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The Key Pros And Cons Of 5 Main Financing Sources
When you reach a point where you are trying to tie up a deal a month, you will realize that the people you will be speaking to the most, other than your partner, are the parties that do the financing.
As soon as I mention this to the resident writers in Singapore, they said that the rate of 1 house a month is impossible in Singapore. Now I don’t have deep local knowledge of how the Singapore real estate market works, but I would state that a house a month is not only possible in the US, it is a small quantity to many active investors and flippers.
There are even hardcore flippers who get involved upwards of 60 deals a year! That’s about 5 a month!
And the only reason these super dealers are not doing more is attributed to the lack of financing or the lack of time. Not due to a lack of profitable deals. Meaning that if they had more access to cash, they would be flipping like a dolphin in a show at a sea aquarium.
The 5 main financing sources are:
- Portfolio loans
- Private investors
- Hard money lenders
- Equity investors
Yes. It takes money to make money. This is especially true in real estate. The silver lining is that there is be almost unlimited leverage if you know what you are doing.
Here are the #1 main benefits and drawbacks of each.
A mortgage is the typical property loan you obtain from a lender (most often a bank) and in return, the house becomes a collateral. How much you can borrow depends on a number of factors including your income, credit score, debt, etc.
This is the most basic financing option easily accessible to home buyers. And for most investors, it is the very last option they would consider. Many even drop their deals completely if the only avenue of funding left is with a traditional bank.
This is because there are just too many red tape around such loans.
Pro: Because this caters to the mass market, it comes with terms that are less “cut throat” and friendly enough not to cause riots in the streets. Long tenor of loans and low interest rates are the biggest attractions with a conventional mortgage.
However, these score little brownie points in the world of investments and pro-active flipping.
Con: From the lessons learned in the years running up to 2008, lenders are no longer that flexible and easy-going when it comes to financing real estate.
Lenders these days want to see at least a minimum of 20% down payment, a house in habitable condition, and credit with flying colors. And once they find that you are already on multiple mortgages, their fears heighten as if an air raid is turned on.
As mentioned before, a problematic mortgage is often the last resort of investors.
2) Portfolio loans
Banks that disburse loans from their own pockets instead of getting it from financial institutions are known as portfolio lenders.
Since these monies are coming out from their own pockets, they do not need to follow the criteria and procedure of traditional mortgages when assessing a loan’s viability. This means that things like credit, debt ratios, and property appraisal value, is theoretically thrown out the window.
Saying so, it does not mean that you can get a loan just by walking into it’s lobby and show the model of the house you’ve built with LEGO bricks.
In fact, because they are using their own funds, they are more careful with where they invest it. The good thing is that they will not throw out a case just because it fails to meet some numbers. Qualitative factors come into play and evaluators will analyze just how viable a deal is.
This means that even if you have no qualifications, no track record, and no credit, you can still walk out of such a bank with a smile on your face while holding a FAT check as long as you have a real estate deal that is deemed as a winner.
They can always take away the property and book in the profits if you default on the loan.
Pro: With such a generous introduction of portfolio loans written above, surely you can already tell what the key advantage of such a loan is?
You can expect to have more flexibility in negotiating terms and your financial standings becomes less of an anchor that’s holding back your progress. So if you have got this far, don’t be afraid to ask for whatever assistance you need. It’s not time to hold back.
This does not mean that your previous bankruptcy is no longer a factor, mind you. It just means that the bankers are using more of their brains than maths to work out your risks.
Con: With such a courteous way to lend you money, you can expect to be on the wrong end of a financing bashing.
Expect to be offered short term loans for as short a period as 6 months. And on top of that interest rates can often run into double figures.
But this shouldn’t faze you unless you are not confident with the deal you are trying to close. After all, it is cash flow that you are concerned about.
Should you indeed fail to flip the property as fast as you predicted, to get out of the tight corner, look for avenues to refinance it.
3) Private investors
Private investors basically refer to people who are willing to fund your investing activities privately.
This can include family, friends, former colleagues, acquaintances, or professionals you’ve met in the past. These days, with the power of connection via the internet, it is also not that difficult to locate private parties who for their own little investment networks to invest in deals like yours.
The key to success in tapping such financing sources is credibility.
Private investors need to know:
- Who you are?
- What experience you have?
- What type of deals you bring to the table?
- What’s in it for them?
Pro: There are much more people out there than you think who are actively looking to privately fund deals. There is so much scamming going on these days and the stock markets are so unpredictable.
It could be easier than you think to get someone to fund your real estate investing and flipping activities.
The main question is: Are you someone they can trust and depend on?
The biggest benefit of private investors is… if you can prove your ability to churn out money like an ATM, they will be more than willing to lend more… and more often. It could very well be an unlimited credit line.
Con: The opposite of the advantage mentioned is the disadvantage. Because private parties, especially wealthy individuals, know that their benevolence can be taken advantage of by bad people.
In fact, many will have already experienced the heartache of being scammed. So they are very wary of becoming the financial angel of someone they are not familiar with.
So it might take some time and extra effort to win over the trust of private parties.
They don’t have a high net worth for nothing. Never underestimate a rich person.
4) Hard money lenders
These are lenders who can provide quick access to cash by securing the loan against a hard asset. They put little thought on the financial status of the borrower as long as they can be convinced that the money being borrowed is used to finance a great deal.
Pro: The best benefit of going to hard money lenders is the speed at which they operate. This is a main reason why they are often the financier of choice among hardcore flippers who have a very high confidence level on their deals.
If you are running out of time, and sure of the profitability of your deal, this is a good option that you can consider.
Con: You can probably guess what is the biggest drawback of borrowing from this source. You shouldn’t be surprised at high interest rates and significant upfront “processing” or “admin” fees.
5) Equity investors
An equity investors are somewhat like taking on partners on your dealings. They bring the money while you contribute the work and expertise. At the end of the day, the profits will be split in the portion previously agreed upon.
Pro: You don’t need to repay the money… unless you have agreed to repay the initial capital with profits generated… This implies that you are taking on the funds as some form of debt… and giving away equity for it.
In that scenario, you should attend more lessons in negotiating class.
Con: This can sound like an ideal situation to be in for some people. But partners can become a nightmare in many cases. Even those who promised to be sleeping partners can rise like tigers when they feel that their investments are getting threatened.
Imagine having to waste time convincing partners of what is actually happening when they have no idea how real estating works. This can be too much stress to shoulder just to acquire a source of financing.