Don’t confuse the tool of Crowdfunding itself with the project you want to get funded.
Crowdfunding is simply an alternative way of raising private money for a project without the hassle of banks or hard moneylenders. This money-raising vehicle enables a project promoter to collect small amounts of money from a large group of people who believe in the principals, the cause, or the specific project.
A massive potential market of capital and investors has largely gone un-served for many years, due to these regulations and economics. There is a market for this fund raising vehicle today, due to market need and demand. That need and demand will be met by the ability of large groups of ordinary people to meaningfully participate online.
Non-banks, also known as “FinTech”became more prominent as a form of crowdfunding in 2012, with the launch of the Lending Club, which reportedly had advanced more than US $250 million in loans via its website in a single month in 2014. Platforms such as the Lending Club gained popularity, as banks increased interest rates or reduced their level of lending activity.
1. The Importance of Private Lending
Regardless of whether you use crowdfunding as a money raising tool or not, having the ability to fund all of your projects with private lending is critical to your success in the real estate investment business.
There are three great reasons for relying exclusively on private lenders to fund your note or real estate deals.
- First, by utilizing private lending you free yourself from having to come out of pocket for such things as down payments, rehab costs, and all the costs associated with acquiring a piece of real estate.
- Second, one of the most powerful aspects of utilizing private lending is to be able to get cash at closing when you fund your projects. When you are using traditional methods of investing you are coming out of pocket to fund those projects or properties. Utilizing private lending often allows you to get a check at the closing table.
- A third benefit of utilizing private funds is that you never have to deal with the banks. You do not have to worry about having to qualify for a loan, and you do not have to worry about getting your property acquisition costs back by having to refinance the property, or having to sell the property when your initial goal was to create a rental for your long term portfolio.
2. Traditional Methods
Banks are very difficult to deal with. You will have to come up with a credit history, fill out applications, qualify for the loan, obey all the bank stipulations and covenants, and complete unbelievable amounts of paperwork.
You are also looked at as an investor, not a homeowner. When you use bank funding for investment properties you can expect to pay a higher rate of interest than if you were just buying the property for your own home.
Furthermore, they do not like to do short term loans as the cost of underwriting and papering a transaction lends itself to a longer term transaction.
You are also going to have to come up with a down payment and you are going to have to fund the rehab projects yourself. This process is much more capital intensive (your capital) when you utilize anything other than private sources of capital.
Mortgage companies are the same as banks with the higher funding fees and all the stipulations that are associated with banks. If you are a full time real estate investor wanting to go get a loan, all the typical red tape of going through a bank also applies to a mortgage company. They look at you as if you are an unemployed individual because you don’t really have a track record or constant influx of cash coming in month in and month out.
Both banks and mortgage companies will allow you to do only so many loans per institution; and total number of loans on your credit report. This makes it more cumbersome to finance real estate utilizing those traditional methods.
Hard Money Lenders
Hard money lenders are another way to finance deals; however, utilizing hard money lenders is costly. Many times the hard money lender will only allow you to fund 65% of the after repaired value (ARV). Many hard money lenders will lend you money at a 65% after repaired value with fees of sometimes as much as 3 to 5 points per transaction.
Hard money lenders do play an important part in assisting Investors to acquire real estate. Typically hard money lenders are utilized only if you do not have your private lenders lined up quickly enough, or the private lenders are in the process of getting their funds gathered up and you have a tight closing window of say a week or two weeks.
For instance, if you do not have 30 days to get money shifted around, either from their institution to yours or from their IRA funds to the third party administrator, that is when you may want to utilize hard money lenders as a “bridge loan”. Certainly you would want to pay off that loan as quickly as possible, utilizing private funds.
Credit lines are another way to access capital to purchase real estate. If you are living in a house that is worth $200,000 and you have it paid down to $100,000, then you have in essence a credit line, an available Home Equity Line of credit of close to $100,000. Even if it was only $80,000, you have that money available in your real estate that you could utilize. You could also utilize a credit line from an investment property. If you have an investment property, say it was worth $100,000 and you had it paid down to $50,000, you could leverage that equity for liquid cash.
Utilizing credit cards is another way to fund short term. If you need a down payment on a piece of real estate you can get a cash advance on a credit card. Keep in mind however that credit card companies have tightened up their rules and restrictions recently, particularly on cash withdrawals. It is not that easy to just go out and take money off the credit card to invest for a down payment so check out the rules on the cards you plan to use.
Limitations of Traditional Methods
- Need to qualify
- Down payments
- Rehab Expenses
- Closing Fees
- Holding Costs
Whether you are using the above methods of financing real estate (banks, mortgage companies credit lines, credit cards, or hard money lenders) you are going to need to qualify. You are going to have cash out of pocket in down payments and rehab expenses. You are going to have closing fees and holding costs making it very cumbersome and taking a lot of your profit dollars right out of the deal.
Other Sources of Funding
Business partners are another source of capital that you can access to purchase real estate. However, utilizing business partners is going to cost you more money than probably mortgage companies or hard money lenders and they are probably going to want a bigger piece of the action.
They want to make sure they are well compensated, as one business partner reminded me, “I am not a bank”. You might be paying them anywhere from 25% to 50% of the profit dollars. So with business partners you lose a big part of your profit.
4. Positive Cash Flow
Number one, pay yourself first. Because you are utilizing private funds you are going to have more money at closing than is needed to finish the deal. You will leave the closing with cash.
For example, if a piece of property is valued, after repair at $100,000 and the property was acquired for $55,000. After a $10,000 renovation you now have a total of $65,000 in that piece of Real Estate.
Because these monies are loan proceeds they are tax-deferred. You win when you buy and the beauty of the private funding program is that you will not have the challenges of making those monthly payments. Because you will have money in your account from the closing and from other closings to help offset out of pocket expenses to make those monthly payments.
5. You Create an Endless Supply of Money
Money for these deals is truly endless. Do not lose track of the fact today there is Four Trillion Dollars worth of cash invested in IRA funds. Investors with money parked in low yield IRA’s would love to be utilizing those funds on something that has asset value such as real estate. It is possible to self direct IRAs to allow you to put first mortgages on such things as residential real estate purchases. Second mortgages can be put on properties, for rehabs and subject-to properties, and also for maintenance on properties.
Another great strategy is taking a second mortgage against an investors IRA on properties waiting to be sold. Say you have a property that is worth $125,000, you have a first on it for $80,000. Because of the equity spread you still have the ability to have a second mortgage on there of say $20,000. That $20,000 second mortgage allows you to pay some of those maintenance and carrying costs. But you must obey this rule of thumb: When you have a second mortgage on a property the mortgages should never total any more than a maximum of 80% loan-to-value. In other words, if your property is worth $125,000, the combined total of both mortgages should not exceed $100,000.
In this example if you have a first mortgage of $80,000 that allows you to put up to a $20,000 second mortgage on that property. Now here is the real beauty of this strategy: You may come across someone who says “hey, I don’t have $80,000 to invest with you, but I do have $20,000 I would like to invest in this program.” You could take that $20,000 and put a second mortgage on a property that has a nice equity spread. Try that with a bank!
And don’t forget about commercial purchases. Having the endless supply of funding allows you to look at some commercial properties where you are going to have a bigger return, a bigger profit dollar to run your business and lifestyle.