding anything with our closing costs for the second transaction for simplicity.)
$48k – $45,500 = $2,500.
In this scenario, for an asset worth $70k, with $45,500 financed, that would rent for $800-900 monthly, I would be out of pocket $2,500.
Can you say HELLO #CASHONCASHRETURN?
The wonderful thing about private financing is how easy it is to work with a private money lender. The downside is that you may pay points and have a higher interest rate than you would at a bank.
4. Hard Money Front-End/Bank Loan Back-End
In this scenario, we have done everything we talked about in option 3, except now we go with a bank loan instead of a private lender loan. I have a wonderful community bank that I work with, and they will loan up to 65-70% LTV, but they require we have a certain percentage into the deal of our own funds. The costs upfront in regard to points are usually lower, and the interest rates are significantly lower.
However, remember in this scenario, if they require we have 20% or our own funds into the deal, we would need to have 20% of the $48k all in number — so we would need to be able to come up with:
$48k * 20% = $9,600 out of pocket, plus any other bank closing fees.
Now, that comes off the loan balance, leaving us with $48k – $9,600 = $38,400 loan balance (which is close to a 50% LTV), but it also means we have to be able to come up with nearly $10k at close.
Not all banks require that, but just KNOW what you are getting into before you are a day or two from closing and have thousands of dollars to come up with that you aren’t prepared for!
There are many ways you can finance your rental properties. What is the way that is working best for you, and why did you chose that path?
Leave your comments below, and let’s talk!