An Investor Answers: Am I Using the Wrong Type of Money to Fund My Real Estate?

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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.

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.

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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.

Related: The Power of Private Financing: 3 No Money Down Strategies That Actually Work

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.

Related: Real Estate Financing: The 4 Best Ways Savvy Investors Fund Deals

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!

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

12 Comments

  1. Adam Schneider

    Dave,
    All good points. You could add using the seller’s money (seller financing). Also, it’s worth emphasizing the importance of using private/hard money to acquire quickly, and then refinancing with bank money once acquired to minimize the interest expense. Added to the conversation is the cash flow component and the terms that various lenders have regarding how much skin the borrower needs to have in the game.
    Thanks for sharing your thoughts, Dave.

  2. Stephen S.

    I find this portion of your post disturbing –
    ====================

    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.

    =====================

    Am I missing something or are you basically saying that you feel that your flips are too risky to use your own money – so you would prefer to risk someone Else’s money? That way if things go badly someone else loses their money? Is that your stated position – or am I mis-reading this in some way?

    • I think he is saying he’d rather use private HML money to finance the short term fix and flip instead of tying up his credit lines. This way he can do two projects at once…oneF&F with HML money another RE deal type with his own credit lines.

      The nature of the F&F is such it should be a short period loan that should theoretically pay for purchase &renovations, The HML financing, and make himself a profit…so why tie your own credit/cash or whatever into it at all.

    • Dave Van Horn

      Hi Stephen,

      Robert is correct. I am using the Hard Money Loan on the property so as to work on another investment that I find to be safer/more liquid simultaneously. Plus the line of credit could be tied to my personal residence, I wouldn’t want to risk losing my home for a single flip vs. multiple notes where my risk is both lower and diversified.

      But it’s true, I’m also using the HML so as to not lose my personal capital in the event something goes wrong. It’s important to keep in mind though, Hard Money Loans operate differently than regular loans, especially in terms of liability.

      Experienced Hard Money Lenders rarely lose money in the event of a default. The house is used as collateral, so they would assume ownership if I was unable to pay them. Most Hard Money Lenders only approve deals at 60-65% of value, so they only lend on properties that they know would be worthwhile to take over. They also have draw schedules for repairs to mitigate their risk.

      I also like hard money loans because most don’t report to credit, so it doesn’t affect my debt-to-income ratio.

      Best,
      Dave

  3. Stephen S.

    Responding a minute ago reminded me of something:

    When I was a child I had saved some money. Odd jobs, summer jobs, Christmas and Birthday (cash) gifts, and so forth – about $500. One day my older brother mailed me a letter asking me if I would lend him some money at a certain interest rate. Maybe for a year; I can’t remember. My money was in a passbook savings account and was getting maybe 4% interest. Oh wait – he offered me double whatever the bank was paying me. So I called him, we talked about it, and I sent him the money. My younger sister had also saved some money, she was interested in earning more on it, and had soon made the same deal. My brother used the money to buy a rental house in Houston Texas. I think he later either asked to alter the terms, or maybe repaid that load, and then asked for a new one. Now granted; houses were much cheaper then but still; it seems like things like that could still be done.

  4. Grant Sevek

    Is there a limit on home equity lines you can take out for cashflow properties. Example. If you own a rental that has 60k in equity and you take out a line of credit to buy another rental cash and it is worth double than what you pay.

    Is it possible to just keep duplicating this process?

    • Chau Cao

      I just got rejected by two banks for a line of credit on a free and clear property. Most banks only allow for a max of 4 mortgages (line of credit counts as 1). Well, I have about 8 loans out of 8 different properties. I ended up having to do a commercial line of credit for it instead. Same product, just more fees involved. Hope that helps.

  5. Jeremy Lea

    Great Article,
    Are there any similar articles which outline the process of refinancing from a hard money loan to a conventional loan? It’s always mentioned as a seemingly easy process, normally done at the three month mark, but the devil is always in the details. What are the terms for a hardmoney loan and a conventional loan that one should aim to secure? What is the timeline and pitfalls of such a strategy? Are there ever any hardmoney loan dangers to NOT being able to refinance and being stuck with such a high interest loan?

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