Why do real estate investors need private/hard money and business purpose loans? Below we discuss a few of the many reasons that real estate investors rely on private financing to acquire, renovate, and successfully retain real estate. Most of the TV personalities that engage in property renovation have used private real estate financing at some point. Unless an investor has access to, and decides it prudent, to use cash, the need for financing is of utmost importance.
Leverage and Liquidity
Real estate financing provides a real estate investor with a tool that reduces the amount of capital outlay, which makes real estate investing somewhat unique. The power of financing increases a real estate investors ability to acquire and build a real estate portfolio that they have never been able to with limited personal capital. Many investors leverage a loan amount to a level by which the total expected or realized rent pays the entire housing payment on a 15 year term. And after 15 years the lessee has effectively paid the loan off for the investor. By reducing the amount of capital outlay, the real estate investor is able to acquire more and more real estate over time. Care must be taken to avoid becoming “over leveraged” with debt that exceeds the value of the property.
ROI – Return on Investment
ROI or “Return on Investment” is a metric that is used to value real estate investments. Typically, the lower the capital investment, the higher the return on investment. For instance, lets assume the acquisition cost of a property is 100k, and the NOI (Net Operating Income) is 20k/year. If the investor pays cash, the ROI is 20k/100k, or 20%. If the investors uses an 80k mortgage, and the net income less debt service is 10k/year, the ROI is 10k/20k, or 50%. There are many factors to consider including CAP rates, ROI, Cash on Cash, leverage ratios, debt service coverage, etc. Investors typically rely on all or some of the metrics before making an investment decision. Private, financing typically allows the investor to leverage more debt compared to bank or traditional financing.
Speed and Efficiency
Hands down, private lending solutions offer a more streamlined and faster approval process compared to bank or traditional financing vehicles. Banks often times are subject to credit committee approvals in addition to regulatory burdens that increase the time lag between application and funding, and make the process more time consuming for the borrowers. This may be the main reason that so many professional real estate investors use private financing over bank financing.
Non-Bank Underwriting
Similar to speed and efficiency, as discussed above, “non bank underwriting” is typically less complicated and invasive to the borrower as private lenders do not have to navigate regulatory burdens and credit committees. Although non banks are absolutely concerned with a borrowers ability to repay, they are more likely to find solutions where banks may be restricted.