WHAT COMES FIRST? THE DEAL OR THE DOLLARS?

Getting Ready to Be Ready

When it comes to real estate investment, funding is like your fuel. Funding keeps the deals going, whether it’s fix and flip projects or long-term holds for passive income. It pays to make sure you have not only enough funding but also the right kind of funding to keep all your investment activities on track.

Do you need funding first or a signed purchase agreement? Do you need to have financing to make offers and cut deals? Or do you need a solid deal and exit strategy to get a loan lined up?

Putting the Horse Before the Cart

It’s the proverbial chicken and egg of real estate investment. So, which needs to come first? In short, it depends.

Confusing, right? The truth is that you need a little of both. Some real estate agents and sellers won’t even speak with you, never mind actually show you a property, unless you have proof of funds to purchase or are at least equipped with a mortgage preapproval letter. At the same time it is difficult for lenders to give you a solid loan commitment with terms that will stick unless they know the details of the transaction.

And when working with asset-based lenders, where the funding is based on the asset rather than the borrower, it gets even stickier.

Lenders are used to providing preliminary funding letters for making offers. If you are using a private money lender, you can get documentation from them. It all depends on what the seller and lender require.

The best way forward is to obtain a preliminary mortgage funding approval based on your financial information and general scenario. Start talking with lenders, learn their funding criteria, and get a list of documentation requirements so that you can act quickly.

Once you have at least a preliminary funding plan in place, then you can go out and make competitive offers with confidence. Once you have a signed contract, then you go back to your lender with all of the specifics, get the loan underwritten, and obtain a solid funding commitment.

So find several funding sources and start the process—but before you do, remember these key points.

Finding the Right Funding Sources for Your Deals

If funding is like the fuel for your real estate deals, it’s important to pick the right kind of fuel. Putting short-term funding on a property that you hold long term can destroy your investment vehicle and your returns.

There are different funding sources specializing in different types of financing. Short-term, long-term, income-based, equity-based—there are lots of different funding options. You have to go to the right lender to get the right fuel for your real estate investment based on where you plan to take it. For example, if you walk into a bank and say you want a loan with no credit check to buy a distressed property, and oh, you want money to fix it up too, what do think will happen? Most likely they’ll smile and show you the door. Take the same deal somewhere else—to an asset-based lender (i.e., the right kind of lender)—and that lender might work aggressively to help you close the deal.

How do you know what kind of lender will meet your needs? It depends on your plans for the property and how long you need the money in play.

Short-Term Funding. A lot of house flippers use what is often called hard money, where the loan terms are usually less than one year and typically come with higher rates and fees. Easier to qualify for, they are usually entirely asset-based, which means the loan is qualified based on the property, not on the borrower (you). The higher cost of borrowing is calculated into the deal. If the numbers work, this type of funding can be a good option. Short-term funding is used for all kinds of properties (e.g., single family, multi-units, commercial and land deals) and is often used to bridge the funding from the initial acquisition into more permanent financing.

Mid-Term Funding. This is great for properties you sell on a lease option or plan to hold as a rental for eight or ten years or less. Some commercial lenders and many private money lenders prefer to fund these types of properties. They get better-than-market interest rates but don’t charge as much as a hard money lender. Their investment is secured by an income-producing asset and they earn secured, steady interest income. The loan can have an adjustable rate for part of the term and/or a balloon payment.

Long-Term Funding. If you plan to hold a property for the long run, then you need long-term financing sources. Federal Housing Administration (FHA) lending guidelines seem to change every six months, and for the real estate investor, securing multiple loans for single-family properties can be a wild goose chase if you look for conventional funding. But it is possible to find a reliable funding source—typically a local portfolio lender. For multifamily and commercial properties, long-term funding is based on the property’s income and capacity to generate cash flow. Be aware, however, that funding for commercial properties (including some multifamily) is typically based on a twenty-year amortization versus thirty years for single-family residential mortgage options.

Regardless of your source of funding, make sure the property and the plans you have for it are supported by a solid plan for the financing. Having a loan called due when you don’t have a good exit laid out is a certain fast track to major setbacks and even failure.

What You Need to Get Going

Depending on the type of transaction you are working, you may need:

•Deposit money

•Funds to cover due diligence

•Proof-of-funds letters

•Closing costs

•Renovation and upfit money

You may also need to plan enough cash and credit to cover holding costs, marketing, and a cushion for reserves. Balloon loans and adjustable rate mortgages can be popular in some niches, but proceed with caution on these types of loans. A balloon payment on a loan when an investor is not prepared to pay it off can immediately steer you off course and turn a great property into a train wreck.

Funding really is like fuel for an investor, and just like any road trip, give yourself enough gas in case of detours or delays. They will happen. In these situations, it may be worth exploring single-close construction to permanent loans, or mini-perms, as well as flexible credit lines based on your overall portfolio equity and net worth.

Longevity as an investor requires making informed choices about funding sources, funding types, and the right funding applied to the right property and situation. Funding is the fuel that can propel an investor forward, but if used haphazardly, it can have the opposite effect. Develop relationships with private lenders, get to know funding sources for your property types, and go into each deal with a solid plan for capital to underpin the property and project.

TAKEAWAYS

This chapter identified five things you need to get going. Of those, which do you have?

Now, list the things you don’t have and what steps you can take to get them.