“Ninety percent of all millionaires become so through owning real estate.”
–Andrew Carnegie

Investing in real estate is never a bad idea. However, it’s no secret that any sort of real estate venture will have you stretching your financial muscles. You need to have accrued a certain level of capital to properly fund the real estate project right from its onset up until its closing.

A myth that you’ll frequently come across is that to get started in real estate you need to be rich. That’s a lie! Smart real estate investors understand that there are various financing options at their disposal to fund real estate ventures. And this is something that not many new developers in the market are aware of.

So in this blog, we are going to change that.

We’ll take a closer look at real estate financing, what it is, why it’s important and finally, what are the different financing options available to you.

Let’s get started.

What Is Real Estate Financing?

Real estate financing generally describes the means through which real estate investors/developers solicit funds to complete their real estate ventures.

At times it’s direct while other times it can involve the use of external brokers to engineer the funding process. Whichever way, the end goal is to always secure funds to succeed the project while ensuring that all parties involved are content.

Why Is It Important To Source Funds For Real Estate?

1. Real estate will offer you long-term financial security. You, your current family and future generations to come will benefit from investing in real estate today.
2. Properties appreciate over time, and thus if you opt to sell in the future, you are in for greater returns.
3. Real estate is a good way to diversify your investment portfolio.
4. Real estate is a reliable source of passive income through rental deposits.
5. Real estate protects you against inflation. When the prices of products and services rise, so will your rental charges meaning you are always on the safer side of the fence.
6. Real estate allows you to have location freedom, meaning if you have various properties under your portfolio, you can live and work from anywhere in the world while still receiving money from your them.

Methods Of Financing Real Estate Developments.

Broadly, the methods can fall into two main categories

i) Traditional Financing
ii) Modern Financing

NB: Traditional does not mean outdated or ineffective. Traditional only means methods that real estate investors are more accustomed to. Modern means methods that have just recently come into play and not widely opted for.

Traditional Methods Of Financing Real Estate Developments.

• Debt financing.
• Equity Financing.
• Financing through personal savings.

Let’s have a look at each in detail

1. Debt Financing.

Just as the name implies, it involves the use of debt to fund a real estate development project. The interested party (can be a group, individual or company) borrows money from another party, like, let’s say, a bank, and pays back the money at a future date with interest. The rate of interest is governed by the market rates and the reliability of the borrower. The higher the interest rates the higher the chance of default. Lenders bear a huge proportion of the risk.

So over the course of time, banks and other lenders have become more stringent in their loaning processes. Unless the use of a right medium is employed, then debt financing can be difficult to obtain especially for starting individuals.

Most Common Forms Of Debt Financing Used By Real Estate Developers.

i) Loans From Banks.
This is the most common route real estate developers pursue. Since real estate ventures are normally cost-heavy, a bank stands out as the most suitable option to meet such high cash demand. Banks also have a wide range of loan options that allow you the flexibility to work with what seems best. A downside to bank loans is that they are hard to get, especially if you are just getting going with no reputation or credibility to your name. It’s a route more feasible to the well established real estate developers who boast robust credit history and possess a long investment history.

ii) Private Lenders (Non-bank lenders).
Private money lenders are entities that offer loans to real estate developers the same way as banks do. But unlike the banks, private lenders have less stringent qualifying measures. This implies that this method is suitable for upcoming and new real estate investors who are just getting started.
It’s common practice to use brokers to obtain private loans.

iii) Loan From A Friend Or Family.
While this is less conventional, it’s actually an attractive route for up and coming real estate investors. These loans come with much looser terms and payment is more tied to your relationship with the friend/family lending the money.

However, this method also has its negatives, one of them being that: it’s less conventional, therefore payment defaults can lead to ungoverned confrontations.

iv) Peer To Peer Lending. (P2P Lending, Crowd Lending Or Social Lending).
This is whereby, borrowers (real estate investors) and lenders are linked by an online platform (e.g an app) and then the platform sets up rates and terms which then facilitates the borrowing process.

