Real estate investing is as challenging as it is lucrative. Long-term success as an investor of any sort requires active management of assets. Even if you hire a full-service property manager, you alone bear the responsibility for your properties and their profitability. Before financing real estate, ensure to consult with industry experts, carefully assess your personal financial situation, and choose an investment type that suits the time and energy you are willing to invest. For those who want to spend very little time on real estate, real estate investment trusts (REITs) or a small rental house make sense. Those who want to make real estate their full-time business may want to own apartment buildings, industrial properties, and office space.
Regardless of the properties you select, financing real estate can be a challenge when starting out. Often, new investors don’t qualify for traditional bank loans, or the bank’s terms are unacceptable. Thankfully, alternative financing options continue proliferating. The following options work great for real estate investors.
Financing Real Estate With Affordable Alternative Sources
First Things First
Before committing to a loan and buying a property, create an LLC, and purchase the property through it. This shields your personal assets from liability created by a foreclosure or casualty event. By using an LLC, you limit your potential losses to the money invested in that particular property.
When a seller offers to finance the property, it’s a bullish sign for the investor because it indicates the seller needs to unload the property fast and will offer a better price. Often, these financing arrangements occur when a seller can’t afford needed repairs, making it a good option for fix-and-flip investors. For investors who want to keep the property long term, refinancing into a bank loan becomes an option after five years.
Hard Money Loans
These short-term loans work great for fix-and-flip investors and for emergencies, such as unexpected repairs or getting a property out of foreclosure in order to sell it at a profit. These loans expire in as little as six months or one year, so they are no good for acquiring rental properties. They require 20% equity in the property, but many fix-and-flip investors can purchase properties with no money down. Hard money lenders use the value of a property after repairs or renovations to calculate loan-to-value ratios. If the rehab profit puts your LTV below 80%, you can own the property with nothing out of pocket. Investors can use hard money loans to acquire property, complete renovations to raise the value, and then refinance into a long-term loan.
Private Money Loans
Are there people in your life who may be willing to lend you money for your real estate venture? If so, private money loans can save you the headaches of applying for a bank loan and, if your private money lenders are generous, they may give you a lower interest rate and more forgiving terms.
Before employing this strategy, think carefully through the implications. There is a major question you must answer before taking out a 401(k) loan to invest in real estate: Will the real estate venture compensate for the costs of the 401(k) loan and yield a profit far above those costs? 401(k) loans come with a unique advantage: the borrower pays interest to him- or herself. However, plan administrators usually charge a fee. Additionally, the 401(k) money you borrow won’t be working for you within the plan. Do the benefits of the real estate venture outweigh this opportunity cost?
Most importantly, consider risk. When employees leave their jobs while having an outstanding 401(k) loan balance, they must repay it in 60 days, which rarely happens. Most end up with a taxable plan distribution and 10% tax penalty.
This lending innovation makes borrowing a snap. It’s as simple as logging into a crowdfunding website and searching for the best financing option. Your loan can be funded in a matter of days, making this a great alternative when you need money fast. However, crowdfunding terms rarely exceed five to ten years, so it won’t work for expensive properties. However, if paying off a less expensive property quickly is the goal, crowdfunding can be the answer.
Borrow Against Life Insurance Policies
If you have a whole life policy, it may have a cash value. Rather than cashing it in, you can take a loan against the policy and, as with 401(k) loans, pay it back to yourself. You get the money and keep your policy. It’s unlikely that you will have enough cash value to purchase a property, but this funding source can help with a down payment or funding renovations.
Enlist an Equity Partner
If you have the time, ability, and inclination to handle the day-to-day tasks of putting a real estate deal together but not the money, consider an equity partner. Equity partners are wealthy individuals looking out for investment opportunities. They likely lack the time or knowledge to handle management tasks and prefer to leave that to you. This can be a great strategy for acquiring expensive properties, such as shopping malls, self-storage facilities, and apartment buildings.
Real Estate Investment Trusts
If you are not ready to take the plunge into owning property directly, consider investing in REITs, which can be purchased on the stock exchange. REIT mutual funds are also available and recommended for new investors who can’t afford a fully diversified portfolio. REITs pay very high dividends, often over 10%. By researching and watching these REITs, you will gain a better understanding of real estate investing that will make you successful when you purchase your own investment properties.
Real estate investing offers lucrative opportunities. With many alternative sources for financing real estate available, these opportunities need not belong exclusively to the wealthy. With a modest investment, it’s possible to start making money with rental properties or fix-and-flip opportunities. As of 2019, the real estate market is red hot in many areas. With careful research and a reliable funding source, investors are cashing in on residential- and commercial real estate.