5 Ways to Finance Your Real Estate Dealsby
You’ve already sunk a gigantic sum of money into the company.
You have about $40 million dollars you could invest, but to do that is to put your last dollar into a company few people believe in.
Bank financing is certainly not an option. Private funds aren’t an option either. Most people really think you’re crazy for pursuing this dream. Nobody will throw money into a venture they think is going to fail.
It’s not even a choice really. Not if you’re Elon Musk.
You put every last dollar you have in to the company.
If you’re not familiar with Elon Musk and his entrepreneurial and innovative journey to creating SpaceX and Tesla, I have posted a few of my favourite interviews with him below. He’s an inspiring and interesting guy who is changing our world.
He’s also the kind of person who finds a way to get things done even when everyone says it can’t be done.
It’s unlikely though that you’ll face anything quite like taking on the big car companies or NASA, but you might need to channel a bit of Elon Musk when it comes to getting your real estate deals financed.
There will be a lot of people who will tell you NO. There will be many who don’t believe it can be done. It’s up to you to persevere and find a way.
But sometimes you don’t know where to start, which is why I have pulled together 5 ways to finance your real estate deals:
1. Traditional Bank Financing:
Your own cash for the down payment (usually 20% or 25% of the purchase price) and a bank or credit union finances the rest. This usually offers you the best possible interest rate, but it’s also the hardest to qualify for. You need to have a good and stable income, minimal debt, patience to pull together all the paperwork and a great credit score.
2. High Ratio Financing:
If you are moving into the property, this is an option. It has even more restrictions than the traditional bank financing option (because it’s insured by a company like Genworth or CMHC), but it allows you to get into the deal with as little as 5, 10 or 15% down.
This is an excellent option for a brand new investor. You can put less down on a home with a suite, move in, and get your feet wet as an investor while you rent out the suite. You also will typically get the best possible interest rate available since you’ll be living there (the banks sees that as a lower risk than if you’re buying it for an investment).
In a few years, you can move out, keep this property as an investment, and do it again for your next one (NOTE: the rules are changing a bit on this so speak with a mortgage broker if this is your plan).
3. Equity in Your Home or one of your investment properties:
You might find yourself able to qualify for financing but short of down payment funds. In that situation you just have to find the down payment money to get your deal financed.
The simplest option is to access equity in your home or property via refinancing or a home equity line of credit.
You need to have a lot of equity in your property to do that though. You’ll need to speak with the bank that holds your mortgage to see what Line of Credit or refinancing options are available to you.
Most refinancing options will not allow you to go past 80% of the value of the home. You can also encounter snags in refinancing if your property assessment is low (the assessment is what your local city assesses the value of the property to calculate the annual property tax. It’s rarely an accurate valuation of your property but the banks still use it as a measure of value for refinancing).
We tried to refinance a property this year to renovate. The assessment value of the property is $260,000 but the real value of the home is closer to $350,000. The bank will only refinance to 80% of the assessment value so we weren’t able to refinance.
Think carefully before you use your own home to fund your real estate deals. I prefer not to lever everything I own just to buy more – especially when it’s the roof that is over my own head. Also, whatever you finance, be sure the cashflow on your new property is more than enough to cover the financing costs and it’s expenses.
4. VTB, RRSP or Private Mortgage:
If you don’t have 20% down, or you can’t qualify for bank financing private money sources are a good option. Private money sources includes VTBs, RRSP mortgages and private mortgages.
A VTB (Vendor Take Back) mortgage is when the seller gives you financing. An RRSP mortgage is when someone moves their RRSP funds into a self-directed RRSP account and then loans you money just like the bank. You can learn more about RRSP mortgages here. Private mortgages are just what they sound like, money from a private individual.These options have a lot more flexibility in terms of the amount you’ll need to put down, the repayment terms and the qualification criteria. In fact, a lot of these details are up to you to negotiate and set up. One of our clients, has funded 100% of the purchase price of more than a dozen deals using private lenders who hold mortgages for up to 15 years. It’s all in finding the person who is a fit the for the deals you want to do.
You can use VTB, RRSP or Private Second Mortgage in first or second position mortgages. First and second position simply refers to the order in which a lender will be repaid in the event the property is foreclosed on. Because the first position mortgage gets paid first, the risk is lower for that mortgage holder therefore you’ll usually pay them a much lower interest rate than you will a second position mortgage holder. If you have bank financing for 65%, for example, you may want to find some secondary financing to get you up to 80%. That’s where you might be able to put a second mortgage on the property using the seller as a lender or an RRSP or private lender.
It’s important to note that most banks will not qualify you for financing if you can’t show you have the whole down payment yourself. They will not accept secondary financing as proof of your down payment. This means you will need to have the money somewhere even if you’re not using it for the down payment (if you aren’t sure what would work as proof, discuss it with your mortgage broker).
Many mortgage agreements also contain a clause saying you can’t ever put secondary financing on the property at all so read your agreement carefully before you do this to raise the funds for your down payment.
If you pursue secondary financing or a higher ratio financing option, it’s also important to stress test your portfolio to see what happens if interest rates rise quickly or values dropped overnight. Where will that leave your cashflow and your overall portfolio equity?
5. Joint Venture Deals (JVs):
When you lack the funds for a down payment and you do not qualify for financing with the bank, joint venture deals are a fabulous option. A joint venture agreement is basically where you and another party come together to pool your resources. There are many potential joint venture structures. In our case, we do the work, find the deals, and bring the expertise while our partner will bring the finance-ability and the down payment capital required.
Our first two deals in 2001 were versions of option #2 – high ratio deals on our own properties that eventually became rental properties.
In 2002 we sought out a lot of creative strategies, with a few VTBs and Private Mortgages to get the money for our deals. In 2003 we started to do Joint Venture Deals (JVs). From there, we’ve done just about every combination of the above that you can think of. The majority of the last 25 deals we’ve done, however, have been joint ventures. It was the simplest way to add great properties in good areas at the best financing rates available on the market.
There are a lot of options to fund your deals and grow your portfolio. No matter what strategies you use, there is no replacing your own hard work and diligence in saving money for down payments, taking care of your credit score and being good about the debt you take on (see 5 things every real estate investor should know about money and credit).
These steps will make you more appealing to banks, private lenders and even sellers who may give you financing.
Every choice has risks and costs to consider. Make sure every rental property you buy has strong positive cashflow, is well positioned to attract good tenants and has multiple exit options. There are also costs beyond cash flow, interest rates, repayment terms and leverage ratios to consider as well.
Elon Musk’s ‘All In’ approach to business takes guts, determination and belief. His high I.Q. and photographic memory probably don’t hurt either.
You don’t have to be just like Elon Musk to access capital for your deals. You just need to have some dedication and belief that there is a way to do what you want to do. Even when the banks are saying no – you have options. And, just because one person or bank says no, doesn’t mean someone else won’t say yes. The money is out there – now, go and get it.
Elon Musk: How I Became the Real Iron Man