How to Finance Your Real Estate Investment

How to Finance Your Real Estate Investment

Why Buy Investment Property?

Investing in real estate has long been a favoured method for accumulating wealth and generating passive income. An investment property refers to a real estate asset purchased with the aim of earning returns through rental income, the rise in property value, or both. This encompasses various types of residential properties like single-family homes, apartment buildings, and condos, as well as commercial properties such as office buildings, retail spaces, and warehouses.

Investing in real estate offers several benefits that attract investors interested in wealth accumulation and income generation. A key advantage is the potential for property appreciation, as real estate values typically increase over time, resulting in substantial capital gains when sold.

Your Options for Financing Real Estate Investments

Investment property financing is more complex and diverse than ever before. While conventional mortgages remain popular for doing so, you have access to a wide range of alternative financing options, from hard money loans and private moneylenders. 
Let's take you through the main options for financing your property investments.

Option 1: Finance your property with cash.

First, you could pay the full price for the property upfront with cash. Of course, this requires having the resources available to do this.
●    Pros: Paying upfront significantly improves your opportunity to purchase real estate since it removes any financing question doubts in the seller's mind. Paying cash enables you to acquire properties at significant discounts in exchange for the convenience cash offers. In addition, paying cash saves buyers a lot of money in interest expenses that come with private, hard-money or conventional loans.
●    Cons: This one is all about risk versus reward. Paying in cash is a safer, more conservative approach, but it caps your potential gains. Paying with cash certainly provides security and stability, but removing the risk dramatically reduces the potential reward.

Option 2: Finance your property with a private individual lender.

Private individual lenders are lenders who operate outside of financial institutions. They make a profit generally by lending money to those who increase the value of their investment properties.

●    Pros: Private lenders tend to be far more flexible than traditional institutions, both with who they are willing to lend to and how quickly they can provide funds. If they see you as a good investment, you can reap a host of benefits. 
●    Cons: Private lenders tend to have higher interest rates than banks, especially if they take on credit risk that a bank was unwilling to take. Additionally, you may need to do some work to build up a private lender network to fund your efforts.

Option 3: Finance your property with hard-money loans.

Some borrowers take this approach with private lenders. It's called a hard loan because it relies on a hard asset — in this case, the property. This loan is a form of a bridge loan, a short-term deal that provides funds until either the house can be sold or a more traditional funding stream can be secured. 
●    Pros: Hard money loans can get approved in as little as seven days, allowing investors to move quickly on a property. Borrowers can obtain the funds needed to purchase and repair a house with little upfront cost, making it a good option for fix-and-flip investors.
●    Cons: The interest rates for hard money loans can be significantly higher than traditional mortgages. These loans require you to know what you are doing. If you are unable to complete the repairs on time (typically within six to 18 months), then you could be stuck paying higher rates or, worse, you could walk away with nothing.

Option 4: Finance your property with conventional bank financing.

This is the most common form of financing. In this case, a financial institution lends money to the borrower based on credit history and ability to pay off the loan in the future.
●    Pros: Although investment property interest rates are higher than loans for a primary residence, this option tends to have a lower interest rate than using a private lender. Also, as detailed above, financing through a bank can maximize your potential profit based on how much cash you have available for a down payment.
●    Cons: One of the potential problems is risk. In the event of a rental property vacancy, having a mortgage payment can quickly eat into your profits. Banks also have a much longer approval process and much stricter lending profiles than private lenders, and borrowers are limited on how many conventional mortgages they can have open at a time.

Option 5: Commercial Loans

Commercial loans are a major source of financing for those wanting to buy multiunit residential properties, commercial properties, or mixed-use developments. These loans differ significantly from residential mortgages and have specific rules, benefits, and challenges.
Commercial loans are used to finance properties intended for business purposes, such as office buildings, retail spaces, warehouses, apartment complexes, and mixed-use properties. They are not intended for single-family homes or owner-occupied residences.
●    Pros: Commercial loans are well-suited for financing large-scale real estate projects like multiunit apartment buildings or mixed-use developments. These loans often have higher borrowing limits, allowing investors to buy more expensive properties. In addition, commercial loans may offer longer repayment terms, which can result in lower monthly payments and improved cash flow. Interest rates on commercial loans can also be competitive, especially if you have strong credit and a solid business plan.
●    Cons: One of the main disadvantages of commercial loans is their more rigorous qualifications. To qualify, you typically need extensive documentation, including detailed financial statements and business plans. In addition, commercial loans often require larger down payments, which can be a significant financial commitment. The approval process can also be long, potentially boxing you out of some property deals. Lastly, commercial loans may have higher interest rates and fees than residential ones, reflecting the increased risk associated with commercial real estate investments.

Investing in a rental property or tackling a house-flipping project is risky, but it has the potential for a big payoff. Finding the money to take advantage of real estate prospects doesn’t have to be an obstacle that stops your venture if you know where to look. As you compare different borrowing options, keep in mind the short- and long-term costs and how each can affect an investment’s bottom line.

While real estate investing can be challenging with market fluctuations and property management responsibilities, if you stay informed, adaptable, and strategic in your approach, you can be well-positioned to capitalize on the prospects that come along.9 As with any investment, it's crucial to do thorough research, seek professional advice, and maintain a long-term perspective so you're never taking on more than your risk tolerance and investment goals dictate.