P2P lenders are individuals who, rather than saving and growing their money in the bank, opt to use borrowers to get a better return on their money.

It’s a method that’s gaining traction fast with platforms like Upstart and Prosper dominating the scene.

v) Home Equity Loans. (Second Mortgage).

If you already own a home or any sort of real estate asset (meaning you have equity in the property) then combining that with good credit – you can easily apply and receive a home equity loan.

A home equity loan basically works like a mortgage in that you have to pay monthly fixed rates to cover the payment that was indebted to you.

Since the loan risk is covered by the property, it results in home equity loans having lower interest rates than the traditional bank loans.

2. Equity Financing.

Equity financing is whereby investors give you the capital to fund your real estate venture, but in return you’ll offer a stake/share of your property to them. Unlike debt financing where investors profit from the interest payments that you accrue, in equity financing, investors gain from the capital appreciation of the property. Their returns will come in the form of dividends or when you decide to sell the real estate property.

This method is more popular to:

• Real estate investors who are just getting going.
• Established investors that want to expand.

However, appropriate caution must be taken when opting to go with equity financing. It gives the investor a long term stake in your company, therefore as your property appreciates, so does the stake of your investor.

Ensure you have a good understanding of the terms of the agreement, so that in case of any eventuality, you are not caught unawares.

Common Sources Of Equity Financing.

• Angel visitors.
• Crowdfunding platforms.
• Corporate investors.
• Venture capital firms.
• Enterprise investment scheme.
• Initial public offerings.

3. Financing Through Personal Savings.

This is a funding option mostly pursued by persons who have been in the real estate game long enough, have made tons of money, and are now reinvesting the earned money back into their real estate business. The main disadvantage of this method is that all the risk is carried by the investor, so in case things go south, it can lead to massive losses that can be very damaging.

Modern Methods Of Financing Real Estate Developments.

i) Mezzanine Financing.
This is a blend of both debt and equity financing that works out as debt financing, but in the case of default in debt payment, the lender has the right to convert the debt into an equity stake.

The lender has the power to take a portion of the property(s) in question, and sell off some of it to cover the debt. It allows flexibility in payment, while also ensuring that both parties are always in a win-win situation.

However, mezzanine is a high risk kind of financing that is mostly used for specific expansion projects and is not ideal for new persons to the real estate scene.

ii) Public Private Partnerships.
Public private partnerships involve the collaboration of government and private entities with the purpose of financing, building and operating real estate projects.

This method is most sought after when there is a need to finance large scale government real estate projects. The way it works is that the private company finances the entire project, and once the property is set up, they’ll cover their expenses and profit through the operating costs of the property.

iii) Real Estate Investment Trusts (REITs).
A real estate investment trust is an investment vehicle that allows different real estate investors to pool resources together and invest in large scale, income producing properties.

Properties that fall within the REIT bracket are like:

• Apartment complexes.
• Hotels.
• Healthcare buildings.
• Office buildings.
• Warehouses.
• Self storage units.
• ….and Retail Centers.

In general, REITs favour more established real estate investors who are now looking to diversify their investment portfolio.

The REIT business model is rather simple, whereby rent is collected from the buildings, and each investor receives a share of the earnings based on the amount invested. It’s a lucrative model that ascertains regular and stable income for a real estate investor.

Which Is The Best Real Estate Financing Model To Select?

Truth be told, there is no best way. But generally speaking, your decision should always be based on the understanding that real estate is a long term game. If in the long term you see your position steady and profitable, then why not!

Need Help Acquiring Real Estate/Property Financing?

It’s easy to get frustrated or feel lost in the pursuit of real estate funding more so when you are just starting out. The funding process can be quite tedious and at times it can be confusing deciding on which financing model to best pursue.

That’s why you need brokers.

As independent finance brokers we have strong relationships with a range of banks, non-bank lenders and private equity sources in New Zealand and overseas. It is our aim to help real estate investors acquire the funding needed to fulfil their real estate ventures while also advising them on the best financing option for them.

So if you are in need of such, reach out to us today and we’ll get back to you immediately.