One thing is for certain in the real estate industry – it takes money to make money. It does not depend if you have been a real estate developer for 50 years or just started yesterday. Without the necessary financing, closing your next property is almost impossible.
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For years, banks were the primary source of finance for real estate developer across the nation. While they still play an important role, especially in financing large deals, developers from coast to coast have begun looking into alternative finance options.
While some of these options are cheaper, the key factor is speed. Waiting for bank approval means a developer is losing money. So in some cases, they might even take a higher rate today if it allows them to take possession of a property. After all, they can always refinance later. Potential non-bank real estate finance options include borrowing against an insurance policy, private lenders, seller financing, and even borrowing from a self-directed IRA.
1. Borrowing Against an Insurance Policy
Actually, loans against insurance policies have been around for years. In the past, a whole life insurance policy was commonly used as collateral for large purchases. However, the advent of term life insurance policies, which are usually cheaper, has led to a decline in the number of people policies which can be used for loans.
Whilst these loans can be simple and don’t need to pay the loan back. The devil is in the details. For example, the insurer will deduct the loan collateral from your policy into a general account. Granted the principal amount does not need to be repaid, but deducting interest payment from the policy is not a good idea.
2. Private mortgages
As the name implies, these are not bank loans. These loans are either originated directly by high-net-worth individuals or brokers who act on their behalf. In most cases, the interest rates for these loans tend to be higher than bank loans. However, they plan an indispensable role real estate finance. In fact, most developers could not function if they did not know at least one private mortgage, also called hard money, lender.
As a new developer, then you want to identify at least one hard money lender you can trust. Based on my research, one lender in California is Crawford Park Financial. A lender such as this can help a developer protect themselves from risk, whilst growing their portfolio faster. The fact is that most off-market deals fail to close due to financing issues and this is why developers turn to private mortgages when they need to close on short notice.
3. Seller Financing
This form of real estate financing is based on a finance agreement between the buyer and the seller. The agreement itself would be in the form of a promissory note which will outline the terms including monthly payment, interest rate, and length of the loan.
Whilst seller financing sounds simple, it is often difficult to get. In some cases, the buyer does not want to let the seller know their exact financial position as this might risk the seller choosing another buyer.
Another risk is default, which would mean that you have not only paid a portion of the sale price to the seller but now they have regained possession of the property. For this reason, seller financing is best as a subordinated secondary loan to help loan the loan to value (LTV) ratio in a bank loan.
4. Borrowing from a Self-Directed IRA
After all, the money in an IRA (Individual Retirement Account) is yours. Why shouldn’t you be able to use it for a loan? While this form of lending is possible, you do need to check the fine print in your IRA account. For example, most IRA won’t allow you to use the funds for the purchase of a home. But using the money to finance the purchase of an investment property is usually allowed.
While the is no interest rate and the profits from any IRA funded transaction would be tax-deferred, there are limits on the number of transactions per year. That being said, this is not something you should do on your own. If you are considering this funding option, then you should talk to your financial adviser to make sure it is properly set up.
As you can see banks are not the only option when it comes to financing a real estate purchase. In fact, most successful property developers are using all of these options based on the best fit at the time. For some, the consideration is speed, especially if they are looking to grow their portfolio quickly. In the end, you compare these options with your adviser to figure out which one is the right fit for you.
