My Top 4 Capital Sources for Real Estate Investing
Real Estate Investors constantly face the classic “chicken or the egg” paradox when it comes to deal-finding and capital sourcing.
Which comes first: The deal or the money?
There’s a common maxim thrown around online real estate investment communities: “If you find a great deal, the money will follow.”
While I tend to agree with this short, pithy statement, there’s a hitch. There are many different sources of capital and learning how to obtain each one is an uphill battle.
I can’t definitively answer which comes first, “the money or the deal”. However, I can attempt to familiarize you with the 4 different capital sources and the order in which I seek them out.
Many aspiring real estate investors stop before they ever get started because they don’t personally have the funds available to purchase an investment property.
“I can’t invest in real estate because I don’t have enough money to put 25% down.”
Getting past this limiting belief is difficult. I struggled with it for years.
Today’s inflated market (Feb 2021) makes 25% down a tall order for anyone, regardless of socioeconomic status. Doing it multiple times over to build a portfolio of rental properties is damn near impossible.
What to do?
Learn how to leverage your personal assets, including your “brand”, to get [closer to] 100% financing.
In the past 14 months, I’ve purchased $770,000 worth of property using none of my own money.
- $240K in Jan 2020
- $215K in September 2020
- $315K in February 2021
Additionally, we spent or are expecting to spend another $230,000 on renovations for these three properties. That’s a total investment of $1M in a little more than a year. Whoa.
I did NOT have the cash available to put 25% down ($250K) on these properties. I didn’t let that stop me. Instead, I started a newsletter (SunShakSunday) to build my authority in the space.
This isn’t a house of cards. My foundation is deep and made of concrete.
Obtaining 100% financing for my projects came down to two things in my lenders’ eyes:
- They first have to know, like, and trust me & my prior experience;
- My Personal Financial Statement needs to be rock-solid
If shit hits the fan, am I willing and able to foot the bill temporarily until things get back on track? The short answer is yes.
Here are the 2 main components of a strong Personal Financial Statement (PFS).
- Annual Income > Annual Expense (Positive Operating Income)
- Assets > Liabilities (Positive Net Worth)
I update my PFS every year and it’s one of the first things I give to lenders whenever I apply for a loan.
The second type of capital I look for is called Hard Money.
Hard Money Lenders get a bad reputation because of how expensive they are. I like Hard Money Lenders because they will finance anything quickly.
If you want to buy an uninhabitable property in the next 2 weeks, a Hard Money Lender is your best bet.
Typical Hard Money Lender terms could be 2-4 origination points and anywhere from 8-12% interest. The cost of the loan is commensurate with the risk.
A strong borrower with a fat deal (lots of equity), will get favorable terms over a weak borrower with a slim deal.
A Hard Money Lender financed the purchase of my 4-family home for 0 points and 8.5% interest-only payments for one year. They also provided me with ~50% of the renovation budget.
I was able to get those terms because of my experience, credit score, personal financial statement, and the anticipated after repair value of the property.
Some people might be afraid to use Hard Money because it’s expensive. I think if the deal is good enough, you can’t afford not to use Hard Money. After all, hard money might be the only source of capital willing to help you acquire the property.
After I line up my hard money lender, I reach out to my network to find a Private Money Lender to fund my down payment, closing costs, & remaining rehab budget.
Once I secure that portion, I’ll double-down and ask the Private Money Lender if they’re interested in funding the entire project. If they say yes, I kick the hard money lender to the curb.
Private Money Lenders are the people in your network that have some extra money and don’t quite know what to do with it.
This money comes in different shapes and sizes. It could be:
- Money in their savings account earning .0001%
- Untapped equity in their homes growing at the rate of inflation
- Cash sitting in an IRA from an old job getting eaten away by inflation
For the most part, these accounts provide sub-optimal returns.
Instead, that same money can earn 6, 8, or 10% by making a loan secured by real estate.
Convincing a Private Money Lender to invest in your deal is difficult at first. But once they get a taste, it’ll be hard for them to go back to earning .0001% in their savings account.
When most other lenders care about debt to income ratio and credit scores, a Private Money Lender just needs to know, like, and trust the borrower and believe in the outcome they’re projecting.
