According to a Federal Reserve Bank of Dallas forecast, rental price growth will rise The
U.S. Census Bureau reports that individual real estate investors own over 74% of rental
properties.
If you are one of the 74% of inventors, how do you best finance a rental property?
Investing in rental properties is a smart and reliable way to create long-term, sustained
passive income. But in order to maximize returns without falling into debt, it’s important
to be aware of all your financing options. In this blog post, we’ll dive deep into 6 of the
best financing strategies for building wealth with rental properties: traditional bank loans,
hard money loans, bridge lenders , private equity groups, HELOCs and private or seller
financing. Learn how each approach works and understand when they are most
beneficial so that you can secure the ideal source of capital for your next investment!
Traditional Bank Loans
As long as the property you are buying is a 1-4 unit building, you can purchase a property in your personal name and do some type of Traditional Conforming loan. These mortgages are typically taken out through a local bank or credit union or mortgage broker and have the most favorable terms for buyers. The mortgage will typically be amortized over 30 years and you will need to qualify based on your personal credit score and income.
Traditional bank loans often come with some of the lowest interest rates, making them an ideal choice for new real estate investors or people who are only looking to purchase one or two properties. A few other ways you can finance with traditional loans:
• You are buying an investment property to first live in. This method allows you to
purchase with as little as 3.5% – 5% down on single family homes. Live in this property
for 1-2 years and then rinse and repeat.
• If you already own a primary residence, you can purchase the property in your personal
name as an investment property. This structure allows you to purchase the property
with 20% or potentially more depending on your credit score and the type of property
you are purchasing.
When my husband and I first began purchasing real estate, we purchased our first 3 buildings by purchasing them to live in for a year or two, and then would move and purchase another property that was slightly bigger or nicer for our needs. Here is a picture of our first building:
HELOCs
If you are not sure where you are going to get the downpayment from, secure a HELOC on your personal home to use for the down payment on a rental property.
A Home Equity Line of Credit, or HELOC, can be a strategic financing option for purchasing an investment property, especially when you have significant equity in your primary home. A HELOC provides flexibility, as it operates similarly to a credit card where you can borrow up to a certain limit, pay off the balance, and borrow again. This allows for continual access to funds without reapplying for a new loan. Moreover, interest rates on HELOCs are typically lower compared to other loan types, which can make it a cost-effective strategy for real estate investors. By leveraging the equity from their home, investors can quickly access capital for a down payment on a rental property, thus potentially expanding their portfolio faster and facilitating wealth growth through real estate.
It is much more difficult to get a HELOC on an investment property that you own, but not impossible after you have built a substantial amount of equity.
Hard Money Loans
Hard money loans are often the go-to choice for experienced real estate investors who need quick access to capital and don’t meet traditional bank loan criteria. Hard money lenders specialize in providing short-term rental financing, usually within a few days. While the terms can be more expensive, hard money loans are typically easier to qualify for and require less documentation than traditional bank loans.
There are a few key reasons why real estate investors might opt for Hard Money loans when purchasing rental properties. First, the quick approval and funding process allows investors to seize profitable opportunities in a competitive real estate market where time is often of the essence. It is typical for a hard money loan to be approved in a matter of days, as opposed to weeks or even months for a traditional bank loan, giving investors a crucial advantage. Second, Hard Money loans offer greater flexibility as they are backed by the property itself and not the investor’s credit rating or financial history. This can be particularly beneficial for investors with less than stellar credit or those just starting their journey in the real estate market.
Hard Money loans typically come with higher interest rates, often in the range of 9-15%, and shorter loan terms, usually around 1-3 years. This is due to the increased risk taken on by the lender. Furthermore, these loans usually come with “points” – an upfront fee based on the loan amount, typically 2-5% – that the lender charges for underwriting the loan. While these terms can be more costly than those of a traditional bank loan, the speed and flexibility of hard money loans can make them a valuable tool for real estate investors looking to buy rental properties quickly and efficiently.
Bridge Lenders
Bridge loans are another financing option to consider when purchasing rental properties. Normally offered by private lenders, bridge loans are temporary loans used to ‘bridge’ the gap between the immediate cash needs and the eventual financing. The primary advantage of these loans is their speed and flexibility. Often, real estate investors can secure bridge loans within just a couple of weeks, if not sooner. The interest rates for bridge loans can vary, but due to their short duration — usually six months to a year — they can often be justified by savvy investors who have a clear exit strategy in place.
A bridge loan could be the ideal solution in various scenarios. For instance, if a real estate investor finds an excellent deal on a rental property and needs to act fast, a bridge loan can help secure the property quickly. Similarly, if an investor needs to fund property renovations before a sale or refinance, a bridge loan can provide the needed funds. Another situation might be when an investor is waiting for a loan approval from a traditional bank but needs to secure a property in the meantime. In all these scenarios, a bridge loan can provide the perfect short-term solution for real estate investors looking to secure rental properties.
