Originally posted on https://fasterfundslending.com/leveraging-multiple-financing-techniques/
There are many ways a real estate investor can fund their real estate deals. Funding sources and an investor’s risk changes as their business progresses. Sometimes there can be so many financing options and strategies it can be hard to know what is best for your real estate business. My goal is to unveil the pros and cons of different financing options and how seasoned investors utilize several different financing options to grow their real estate business.
What does the financial cycle of an investor look like?
Real estate investors change their financing strategies as their real estate business progresses. They can utilize multiple different options such as credit cards, lines of credit, private money, hard money, commercial loans and personal savings. All these options have pros and cons and can be great tools when utilized effectively.
Credit cards can be both a risky tool and great financing tool depending on how the credit card is being employed. Credit cards are risky because they have high interest rates. Typically, higher than hard money costs and the interest compounds daily. The interest costs can add up fast and put a real estate investor in a tough spot financially.
Some investors will get funds for the purchase price for a property from either a private lender or a hard money lender and then put their renovation expenses on a credit card. If a house is cheap enough, investors have put an entire house purchase on a credit card. This can create a big credit card balance fast and might be a little overwhelming when the interest starts compounding.
It is recommended to keep your credit card balances and other revolving credit lines under 35% of the total credit card limit to keep your credit score strong. Completing larger purchases like total house renovations or real estate home purchase on a credit card has multiple negatives such as paying a higher interest rate, and potentially negatively impacting your credit score which could hurt your ability to qualify for future real estate long term financing options. This is not a great use of this financing tool and is very risky for real estate investors.
How do I utilize credit cards in real estate investing without putting my business at risk?
Credit cards can have limited offers or rewards programs that can be very incentivizing to a real estate investor. For instance, if you purchase all your renovation materials on a travel reward card and pay the balance off each month this could have many perks. You likely would get a points bonus for taking the card out initially and continue to greatly increase your point balance with regular purchases. Some investors can qualify for companion fares through airlines (buy a ticket and another person flies free) as well as several other free flights just with the amount of rewards points accumulated.
There are several other kinds of rewards cards like cash back programs, low introductory rates and balance transfers. The key to using credit cards wisely as an investor is to make sure you don’t exceed 35% of maximum credit line utilization and to pay your card off each month. Credit cards need to be used both carefully and strategically.
Lines of credit can be a great financing investment source. Typically, lines of credit can be established if you have a lot of equity in your rentals or your personal house. The bank would utilize the equity and real estate as collateral for the financial backing of the loan. What is nice about a credit line is you can pay off the balance once you no longer need the funds. With this strategy you are only paying interest when you are using the line of credit and you don’t have interest costs when you’re not utilizing the line of credit.
Lines of credit have two main downsides. First, if you recently purchased your personal home or just started building your business it’s likely you won’t qualify for a line of credit. Equity is a necessity for this banking product. Secondly, lines of credit have variable rates and can be unpredictable over time. It may be hard to know if the interest rate will be competitive over time. It’s also hard to project future interest expenses.
How can a real estate investor best utilize a line of credit?
Lines of credit usually have lower interest rates then hard money, credit cards or private financing. Lines of credit are variable interest rate loans that are set by the banks current interest rate guidelines. Their interest rates are more reflective of lower bank financing and are a great option.
Many investors best utilize lines of credit by using hard money to purchase a house and then using their line of credit to finance all the renovations, labor and materials. By diversifying your financial borrowing then you decrease your interest expenses overall via utilizing the lower interest rate of a line of credit versus using just hard money for everything.
Private money is a more advanced real estate financing technique. A real estate investor usually approaches friends, family and accredited investors and asks for funds to help them grow and continue to build their business. This can be challenging and uncomfortable for investors. Friends and family may have tough expectations to meet when it comes to their money. Furthermore, they may or may not have realistic expectations on timeline, profits and risk. Many investors may not want their business to be dictated by investors who may struggle to understand the real estate market.
Real estate investors either pay a competitive rate of return to their private lender, generally 8 to 10%, and may even have to give up equity to get the deal done. Giving up equity can be very costly to a real estate investor later in the real estate deal cycle. Private money takes a lot of courage, good network, negotiating skills, and investor relations. Private money is more time consuming but often has lower financing costs then hard money. This is a great tool for investors if it fits their skill set and network.
With this form of investing it is important to remember that you are risking other people’s money and livelihood. It is important to be confident in your real estate deal and your skill set. Again, this is not a good choice for beginners. This is a financial tool for a well-seasoned real estate investor.
Hard money is one of the best and most utilized tools in the real estate investing business. The advantage is a real estate investor gets to leverage other people’s money to build their business. There is instant access to business capital while creating a business relationship with a partner, your hard money lender, who is familiar with the real estate market and needs of a real estate investor in your market.
Hard money is readily available in most metropolitan areas. It is beneficial to find a local team who knows the market and can help your business thrive. Hard money rates and terms can be drastically different from company to company. Make sure to do research on your options before you pick a lender. Some hard money lenders can offer you purchase, construction funds, and closing costs. As an investor, if you don’t have to stress about any aspect of the financing and can get all your financing needs in one place, then you’re able to decrease your burden. Hard money is one of the easier to use financial options.
If a lender gets comfortable with you and your relationship is strong they will also do multiple hard money loans at once with you. This allows real estate investors the ability to scale their business using other people’s money and not be limited by their own personal financial means.
