| Often the hardest part of investing in Real
Estate is not finding the right property, but figuring out how much to
offer and how to finance it! Cash is always a great option if you have
enough of it to invest, but very few property investors have the
resources to use their own cash in an investment property.
Many investment properties, especially rehabs, don't fall into the
typical property-financing model. For example, an investor looking to
remodel a summer cottage into a year-round home may find problems with
getting a loan because many lenders have a minimum living area (e.g.
over 850sf) required for loans.
This often means investors have to turn to non-traditional sources of
financing for their investment projects. A few of the most common
options include:
- Other people's cash
- Home equity loans
- Retirement accounts
- Credit cards
- Assumable loans
- Seller funding
Other People's Cash
Getting cash from other people can be done in the form of personal
loan notes from friends or family; loans from non-traditional lending
institutions (investment trusts, private money lenders, investment
partnerships, etc.); and even the seller of the property.
The key to utilizing other people's money to finance your investment
purchase is to factor the cost of borrowing the money on a short-term
loan into the cost of remodeling the home, being sure you can make a
reasonable profit even if the remodel takes twice as long as
anticipated.
Remodel Investment Example
|
| List price of the property |
$100,000 |
| Accepted Offer price |
$80,000 |
| 1st Loan from Aunt Hilda @1%
per month ($200/month) |
$20,000 |
| 2nd Loan from Private Lender @
2% per month ($1,400/month) |
$70,000 |
| Expected Repair Cost (funded
from loans) |
$10,000 |
| Market Value after repairs |
$130,000 |
| Cost per month for loans |
$1,600 |
| Estimated time to
complete repairs is three months (budget six) |
|
Budget |
| Expected
Selling Price |
120,000 |
| Loan repayments |
-90,000 |
| Project excess
costs |
-4,000 |
| Interest (6
months) |
-9,600 |
| Cost of sale
(5%) |
-6,000 |
| Expected
Profit |
$10,400 |
In the simplified example shown on the right, even if the project
takes twice as long as anticipated, you can still make a healthy profit.
However, if the property were to take six months to sell, your profits
would be used up in interest payments; which is why we sell the property
at below market value to ensure a quick sale.
This is a critical calculation to do when determining how much to
offer for a given property (remodels only). By determining how much the
property should be worth after you have remodeled it, you can calculate
a maximum purchase price that will still yield a satisfactory profit
(ignoring the asking price for the property).
Of course there is no guarantee this will always work as many factors
can impact your calculations; for example, the project could take longer
than anticipated, the estimates of the costs to complete the work might
be too low, the anticipated market value after completing the work might
be too high. In fact, there are so many factors to consider that the
only real way to get a feel for how much you could make on a given
property is through experience.
| HOME INVESTOR TIP
The faster you can flip properties like this, the more profit
you can make in a year.
If you hold onto properties in order to try to maximize your
selling price, you may lose more money in interest (or the opportunity cost of the money) than you
gain in getting the higher price but taking six months to do it. |
Your Home Investor Specialist (an independent members of the
Association of Home Investor Specialists) can help you by locating
potential investment properties for you to consider and by providing you
with an estimated market value for the property as if the anticipated
work had already been done based upon an analysis of recent comparable
sales in the area. They might even be willing to suggest a projected
selling price to have the home sell quickly in the current market
(market conditions can change dramatically from one month to the next,
so you will need to get this done again as the work nears completion and
you prepare to put the property on the market).
The key to utilizing other people's money does not necessarily lay in
getting the loan at the lowest rate of interest; instead it is in buying
the home at the right price and being able to flip the home quickly so
as to reduce your exposure to market fluctuations and carrying (finance)
costs.
Home Equity Line Of Credit
Taking advantage of the equity in your existing home by taking out a
Home Equity Line Of Credit (HELOC) or a Home Equity Loan is a great way
of financing all or some of your in-vestment project.
The advantage of a Home Equity Line Of Credit is that you will be
able to write checks against your line of credit up to the maximum
amount of your loan approval. You can also pay back the loan again and
again and use it just like a bank account. This allows you to
effectively utilize this to finance multiple consecutive projects and
also utilize it for paying for re-modeling costs. Your local Home
Investor Mortgage Specialist (independent members of the Association of
Home Investor Specialists) can typically assist you in establishing a
line of credit and may even help with non-traditional funding sources.
Retirement Accounts
If you have a self-directed individual IRA (or an employer
self-directed plan Keogh, 401(k), SEP), you can invest the money in your
plan in real estate. Third party IRA administrators can assist in
setting up your retirement accounts so you can utilize them for property
investing. Because you will be utilizing retirement accounts, you need
to remember that the profits from the investments cannot be withdrawn
early without penalty. There also rules governing exactly what types of
property investment qualify under the rules.
Typically you are not permitted to derive any personal benefit from
the investment, such as living in the property while you remodel it.
| Tip: You can potentially utilize other people's retirement
accounts by setting up a loan from their self-directed account
secured against the property deed and providing the account with
an interest payment significantly better that they might be
earning on the stock market on in a money market account. The
interest can be setup to be paid into the account only at closing,
so the loan operates on a deferred interest basis while the home
is being remodeled, reducing the drain on cash flow. |
Credit Cards
Although the cost of borrowing on a credit card can be high
(sometimes over 20%), if it is for a short-term project, a credit card
can be used to help fund the purchase. They key here is keeping this
option for short-term flips only, where the cost of carrying the loan
can be minimized.
Assumable Loans
Although there are fewer and fewer assumable loans around these days,
many private lenders do not include a "due on sale" clause in
their loan agreements. These loans may be assumable by the buyer at
reasonable rates of interest.
Seller Funding
Many sellers, especially those desperate to sell their property, may
be willing to fund all or part of the sale in return for better terms on
the sale (e.g. higher price or attractive interest). This is especially
true if the seller doesn't need to take all of their equity out of the
property at this time. They may be willing to take their equity over a
longer period if it means they get a better return on their money than
they would by investing it elsewhere; especially if the money is secured
against the property deed.
Real Estate Financing:
this articles explains the various loan financing options open to
investors.
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