Once you’re lucky, twice you’re good. A proven track record goes a long way with a Private Money Lender. Your success should look like a repeatable system and they’re the newest cog in your machine.
Private Money Lenders also want to see you have some skin in the game. Sometimes the skin in the game is money. Other times it can be collateral.
I typically try to have none of my own money in a deal. However, I am happy to secure a $50,000 private money loan with a $75,000 asset. In this scenario, I stand to lose 50% more than I borrowed. That’s skin in the game.
Read Raising Private Capital by Matt Faircloth to learn more about what it takes to raise funds from your network.
4️⃣Banks (Traditional & Otherwise)
The last place I look for money when acquiring property is a traditional lender like the bank you pass on your morning commute.
Unless you check every box, don’t waste your time talking to banks about buying an investment property. In my experience, they’re quick to run your credit and charge you for an appraisal but slow to process your application.
The number of “decision-makers” in the process of obtaining a loan from a bank is laughable. There’s the broker, originator, officer, underwriter, some VP in an Ivory Tower, etc.
Time is the most important factor when it comes to real estate investing. You can’t afford to get bogged down by bureaucracy.
Time spent jumping through hoops leaves the window open for market factors to turn against you.
- Material costs can go up
- Market values can shrink
Sellers aren’t waiting for you to figure out your financing. You either have it or you don’t.
If you’re doing a fix and flip, don’t waste 2 or 3 months trying to get a traditional lender to finance the transaction to save a few basis points on the loan.
Instead, acquire the property with hard or private money in 2 weeks and use the extra 45 - 60 days to get the job done on time and within budget.
If you’re trying to acquire a rental, use hard or private money to close in 2 weeks and then start looking for a traditional lender to refinance you out after closing. Let the traditional lender see you in action. Communicate your plan:
- Rental Increases
- Acquisition Price, Rehab Budget, After Repair Value
Traditional Lenders like to be spoonfed. It takes time to wine-and-dine them. Put in that groundwork after you already control the property.
I’d suggest looking for a portfolio lender. This is a bank that will not try to sell your loan to another lender. Instead, they’ll keep it on their books for the length of the mortgage. Portfolio lenders usually come in the form of a local credit union.
5️⃣Super Secret Source of Capital: Seller Financing
I saved the best capital source for last.
Seller Financing should be numero uno, but I only wanted the people who stuck with me until the end of this post to see it.
Seller Financing is the ultimate cheat code when buying property.
- It removes financing constrictions during the closing process.
- It gives the buyer a higher level of confidence if the seller is willing to hold a note.
- The seller continues to benefit from the property after relinquishing control & ownership.
- Closing / borrowing costs are typically lower.
According to Bloomberg, roughly 40% of homes in America are owned free and clear. That’s 2 out of every 5 houses.
We almost obtained seller financing on our 4-family. However, the seller backed out after agreeing to a $50K price adjustment a few weeks before we closed. Understandable.
We did, however, get seller financing on our latest acquisition (Mixed Use). The seller only needed a portion of his proceeds upon sale. We were able to get $100K of seller financing at 5% interest only for one year.
As a buy and hold investor, I understand how hard it is to get good loan terms on a rental property. My friends on IG also agree.
For current owners who paid off their homes, seller financing is a great way to continue making cash flow off their property without having to manage the day-to-day.
If you can come to fair terms, Seller Financing is a win-win situation. Always ask for it.
This entire post is about using different forms of debt to acquire real estate. Let’s not throw caution to the wind. After all, over-leveraging is probably the biggest contributing factor to portfolios turning sour.
If you’re going to use debt to acquire a property, there’s a smart way to do it.
Make sure to keep the following in mind:
- Fixed Interest Rates
- Long Term Debt (nothing shorter than 10 years for a stabilized property)
- Conservative Financial Ratios
For conservative financial ratios, here are a few to keep in mind:
- Loan To Value (LTV) - 70% or less
- Debt Service Coverage Ratio (DSCR) - 1.25 or higher
- Runway or “burn” - 3 months or more
- Monthly Rent To Value (RTV) - 1% or higher
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