Raising Capital & OPM: Other People’s Money

You don’t need me to tell you that you can’t build a real estate empire with nothing but your own cash.

Real estate investors quickly run out of cash for deals. That means they have to learn how to borrow and raise money from other people.

But how do you do that? Who can you borrow money from? How do you approach them? 

Strap in, because learning to invest in your own properties with other people’s money remains one of the most crucial skills in real estate investing.

Traditional Financing — And Its Pros & Cons

When they first start buying rental properties, most novice investors start by calling their home mortgage broker. 

You can get away with that for a property or two. But no more than that. 

Conventional mortgage lenders report your loans to the credit bureaus. Adding too many can mess up your credit history, and most conventional loan programs only allow a maximum of four mortgage loans to appear on your credit report. 

On the plus side, conventional loans offer relatively low interest rates and points, and sometimes decent loan-to-value (LTV) ratios. The advantages end there however.

Conventional loans are slow, rigid, and difficult to work with. Looking for more speed and flexibility, house flippers and BRRRR investors quickly turn to hard money lenders. They specialize in short-term renovation loans for fixer-uppers: ideal for flipping houses. 

Meanwhile, long-term rental investors turn to portfolio lenders. (These lenders keep the loans within their own portfolios, rather than bundling and selling them off — hence the name.)

Properties with five or more units fall under commercial zoning, and require a commercial lender. More on them next time around 😉

House Hacking

Is there ever a time when it makes sense to use conventional mortgage loans for an investment property? 

Yes. Sort of. 

When you first start investing in real estate, consider house hacking for your first property or two. Multifamily house hacking involves buying a 2-4 unit property, moving into one of the units, and renting out the other(s). 

The idea: your neighboring tenants pay enough rent to cover your mortgage payment. You score effectively free housing. 

And you buy the property with an owner-occupied mortgage loan with a low interest rate and down payment. 

You don’t have to live there forever. As long as you live there for at least the first year, you’ve satisfied the owner-occupancy requirement from the lender. 

That means you can theoretically buy a new fourplex every year, all with owner-occupied mortgage loans. When you move out of a unit, you just lease it out and keep the property as a rental. 

Lending advantages aside, it also gives you some hands-on experience managing renters and properties. That experience will serve you well as you scale your portfolio. 

Professionalize your real estate business

Professional athletes don’t duct tape together their shoes. So why are you trying to duct tape together your real estate business?

If you want to earn profits like a professional real estate investor, use the tools your pro competitors are using. That starts with marketing and accounting tools like REsimpli. 

Don’t take our word for it. Try it out for yourself with a 30-day free trial. 

We look forward to hearing your feedback and successes after your first month running with the big dogs. 

Creative Financing

The term “creative financing” can mean a lot of different things. In fact, it really just means “anything that isn’t more traditional financing.” 

So what options do more experienced real estate investors use to finance their deals?

Seller Financing

When investors talk about creative financing, the first thing they usually mention is seller financing (AKA owner financing).

You can negotiate your own interest rate, your own loan term, your own down payment. For that matter, you can negotiate seller financing to cover the down payment for a hard money loan or portfolio loan!

That means you can use owner financing to buy properties with no money down. 

Seller-held notes can be the primary mortgage (first lien position) or a second mortgage. You get what you negotiate with the seller. 

That raises the greatest challenge with owner financing: explaining and negotiating it with the seller. More on that later. 

Business Credit Lines

As a real estate investor, you qualify as a small business owner. That means you qualify for business credit lines. 

Unlike mortgage loans or even seller financing, these credit lines aren’t secured with a lien against a property. You can open unsecured lines of credit. 

“It’s not like I’m planning to default — why does it matter if they’re secured or not?”

That matters because it means you don’t have to pay thousands of dollars for a title search and lien recording, when you open these credit lines. In fact, you may not pay any fees at all to open unsecured business lines of credit. 

Credit Cards

You can also draw on credit cards to cover the down payment of a property. For that matter, you could theoretically cover the entire cost of buying a property that way. 

Credit cards also offer a great way to cover renovation costs. You can charge material costs directly to them, and many contractors accept credit cards nowadays as well. 

“But won’t I pay expensive cash advance fees, and hit the lower ceiling for cash advances?”

Not if you use a service like Plastiq to pull money off your cards. They charge 2.9% and the charges appear as purchases, not cash advances. 

You may even be able to make that 2.9% back in the form of credit card rewards. Which raises another advantage of using credit cards to cover real estate investing costs.

Just as you can open unsecured business credit lines, you can do the same thing with business credit cards. Companies like Fund&Grow charge an up-front fee to help you open as much business credit as possible, often up to $250,000. 

HELOCs

Alternatively, you can open a rotating line of credit secured against your home. Or, for that matter, against your rental properties if they have enough equity. 

Home equity lines of credit (HELOCs) usually come with two phases: a draw phase (when you can pull money and repay it at your own pace) and a repayment phase (when it transitions to a fixed-term loan. 

