Lack of money is a major barrier to most aspiring real estate investors. Fortunately you don’t have to be personally wealthy to get started. Raising money can be surprisingly easy for those who know that banks are not the only players in the world of finance.
There are many sources of cash and financing out there. I believe one of my most valuable real estate investing skills is finding capital. All it takes is some professionalism and a whole lot of persistence.
The first place you’ll want to check is your bank.
Bank loans, though, have become much more difficult for real estate investors to obtain. Your bank may have a number of products but for real estate investors the most common is the conventional conforming loan.
Basically, a conventional loan is a loan that is not guaranteed by the federal government. It’s pretty much any loan other than a VA, FHA, or RHS loan. Conforming means that it complies with Freddie Mac and Fannie Mae guidelines for loan packaging and reselling to investors as securities.
Five or six years ago an investor could call the local bank and as long as she had a respectable credit score she could secure an investment loan with a relatively low down payment and reasonable restrictions. I contacted Tom Zinzi who is vice president and senior loan processor at George Mason Mortgage LLC, to find out what kind of terms a real estate investor could get these days.
He told me that right now you could buy an investment property with 15 percent down but there will be a fairly stiff mortgage insurance premium tacked on to the monthly payment if the investor does not have at least a 20 percent down payment. But the real hurdle is the bank will only allow the investor to own a maximum of four financed properties and it requires at least six months of cash reserves for all the properties owned. That means you need enough cash in a bank account, after you make the down payment and closing costs, to pay all your mortgages for six months in the event that you lose every penny of income. So if you own four homes with a $1,000 payment on each, you’ll need to have $24,000 in a bank account.
There are additional hurdles such as debt-to-income ratio requirements and banks’ reluctance to finance investment properties that need significant repairs. These are very specific situations that are decided on a case-by-case basis.
Some local banks still offer portfolio loans. These are loans that are non-conforming so they cannot package them up and send them out to the equities market. They keep them in house and service them locally. These are great products if you can find them. They usually have very competitive interest rates and they are often equity driven, so as long as you have a good down payment you have a very good chance of getting financing for your investment property.
However, I do not know of any specific banks that offer these anymore. These loans were primarily offered by small local banks that were hit hard by the 2008 financial crisis. Conforming loans offer very little flexibility and they make no consideration for varying circumstances, business track records or personal abilities. Unfortunately, we’re facing a one-size-fits-all financial system and the small investor is being left pretty exposed.
Here are some other financing options for real estate investors:
●Private financing: Private loans are funds that are lent out directly from a private citizen. It can be a relative or friend or it can be a professional private lender. In real estate investing, the terms private lender and hard money lenders are sometimes used interchangeably. They’re not exactly the same by definition, and in general real estate lingo, a private lender is usually a specific individual lending his own money and a hard money lender is usually someone who is dealing with funds from a group of private individuals like a broker or a fund manager.
Private funding is much more flexible and faster than most any bank product. However, it is normally much more expensive. Private lenders will usually charge around 12 to 16 percent interest per year and four to six points. One point is one percent of the total loan amount and this fee is due up front. They are normally short terms loans requiring full payoff within six to 24 months. And in general they will not loan out anymore than about 60 to75 percent of what the property is worth. But that doesn’t always mean you have to make a down payment. If you are buying a house that is worth $100,000 but you are only paying $60,000 because you negotiated a great deal then there is a good chance that a private lender will give you every penny you need to buy the home and they might even give you a little extra to fix up the place.
Finding a private lender might be the biggest challenge. You can ask your wealthy friends and family and, in fact, doing so is highly recommended. I hate soliciting for money but I actually just had a friend of a friend wire me $145,000 to fund a project. It’s really surprising how many people are looking for an alternative to the stock market. If you’re lacking wealthy friends, then the best place to look is real estate investing groups — especially local ones such as Northern Virginia Real Estate Investors on Facebook and LinkedIn.
●Partnerships: I still use private financing but after doing it for a while one of my private lenders agreed to fund all of my deals on a partnership basis. Partnerships are a great tool and the terms are whatever you can negotiate. This is also true about private financing and, in fact, partnership is just private funding.
Building a partnerships boils down to assigning value to different duties, expertise and risk. In my partnerships, I always handle every detail associated with real estate and the property. My partners are not silent but they are happy to let me do all the work. So in a scenario where I’m bringing minimal money to the project, I usually get about 50 percent of the profit and I generally concede that taking most of the financial risk is worth about 50 percent of the project as well. My partners usually make about 10 to 20 percent return on their investment within about four to six months and so far everyone seems to be happy.
●Seller financing: Is another form of private financing where the seller finances the sale of his or her own property. Rather than being paid in full at the closing table, the seller agrees to take payments on the home at a given interest rate and terms. Normally the seller registers a mortgage just like a bank.
These are only very brief descriptions of some of the most common forms of real estate funding. There are more options out there and the options above can be mixed and matched to create solutions for differing situations.
Your ability to fund a deal is only limited by your imagination. Find the funding and the deals will sometimes find you.
Justin Pierce is a real estate investor in Northern Virginia. In his occasional column, he will write about investing in real estate.