financing real estate deals

Imagine your company has one week to live unless you’re able to get a huge capital infusion.

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

In the game MONOPOLY, “Money can be loaned to a player only by the Bank and then only by mortgaging a property. No player may borrow from or lend money to another player… In life away from the game, getting a mortgage can be a complicated, tedious, nail-biting and hair-pulling ordeal. In MONOPOLY, it’s quite simple. Unimproved properties can be mortgaged at any time. No haggling or negotiation is necessary – or, for that matter, allowed. The ‘Mortgage Value’ is printed right on the property deed.”

– Alan Axelrod, Everything I Know About Business I Learned from MONOPOLY

In less than two weeks, I will be over at Julie’s parents home on Salt Spring Island to celebrate Christmas. I fully expect that we will play at least one game of MONOPOLY. It’s not just family fun for the Broad’s though. Her parents have been investing in commercial and multi-residential real estate for over 25 years. It’s never a relaxing game. Everyone is out to win. It’s not just about pride … it’s about proving your real estate investing prowess, or at least it feels like it!!

The reality is that MONOPOLY is much simpler than real life. Thankfully, unlike in MONOPOLY, there is more than one way to finance a property. You can ask your father-in-law or you can get a first and second mortgage. You can assume someone else’s mortgage or get financing from the vendor.

And best of all in real life, you can get a mortgage broker working for you, and they will handle the time consuming part of shopping the mortgage around and coming up with the best options given your personal situation. It’s not to say that you can’t get a good deal if you go directly to your bank, but what we’ve found is that banks have a well defined box that they want everyone to fit in, and as a real estate investor, you probably aren’t going to fit nice and neatly into that box. Maybe on property #1 you will, but pretty soon you won’t. And, a mortgage broker that works with real estate investors will know who to talk to and where to find the type of mortgage product you need. (In October we did a five part interview with our mortgage broker which you can check out on our website…we covered everything from buying a property in a corporation to Americans buying in Canada and Canadians buying in the U.S.).

What financing options are available to you?

Hopefully after last week, where I discussed down payments for your real estate investments, you understand that I am not going to teach you how to do “no money down” or 100% financed deals. They are so risky and stressful that it’s just not the way we would recommend you get into real estate. So, I am not going to specifically address the questions our readers have sent in about getting 100% financing.

“Where to start? What’s the best way to finance?” – reader from Loveland, COInstead, I am going to focus on the many questions that revolved around just understanding the basics around financing property purchases:

“How to talk to mortgage guys to come up with creative ways to do deals.” – reader from Johns Creek, GA
“How do you get a hold of the necessary funds to fund a deal/property with the market as it is right now.” – a reader from Tempe, Az

First, let me say that the banks ARE still loaning money. The tap has not turned off, so don’t throw your hands up and say “I’ll never get a loan”. That said, it is a bit more difficult, but with interest rates at historic lows, it’s a pretty darn good time to at least give it a try. And if you aren’t successful with the bank, know that there are private money lenders, sellers willing to finance and a few other options. If you don’t like these alternative options as much, you can always use one of them for financing for a year or two, and then try the bank again once the smoke has cleared from the current financial crisis.

So, let me take you through the essential things you need to know before you set out to fund your investments.

The Most Common Sources of Financing Real Estate Deals:

Banks:Well, actually, I should call these traditional lenders because it does include credit unions and trust companies, but mostly you’ll think of banks when you think of a traditional lender. This is typically your cheapest source of funds, but they have very rigid rules about what qualifies for a loan from them.

Sellers:Also called Vendor Take Back Financing or VTB’s, seller financing is basically when the seller of a property will essentially leave some of their equity in their property (instead of taking cash for it) and the buyer will borrow it from the seller and make monthly payments towards paying it down. You can typically expect to pay the seller a slightly higher rate than you’d pay a traditional lender, but many sellers are willing to do this because they get a guaranteed return on their money and their money is secured against the property. It’s also the only way certain properties will sell. If the buyer doesn’t make payments, the seller can often just take back the property. However, this only works when the seller has quite a bit of equity in the property or owns the property completely.

Secondary Lenders:Companies that provide higher interest rate loans to candidates that do not fit into the traditional bank boxes.

Equity Lenders:More common in commercial real estate than in residential real estate investing, but it’s essentially a company that will loan money based on the value of the property alone. They usually will loan up to 60% of the property value no matter who is the borrower.

Private Lenders:When you think of private money you might think of the mob or someone backed up by a tough guy with a baseball bat. Maybe that is because they are also called “hard money lenders”, but the reality is that it’s anybody or any company that has money in a fund that they will loan to an investor. You can expect to pay a higher interest rate and often a fee for their loan, but there are many options in private money.

With the exception of Equity Lenders and possibly sellers (VTB’s), every other lender on the list will pull your personal credit score, so make sure you know your credit score and are working on increasing it.

For us, we typically try for seller financing on every deal. We have often been able to get the seller to take a second position (which means they will provide a small portion of the financing and will sit second on the mortgage behind the bank). We’ve only been able to get complete seller financing once. Usually the vendor wants their cash out for a different purchase or they just don’t have enough equity in the property.

When properties aren’t selling, which is the case in many areas in North America right now, motivated sellers who have 50% or more equity in their properties will be more likely to hold a short term VTB just to sell their property…so you should always ask!

You will find that every deal is different. Our first two deals were financed by banks with 10% down and 5% down respectively. Our third deal we assumed the mortgage from the seller and got a small loan from our real estate agent that was secured against the property.

We’ve done seller financing on several deals, but to be totally open with you, most of our investments have been purchased using our mortgage broker who shops us to every traditional lender she knows, and finds us pretty darn good rates with lenders who are willing to get creative!

Next week, as we roll into part 4 of our “Rev N You Readers Biggest Real Estate Investing Questions” series, we are going to answer the biggest question we get asked at social gatherings: “Is now a good time to buy?”. The answer might surprise you. Sign up for our Rev N You with real estate newsletterto make sure you get the article!

Published December 15th, 2008

5 Ways to Finance All Your Real Estate Deals