Unfortunately, most of us are not yet rich. Unfortunately as well, being a real estate investor takes money, sometimes lots of it. Thus, in order for us to build our real estate portfolios and become successful investors, we need access to money. We need access to financing.
There are, in a very broad sense, two routes one can choose to take when seeking real estate financing — the traditional route or the creative route. In this post, I want to take a brief look at what each of these routes of financing are and why the creative route may make more sense for you as a real estate investor.
The first thing I need to do is define what I am talking about. What is traditional financing? What is creative financing?
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
Traditional financing can be thought of as bank financing. This route is likely what you or your parents did when they bought their first house or investment property. To get traditional financing, you go to a traditional brick and mortar branch of a local or national bank, you fill out a bunch of paperwork, you fill out some more paperwork and then hopefully get approved for a loan or mortgage.
Creative financing is just about everything else. It could be owner financing or rent to own. It could be the use of hard money. It could be the use of some type of line of credit. It could be private investors or crowd sourcing. It could be a joint venture or partnership of some sort. It is almost anything your creative mind can come up with.
Related: When the Bank Cut Me Off, I Had to Get Creative With Financing: Here’s What I Learned
And because of this creativity, this route holds many advantages to us real estate investors.
The Problems With Traditional Financing
Traditional financing is fine for the average homebuyer — and even for your first couple of investment properties. After that, however, traditional financing loses steam. This is because traditional financing is just not tailored for us investors. It is designed for the first time home buyer or the person that will only own one or perhaps two pieces of real estate at any point in time. It is structured by numerous rules that we just can’t mold to, nor can it mold to us investors. It has too many boxes that need to be checked and too many hoops to jump through.
Furthermore, traditional financing:
- Is too slow. It can take weeks, even months, to get your loan approved. Many real estate deals just do not last that long.
- Requires down payments. That usually means money out of your pocket. Creative financiers do not use their own money.
- Is full of people who can say no. Traditional financing requires input from appraisers, inspectors, and underwriters, all of whom can say no and kill your deal.
- Is inflexible. There are just too may guidelines, policies, and procedures to suit our needs.
The Advantages of Creative Financing
Due to the above issues, real estate investors must learn about and use creative financing techniques as it offers many advantages that may actually seal the deal.
Creative financing can be fast. The use of hard money lenders or private investors who have cash readily available, who trust your analysis, and who do not need an appraisal or inspection can really help make the deal. Imagine being able to tell your seller that you can close as soon as the title work is completed — perhaps in as little as 3 or 4 days. That can make a big difference if your competition needs a month plus for an appraisal and an inspection.
Many times with creative financing, it is just you and the seller making a deal that works for each of you. There is no underwriter. There is no appraiser, no inspector. No one to tell you no. This is one of the best aspects of creative financing in that you get to work directly with a seller. But you had better know and be sure of your numbers because there is no one else to fall back on.
While traditional financers tell you what the terms will be, you get to decide with creative financing. The interest rate, points, loan term, etc. are all things you and your seller can negotiate and decide what works best for the two of you. So not only can you negotiate the price, but you can also negotiate the terms.
Most traditional lenders want the borrower to have some skin in the game and thus require some form of down payment. I prefer to use OPM (other people’s money) instead of my own as much as possible. Creative financing allows you to do that. Private lenders may provide all the capital you need. Imagine negotiating a no interest loan or no money down. It can all be done with creative financing.
Many properties that we real estate investors want to invest in are distressed, and by that, I mean they need major repairs. If you find such a property, don’t even think of going the traditional financing route. Traditional financiers just do not like distressed properties and will generally not finance them. If they do, they will make you jump through an incredible number of hoops. But distress is where the money is, right? So what is an investor to do? Well, creative financers are also looking for distressed properties because they also know that is where the money is. They know that is the way to make money and have no problems with the amount of repairs needed. They will loan you the money to buy and fix up your deal when traditional financing will not touch it.
As you can see, creative financing solves a lot of problems for the real estate investor. It allows us to speed up our deals, lets us be the principal negotiator, and gives us a wider range of properties, especially distressed ones, to choose from. Sure, you can start off your real estate career with traditional financing, but you will quickly exhaust this resource. Successful real estate investors learn about and seek out creative ways to get the deal done. You really can’t be successful unless you do.
What’s your favorite form of creative financing to use?
Let me know your thoughts with a comment!