Funding Strategies in an Evolving Market
Expert tips for developing your correct financial structure
by Kendra Rommel
Since the COVID-19 pandemic began, there has been an odd sense that we have been operating in some sort of time warp. Anything that happened before March feels like years ago, yet the fact that it’s October seems almost surreal.
Nothing exemplifies this feeling more than the roller coaster ride of the real estate market. The uncertainty created obstacles and accelerated the velocity of change, challenging investors, contractors, lenders and related businesses to address and adapt to a myriad of challenges and obstacles.
Remarkably, even amidst the uncertainty, a health care crisis did not become a housing market crisis and the real estate market has continued to be strong.
Thriving as a real estate investor, broker, or lender, today requires a sound and stable financing strategy. Having a consistent, reliable capital partner is perhaps the most important element to building a solid business model. This may evolve over time— from your start in business to becoming an experienced pro.
Regardless of your strategy, there are a myriad of capital or financing options available to you. Here are some tips for developing your correct financing structure.
Types of Finance
- Private lenders. There are two types of private lenders: (1) Individuals such as friends, family, accredited investors, etc. that are known to be syndicators or funds, and (2) Institutional private money lenders, sometimes called hard money lenders, who have their own capital as well as institutional capital partners, such as banks and Wall Street investment firms. A notable difference with private money is the fact that they base risk on the asset, rather than on the individual’s personal borrowing strength. This makes the loan process considerably faster and easier than conventional lending.
- Conventional Lenders. Banks, credit unions and mortgage lenders are common for investors who have strong individual borrowing strength. Interest rates with conventional lenders are at historic lows. However, LTVs are lower and down payment requirements are higher than private money programs. Qualifying for a bank loan on an investment property can be onerous, difficult and time consuming. Additionally, banks typically have a maximum exposure limit for the borrower which limits the amount of properties they can finance.
- Mortgage brokers. They do not lend their own money. Instead, brokers work to find you the right lender from all the options available. For this, they take a commission in the form of points on the loan, which are paid at closing.
- Real estate partnerships, Joint Ventures (JVs) or Equity participants. These are individuals or companies included in the participation of any one deal, (usually as a limited partnership or as a passive partner to the primary). It is standard for a prospective partner to want to review the investment strategy, summary, pro-forma and intended exit strategy.
- Warehouse Banks/ Bank Lines. These are banks that extend a line of credit to lenders at predetermined terms, such as type of assets, terms, pricing, and LTVs. This line enables lenders to fund less on their company balance sheet.
Selecting A Capital Partner
Circumstances such as the recent pandemic clearly illustrated the absolute imperative of conducting due diligence when choosing to align with a capital partner. It is important not to think merely in transactional terms—getting a good deal on one property—but rather focusing objectively on who will be your best capital partner as you grow and change through market shifts, both forecasted and unexpected.
- Capacity and Access to Capital. At the onset of the pandemic shutdown, many lenders had their warehouse lines leveraged and they were reliant on institutional capital partners buying their loans at a premium to remain profitable. Overnight, warehouse lines and institutional/Wall Street buyers froze. This forced many lenders into a compromised position of which they had to stop originating or funding deals.
- Experience. There is simply no substitute for experience—whether it is a sales associate, broker, or lender. They need to have a broad perspective and know how to deal with fluctuations in the market, handle challenging or creative scenarios, and understand what makes a mutually beneficial deal. The industry has been feast or famine over the past decade and those who have weathered the ups and downs can bring that expertise to bear for your benefit.
- Options. One of the biggest rookie mistakes is to focus on rates. Keep your focus on the entire financing structure. This will ensure you do not miss crucial details in achieving the highest ROI possible. When evaluating a credible finance partner, they should strive to understand each unique strategy and exit plan to enable them to provide the best loan options to meet their clients’ individual needs and goals. True capital partners are problem solvers.
- Communication. Clear communication and transparency are vital for building a successful relationship with anyone, especially your capital partner.
Funding Strategies
It is critical that financing strategies and guidelines align with the specific investment opportunity. Financing solutions are not one-size-fits-all. Each sponsor or property likely will have a different strategy and disposition plan. Therefore, be clear on your intention with the asset(s) so you can determine the short and long-term objectives. Having a clear exit strategy in advance, including timelines, will help you find the right financing solution while maintaining the highest margins or returns:
- Fix and Flip. When you find a good deal, you have to be able to move quickly to acquire it. It is important that you have supported data verifying the neighborhood value range, the bottom and highest comps. Also, know what types of finishes or appeal warrants the high versus low end of that market. In today’s market, investors are optimistic that they can reap returns quickly, whether it is through simple cosmetic updates or more complex ones.
- Rehab Financing. When you finance your rehab, this portion of the loan is typically held in a control fund & issued in draws as a reimbursement when the work is completed. This is a great option to preserve your liquid position and be ready for the next opportunity.
- Value Add and Hold. Real estate, as an asset class, has continued to generate attractive returns. Demand for rental properties is high which enables investors to benefit from both monthly cash flow as well as long-term property appreciation.
- Bridge-to-Conventional Financing. Oftentimes a short-term private money loan will give you time to either improve the property or to generate the monthly-cash flow required to refinance into a cheaper conventional loan.
- Cross-Collateralization. For investors with multiple properties, you can leverage the collateral of all the assets into one private money loan, enabling you to execute on a new opportunity.
Capital Considerations
The real estate market is anxiously trying to figure out what the future holds.
It is natural to be apprehensive in our current climate. It is often in the most uncomfortable of times when the greatest opportunities are born. For lenders, Wall Street has begun opening back up, so expect more capital to come back into this space. Investors preparing themselves to be in the best possible liquidity position to exploit these opportunities will be poised for the greatest business growth.
