Real estate investors use both debt and equity to finance their transactions, but loans for investment properties are quite commonly used. There are many reasons why real estate investors seek out debt financing for their properties. Here I will only discuss 3 reasons real estate investors seek out debt financing over equity financing. One very popular type of loan for investment properties is called a hard money loan. A hard money loan is any non-bank loan against a ‘hard’ asset such as real estate. This type of loan has less requirements as compared with a bank loan, but also comes with a higher interest rate. Despite the higher interest rates associated with these loans, here are 3 reasons real estate investors leverage this kind of debt:
Quick Loan Fundings: As compared with bank loans, loans for investment properties, such as hard money loans, fund very quickly. For example, a typical hard money loan can close and fund in between 5 to 14 days. In contrast, a bank loan can close and fund in an average of 21 to 45 days. For a real estate investor who must move quickly to take advantage of a good price on a purchase, the quick loan fundings of hard money loans are crucial for success.
Lower Qualification Requirements: Bank lending standards still haven’t relaxed much since the onset of the Great Recession in 2008. For example, in order to qualify for a commercial bank loan, an investment property cannot be vacant, except in rare cases. Because hard money lenders are willing to make loans against properties with low or no occupancy, it allows real estate investors to buy undervalued assets and stabilize them. They can later refinance these short-term loans on their investment properties with permanent bank financing.
Opportunity Cost: During 2009 to 2010, when so many assets were available at low prices, real estate investors leveraged debt in order to make their cash go further. To have all of their available cash tied up in just one asset would have been unthinkable. Investment property loans allowed these investors to make their cash go much further, and thus, they were able to pick up a larger number of distressed assets during the years between 2009 to 2010.
These are just 3 reasons why investment property loans are so necessary to real estate investors. Real estate investors with large portfolios of 5 or more properties, can use these loans to leverage their portfolios. What else would you add to this discussion? Have you had an experience where a hard money loan was crucial to your success in some way? Please share.
For more information about the different types of investment property loans offered by Private Money Utah, visit our loan programs page here, or please send us a message via our contact form and we will be in touch with you soon.
Why would a real estate investor who invests in high end, luxury homes ever use a hard money lender? In this story, a real estate investor in Park City, Utah has experience in the local market using hard money loans to finance his projects. The area is renown for its ski-in, ski-out properties, and when deals become available in Park City, Utah, real estate investors flock towards these homes for use as both investments, and as second homes. And for the financing of these fast purchases, whether as lot loans, construction loans, or rehab loans, this is the specialty of hard money lenders. Hard money lenders are also able to lend on properties that most banks won’t or can’t lend on, such as land or vacant property.
The investor in this story, James O’Connell, could easily qualify for a bank loan, as his credit is impeccable and the income from his growing business is more than sufficient to qualify. Under this particular scenario, James financed a speculative home construction project himself. Leveraging only a small bank loan to acquire the lot, James used his own cash to fund the bulk of the total project cost. This was James’s first mistake on this project. Never start out with too small of a loan on a construction project. Once you commence construction and liens begin to pile up on a property, you may never be able to obtain additional financing to finish the project should you run into problems along the way.
The biggest hurdle the investor James O’Connell had to overcome on this project was that his general contractor had gone grossly over budget on the cost of the construction. This pushed James’s cash reserves to the limit. Convinced it would be no problem to fund this spec construction project himself, James was disappointed to discover that this would not become reality. In a stage where he was 90% complete with the project, he turned to Private Money Utah, a local hard money lender in Park City, Utah who had financed two of his previous projects. Unfortunately, the local lender was brought into the project at a dangerously late stage in the game. Most lenders would immediately turn away from such a loan scenario, given that it would be difficult, if not impossible, to obtain lender’s title insurance for a loan to complete this project. During a construction project, the interests of subcontractors and other vendors can later show up as mechanics liens.
Because of his relationship with Private Money Utah, James was able to get them to work on his behalf, along with a knowledgeable title company, to have the majority of the interests removed from the property that were placed on it by sub contractors. Because the general contractor could prove he had paid the subs, they removed their claims, one by one. By funding the loan in tranches, as claims by sub contractors and vendors were slowly removed from the property, James was able to complete the project with no delay. This timely funding was also extremely crucial, as James was rapidly approaching the onset of the busiest time of year in real estate sales in the Park City market.