Hard money lenders are unregulated and can be flexible. If an investor just wants purchase funding on a house, they can do that. Or, if a real estate investor wants just construction funds then they can do that. Some investors may want purchase funds and closing costs. All these options and many more are possible with hard money lenders.
Commercial lenders are also able to fund various real estate investment deals. It’s important to form a relationship with a commercial lender and see what comprises their typical real estate investment parameters. Many commercial lenders expect real estate investors to put 20 to 25% down on any real estate deal. They will provide only 75-80% of purchase. This can be a financial stretch for many investors. That’s a lot of capital!
Also, with this financial strategy the real estate investor is not getting any construction funds or closing costs. They will have to put even more money into the deal in order to finance all the renovations among other expenses. This could be anywhere from $5,000 to $100,000 depending on the house and the renovations needed.
Most commercial lenders prefer investors to use hard money or other financing to get a real estate asset performing. This most directly applies to rental properties. Performing is defined by a house being completely renovated, rented and creating revenue. Bank’s appraisers and systems are more prepared for houses that have been fixed up and that match the finishes of comparables in local real estate market.
The pro of a commercial loan is the rates are lower than both hard money, private money and credit cards. The con is you’ll need a lot more capital, a good credit score and be bankable as far as your debt to income and other factors banks consider. Also, the bank will have to feel comfortable with the deal and with your real estate investment strategy. If you are going to use commercial funds, it’s very important to find a bank that understands real estate investing and is comfortable with construction loans. Many distressed houses are out of their normal lending wheelhouse.
When should an investor use a commercial loan?
Commercial lenders are amazing long-term solutions to financing. They love when investors use the BRRRR strategy. The BRRRR strategy is to:
Once the house is renovated and the investment is making money a bank is much more comfortable investing in it. Their risk is mitigated because regular rental income is coming in, and the house is worth more on an appraisal because it’s been renovated. The commercial lender will pay off the short-term hard money loan and you’ll have solidified long-term financing at a competitive rate. It’s a win all around.
The most important investment you can ever make is in your business and your own success. The smartest real estate investors take a minimum 10% of their revenue and save it for growing their business or for cash reserves in case of an economic downturn. If a real estate investor gets a big check, maybe from a flip that just sold or a wholesale deal, it can be so tempting to just spend the money on frivolous things.
Most people go out and buy a new car, go on a lavish trip or go on a shopping spree. The wise investors are always thinking about how to invest money back into their business to continue to spur growth and how to prepare for future uncertain events. Remember, investing in yourself and saving will help you feel confident and secure as a real estate investor. You will be prepared for whatever the future brings next.
To have the most positive impact on your business, advanced investors will combine several of these financial techniques to maximize the pros of the different financial tools while limiting the cons.
My name is Arielle Morris and I’m a real estate investor in St Louis, MO. Here is my financial technique as a real estate investor and how I personally fund my fix and flips as well as long term buy and holds for my rental portfolio.
First, every year I research the best business credit cards available and the different reward programs available. I pick the one that meets my needs and interests and commit to it for the next year. This is usually a travel rewards card since traveling is a passion of mine. There are many good websites with good data and reviews on different credit card products. Currently, I run as many contractor payments, material purchases and other business expenses through the credit card to maximize reward points. Monthly, I pay off the credit card balance in full. I would not suggest using a credit card for real estate investing unless you can pay it off monthly.
Second, I use hard money to finance the purchase price of my real estate investments as well as closing costs. This allows me to not tie up too much of my personal capital in one deal. Typically, I run 4 to 5 real estate investment renovations at the same time with a mixture of both rentals and flips. The four projects I have going currently totals close to $500,000. This is a lot of capital if you’re trying to self-finance your real estate investments. With hard money as a tool, I only need personal capital for my rehab expenses, carrying costs and financing costs.
Third, now the challenge is funding the materials, contractor labor, carrying costs, taxes and financing costs. I like to use several strategies for these expenses including a mixture of a line of credit, private money, personal savings and reinvesting profits back into my business.
As far as private lending, I negotiated with my private lenders to pay them a set interest rate just when I am using their funds. This is a great way to save your business interest fees. They are given monthly updates on their fund’s allocations and interest earned. Private money is a great source of funding if you find people who trust you and your business vision.
Lines of credit are great because you’re not making interest payments when you’re not using them. I personally use our line of credit to help fund renovation expenses. A strategy when you refinance or sell a flip is to pay the line of credit off and stop your interest expenses. They are variable rates and it’s important to consistently monitor interest rate changes in case an increase means it’s no longer the cheapest form of financing available to you. Funds are usually accessed via check or card. Due to ease of funds access and ability to pay off the balance, lines of credit are great renovation budget financing tools.
With each new real estate investment, I am taking on I look at all the possible funding sources I have available and I weigh my costs. Strategically, I use the least expensive financing options first then move on to the next least expensive in order. This minimizes overall interest expenses. The cheapest source of financing is your personal savings and investing profits back into your business. Being financially diligent will really help you further your business. Think about the consequences before you spend all your profits.
When you have multiple projects going at once you need a lot of funding and diversity. Running out of money limits a real estate investors ability to scale and ability to increase revenue and profits. Money is often the source of the most stress for a growing real estate business. It’s important to understand all your options and how they can all be utilized together to create a thriving and financially healthy business.
As your real estate investment business progresses using multiple financing sources at different times becomes a natural progression. It is an advanced technique designed to decrease costs, increase productivity and explode growth. Investors should look at all financing options and determine what is the most strategic for their business’ financial future.
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