Fix & Flip Bridge Loans
Fix & flip bridge loans present an attractive financing option for real estate investors looking to renovate and quickly sell properties for a profit or transition into long-term financing. This type of loan is specifically tailored to properties that require improvements, allowing investors to secure the funds necessary for both the purchase and renovation of a property. The loan amount is typically based on the anticipated after-repair value (ARV) of the property, rather than its current value. This can be hugely advantageous for investors dealing with distressed properties that have significant potential for value increase post-renovation. Fix & flip bridge loans feature expedited approval and funding processes, similar to other bridge loans, which can be beneficial in competitive real estate markets where speed often equates to success. Once renovations are complete and the property is either sold or refinanced into long-term financing, the loan can be repaid.
Private Equity Lenders
Private Equity lenders are another valuable source of financing for real estate investors. These lenders are private firms or individuals that invest directly into a company or property, providing capital in exchange for an equity stake in the property. This type of financing can be an appealing option for investors who may not meet the strict requirements of traditional lenders, or who are seeking larger amounts of funding than what typical loans can offer. As these lenders take a share in the ownership of the property, they are typically more invested in the success of the project and might offer more favorable terms. Real estate investors might consider Private Equity lenders when they are investing in larger or commercial properties, undertaking substantial renovation projects, or when they anticipate a high return on investment that would justify sharing profits with the lender.
Private & Seller Financing
A popular type of financing in the city I live in, in Wester PA is Private Financing. Private financing is when an independent, non bank person decides to lend money to real estate investors who are purchasing the property, usually at a much higher interest rate than what traditional lenders would offer, but with other benefitial features.
This type of financing can be attractive for real estate investors who need flexible terms or have difficulty qualifying for traditional loans due to poor credit or other factors. The terms of such loans are often more lenient than those of traditional loans, with the seller offering lower interest rates and longer loan periods. It is important to note that when using private financing, the investor should carefully consider the terms of the loan as well as any potential risks that might be involved.
I purchased a handful of our investment properties by using the funds of a private lender. Here is an image of the property that we still own today:
Seller Financing is similar to Private Financing in that it involves a buyer borrowing from the seller of a property. However, in this case, the seller acts as a lender instead of an investor. This type of financing can be beneficial for real estate investors who have difficulty qualifying for traditional loans and need more flexible terms than what traditional lenders offer. It is important to note that when using Seller Financing, the buyer should carefully consider the terms of the loan as well as any potential risks that might be involved.
Overall, Private & Seller Financing present an attractive option for real estate investors looking to purchase rental properties with less stringent requirements and more flexible terms than what traditional lenders offer. With proper due diligence, these financing methods can provide the necessary funds for a successful investment.
Publicly Traded Debt or Equity Instruments
Finally, another financing option to consider when purchasing rental properties is publicly traded debt or equity instruments. This type of financing usually comes in the form of government bonds, corporate bonds, preferred stocks, common stocks and other such instruments that are available on public exchanges. These instruments typically offer relatively low interest rates and long loan periods. Investors can also use these instruments as collateral for traditional loans from banks or other lenders, which can help to reduce the amount of out-of-pocket expense needed for purchasing the property.
Publicly traded debt and equity instruments present an attractive option for real estate investors looking to purchase rental properties with reduced upfront costs. However, these instruments are usually more complex than traditional loans and require careful research in order to understand the potential risks. Additionally, it is important to remember that the rate of return on these instruments may fluctuate depending on market conditions, so investors should always have a plan in place for how they will manage their investments over time.
Overall, real estate investors looking to purchase rental properties have a variety of financing options at their disposal. From bridge loans to private equity lenders and publicly traded debt and equity instruments, there are a number of solutions available that can help investors get the funds they need for their rental projects. It is important to carefully consider each financing option and understand the associated risks before making any decisions. With proper due diligence, real estate investors can find the best financing solution for their investments.
In summary, real estate investors looking to purchase rental properties have a variety of financing options at their disposal. From bridge loans and private equity lenders to public debt or equity instruments, there are a number of solutions available that can help investors get the funds they need for their rental projects. It is important to carefully consider each financing option and understand the associated risks before making any decisions. Additionally, it is important to have a plan in place for how the investment will be managed over time. With proper due diligence, real estate investors can find the best financing solution for their investments and maximize their returns.
At the end of the day, whether you are an experienced investor or just getting started in rental properties, finding the right financing options can make all the difference when it comes to building a successful and profitable rental portfolio. With access to the right financial resources, real estate investors can maximize their returns and achieve long-term success.
Don’t miss out on the opportunity to make your real estate investment dreams a reality. If you’re ready to take the next step, click on the “Schedule a Discovery Call” button below to speak with an Investment Property Specialist from our team at Co/LAB Capital Funding. Our experts are on hand, ready and eager to guide you through your financing options and help you secure the best solution for your needs. Let’s work together to make your rental property portfolio a profitable success. Don’t wait, schedule your Discovery Call today!