Because Private Money Utah is a hard money lender who understands the market, the borrower, and the unique needs of the project, James finished the house in time for the high selling season. James quickly sold the home within two months of obtaining the certificate of occupancy for the property. What were some of James’s biggest lessons learned on this spec construction project in Park City?
- Never start a construction project with too small of a loan at the outset and expect to finance it with your own cash or private equity. Even hard money lenders will shy away from funding such projects if construction has already begun.
- Get a hard money lender to finance the entire project at the outset to see it through from start to finish.
To learn more about our real estate financing programs, send us a message on our contact page or leave a comment below. Private Money Utah is the premiere hard money lender in Utah and in the Western U.S. for all types of private money loans on real estate.
When real estate investors use cash or equity to purchase properties, loans for rental property allow them to leverage their portfolios. The interest rates paid on these loans is less than the higher rates of return that these real estate investors can earn if their equity is working in new projects. This is one of the primary reasons that real estate investors take out such loans for rental property.
Another reason that investors use these loans is to buy out equity and replace it with debt is to end costly or troublesome real estate partnerships. For example, a real estate partnership whereby one partner is employing family members to manage the asset may be more costly to the bottom line as this enters a gray area where business and personal matters collide. In this case, the borrower used a loan to buy out the partner and this resulted in an annual cost base on the asset that was far less than before.
The interest rates on loans for rental property can range as low as 6%, to as high as 10%, depending on the various factors involved. Most loans against rental property portfolios require a minimum number of properties, or a minimum portfolio value. For example a real estate investor owns a portfolio of 10 rental properties with a value of $750,000. The properties were purchased with all cash, rehabbed, and then rented. The real estate investor obtains a cash out refinance loan against the portfolio of rental properties to leverage the equity in the portfolio. The investor then uses the funds to purchase additional investment properties.
Because rental properties in a portfolio may be located in different States, loans for rental property are often not available from traditional banking institutions. If these loans are available, real estate investors may not meet credit score requirements of bank loans due to past foreclosures. The most favorable loans of this type, may come from a non bank lender, also called a private money lender. Because the requirements of private money loans are far less than of that of a bank, qualifying for these loans is easier than obtaining a bank loan in some cases. (Here are some more reasons why borrowers may choose private money loans over bank loans). For more information on private money loans for rental property, fill out a short form on our website here.
When a real estate rehab project is starting to go sideways, never shut the door on your hard money lender. Maintaining strong, open communication with your hard money lender on a real estate project is your best chance of success. Particularly on a rehab project when unforeseen obstacles appear such as budget overruns or cash flow problems, don’t act like a frightened turtle and go hide in your shell. If you have a hard money lender on the project, give your lender a call and tell him or her what’s going on if trouble arises. A hard money lender may have experienced similar obstacles before and may have some creative solutions to overcome them.
An example is a real estate rehab that we provided a hard money loan on fairly recently. We did a final walk through prior to closing on the loan and the house had some crazy paint colors (e.g. pink, green, and orange), but it didn’t seem to need more than just some cosmetic remodeling. When the third loan payment was late and the property was still not listed for sale, we called the borrower to find out what was going on. He informed us that his partner had split town along with the funds to complete the rehab. Long story made short, the borrower simply did not have anymore money to finish this rehab project. All of the demolition had been completed, the trash had been hauled away, and the house was a clean slate on the interior ready for carpet, paint, cabinets, and fixtures.
With no money to complete the project, this borrower was up a fast moving river without a paddle. He said he was afraid to tell us that he was in trouble and was trying to come up with the money and solve the problem himself without getting us involved. But failing to communicate with your hard money lender in a bad situation like this is a big mistake. Once we knew the situation this borrower was in, we were able to provide some of our own resources, including contacts in our network, to help solve the problem. A real estate investor in our network reached out to the borrower because he saw the merits in the rehab project and decided to partner with him. Because this borrower told us that his deal had gone sideways, we were able to step in and lend our contacts which ended up saving the deal.
Never leave your hard money lender out of the loop of communication on a deal if things go sour. Your lender is similar to a partner on a real estate deal and needs to be communicated with if unforeseen obstacles come up. If everything is going smoothly on a rehab project, on schedule and on budget, then no news is good news. But sometimes serious problems begin to appear such as: running out of money on a rehab project, repairs go way out of scope, an environmental issue arises, a State, City, or County conflict rears its ugly head, etc. When serious problems arise in a real estate deal, a lot is at stake. Give your hard money lender a chance to provide advice, resources, contacts, or even additional capital if necessary, rather than lose the deal altogether.