The main downside to HELOCs is that they require a full title search and lien recording. That costs thousands of dollars in up-front fees. 

Retirement Accounts

You can also tap into your retirement savings to invest in real estate. If you don’t mind risking your retirement, that is. 

One way to do this involves borrowing a loan from your 401(k). On the plus side, you pay low interest, and that interest goes to your own 401(k) account. But these loans typically allow just 50% LTV against the balance of your account. 

Another option involves opening a self-directed IRA (SDIRA) and using it to invest in real estate. You can’t use it to fund your own business (like, say, a house flipping business) but you can buy rental properties with it. 

These come with their own drawbacks however, including annual fees. The tax treatment also gets complicated, with rules like “unrelated business income tax” and only the portion of your property bought with the SDIRA getting the tax benefits. Speak with an SDIRA custodian such as Directed IRA for more information. 

Private Loans

As real estate investors gain experience, many build a deep network of private lenders. 

Some newbies confuse the terms “hard money lender” and “private lender.” A hard money lender is in the business of lending money. A private lender is a person who lends you money, often a friend or family member. 

When you borrow money privately, you could use it to buy a specific property. Perhaps you secure it with a lien against a property, or perhaps not. 

If unsecured, you can potentially use private money to grow your business, such as sending direct mail campaigns. Or you may put the same loan toward down payments on multiple properties. 

As for the legal arrangement, investors typically sign a private note document with the lender. A “note” is the legal promise to pay back a loan, along with the terms of it. More on this next time. 

Equity Sharing & Syndications

For larger projects, some investors offer a piece of the pie when they raise capital. 

That typically comes in two forms: a joint venture partnership or a syndication. 

In a joint venture partnership, you might say “I’ll do all the work of flipping this house, you provide the down payment, and we’ll split the profits 70/30.” These tend to be straightforward arrangements where both people share ownership on the deed, and both sign for the hard money loan. 

Real estate syndications are more complicated. Common in commercial real estate, the arrangement often looks like this: “I’ll buy this apartment building and get a loan for 70% of it, I’ll come up with another 10% of the purchase price, andI’ll cover the rest by raising money from 30 other investors.”

Those passive investors — or limited partners (LPs) — invest for fractional ownership in the property. They don’t appear on the title and don’t have to sign for the loan. But their piece of the pie depends on the terms set by the syndicator (the “sponsor”). 

Often that looks like a 7-8% preferred return (repaid before the sponsor gets their cut) plus a profit split, such as 70/30. 

The downside? They’re the last to get repaid if the deal gets in trouble and sells for less than the acquisition costs. 

I’ll cover this in more detail next time. 

Some Deals “Lend” Themselves to Seller Financing

For the average house flipper or rental investor, two of the tactics above stand out as the most common: seller financing and private notes. They deserve a deeper dive. 

Your average home seller has no interest in becoming a private lender. They don’t understand owner financing and have no interest in learning. 

Extremely motivated home sellers, such as those in distress? They’re a more captive audience. They may accept a long-term income stream in place of a one-time payout. 

But the true bread and butter for seller financing is other investors. Specifically, “tired landlords” who want to sell and understand the premise of owner financing. 

What many sellers don’t understand is that seller financing helps them spread out their tax liability. Rather than taking a lump sum payout and paying capital gains taxes on the whole thing in one year, sellers can reduce and spread out their tax bill over many years through owner financing. 

For the best odds of negotiating seller financing, identify tired landlords. Look for properties with deferred maintenance, or under-market rents, or recent vacancies or evictions. Make those owners an offer they can’t refuse: ongoing income with no landlording headaches and lower tax liability. 

As a final thought, make sure you have a plan to pay off the owner financing before the balloon date. No seller wants to hold a loan for 30 years, so when you negotiate terms, you’ll set a balloon date by which you’ll pay off the remaining balance in full. 

Have a plan to either sell, refinance, or otherwise cover the cost of repaying the loan before then. And if that plan depends on a seller’s market or low interest rates, add a backup plan. 

Building Your “Financing Toolkit”

Years ago, I interviewed an investor who put it like this: “Aim to build a ‘financing toolkit’ with as many different financing options and lenders as possible.” 

You don’t have to pick and choose among the financing options above. Quite the opposite — they work best when you mix and match them. 

Next time, we’ll dig deeper into both how to build an army of private lenders and how to start scaling into commercial real estate with other people’s money. 

In the meantime, pick one of the funding options mentioned above and find a viable source of it. Research hard money lenders and portfolio lenders. Look up business credit card and credit line offers. Check whether a HELOC or retirement accounts could work as flexible fund sources.

Most of all, keep expanding and earning money in your wholesaling or flipping business. Keep marketing to prospects through REsimpli’s CRM. Keep turning deals over. 

That cash flow will help you fund future flips and rental properties, even as you build out your financing toolkit with other people’s money.