For most people, owning a home remains a key part of achieving the American Dream. A house is usually the biggest purchase of your life, from the usual 20% down payment to the monthly mortgage payments you have to make for decades afterward, but having a place to call your own definitely makes everything worth it.
Once you have it, it's natural to wonder what's next for you. You want to be able to live the life you want, pursue your true passion, of course, without leaving your family in the lurch. This means you'd have to have enough savings, investments, and cash to sustain the lifestyle you want for yourself and your family--the very definition of financial freedom.
One way of achieving this is through real estate investing. While it can be intimidating, it can be an intensely rewarding experience. And though it doesn't come cheap, there are a myriad ways in which you can get funding for your real estate investments.
Ready to get started? Let's dive right in.
Although you may consider the home you live in as an investment, strictly speaking, an investment property is a piece of real estate acquired with the intention of generating income through renting, the future sale, or a combination of both.
Real estate properties require significant capital, and unless you're flush with cash, you'll most likely turn to a lender for help. Unfortunately, traditional lenders like banks and mortgage companies are wary of extending loans for investment properties. But fortunately for you, there are plenty of financing options to help get you secure real estate funds and get you started on your investing journey.
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With the massive investment required in funding real estate deals, not just financially, but also mentally and emotionally, it makes sense to have other investors involved.
When you team up with other real estate investors, you'll be able to divvy up the workload and pool your funds together to acquire bigger and more profitable investment options, such as a multifamily rental property as opposed to a single unit if you're relying on your resources alone. What's more, when working with a group, you're each able to bring your individual talents to the table which can lead to a fruitful and productive business relationship.
Since the workload is divided, it follows that the earnings will be divided as well. This can be particularly challenging in a down market, or if the investment doesn't turn out to be profitable.
Additionally, differences in views, attitudes, work ethic, and personalities can drive a wedge between the partners. Therefore, a partnership agreement, in writing, must be drawn up from the get-go, to prevent conflicts even before they arise.
Would you believe that it is possible to invest in real estate without directly owning and managing it? Let's face it, managing a real estate portfolio can be a demanding job not everyone is cut out for. But with REITs and real estate funds, your money literally works for you and earns you dividends!
In any case, you must know the difference between the two so you'd know which would best help you meet your real estate investing goals.
Real estate investment trusts (REITs) are a corporation that invests in income-generating real estate. They are publicly-listed, which means they are traded on the stock market. By law, REITs are required to distribute 90% of their taxable income to their investors annually, so investors can count on receiving dividends as opposed to real estate funds which have no such requirement.
REIT portfolios can be composed of residential, industrial, or commercial real estate, and their income comes from the rent they collect (equity REITs) or the interest earned from the loans they provide (mortgage REITs). So-called hybrid REITs are a combination of equity and mortgage REITs.
On the other hand, a real estate fund is an entity where investors pool their money to invest in securities offered by publicly-listed real estate operating companies which also include REITs. Investors earn from them primarily through capital appreciation which can be realized once the properties are sold. This is particularly appealing to long term investors with investment horizons of at least 10 years.
There are three types of real estate funds:
Real estate ETFs: Exchange-traded funds, or ETFs are a passive investment instrument. They are a portfolio of real estate related securities, which means they track major equity indices so a real estate investor can depend on average market returns instead of trying to beat the market. Like REITs, ETFs are also traded on the stock market; however, they are not required by law to distribute their income to investors.
ETFs don't have a minimum investment amount, so they are very accessible to investors who are only starting out on their investment journey. Since ETFs are passively managed, they have friendlier management fees.
Real estate mutual funds: In contrast to ETFs, real estate mutual funds are designed to beat market returns. They don't track the underlying index, which means the composition of the fund varies from time to time. A mutual fund is typically actively managed so they can strategize depending on market behavior. This constant monitoring means they charge a premium in management fees.
Private real estate funds: These funds are only accessible to sophisticated and accredited investors such as high net worth individuals. They invest directly in individual properties and have steep minimum investment requirements.
Both are hands-off investments, which means you don't have any control over where the corporation or the fund managers place the pooled funds. You can only control your entry and your exit.
For real estate funds, you have to pay management fees each year on top of taxes, and this can really eat up your gains.
For REITs, like any other stock, there are commission fees when you sell. In addition, the dividends you are looking to receive is dependent on their performance for that year. In the event of a cooling real estate market, your earnings might be less than you expected.
Hard money loans are a great way to finance your real estate investment. Less stringent than banks and mortgage companies, they provide nearly instant access to funding for real estate investors, which typically makes the deal possible.
Quick approval process: You can get real estate financing in a matter of days which is a godsend for many investors.
Lenient lending criteria: These loans are secured by the property you're buying, so you don't have to undergo a credit check compared to traditional financing. The lender primarily looks at the profitability and viability of the real estate deal instead of your personal history, so you don't have to submit tax returns, pay slips, and the like.
Favorable loan terms: Depending on the lender, the maximum loan amount you can borrow can be up to $5 million. Even better, they offer interest-only loans, which means you only pay interest for the meantime, resulting in smaller and more manageable monthly payments, with the principal to be paid at a later time. This takes a lot of pressure off your shoulders and allows you to better situate your investment financially to ensure maximum profitability.
Shorter loan terms: These loans typically have to be paid back within a year or two, so the real estate investment must be carefully studied beforehand.
High interest and upfront fees: Since these are riskier than regular mortgage loans, interest rates are higher. They also charge an origination fee, and in some cases, prepayment penalties, so be sure to read the fine print before signing going ahead with the loan.
Lower Loan-to-Value (LTV) ratio: You can only loan about 50-75% of the property's market value compared to 80% and up for a traditional mortgage.
Experience required: Some lenders require a history of successful flips before they will give you access to funding. This can be an impediment to a real estate investor who is just starting out.
For buyers looking to purchase their home and have their first investment property at the same time, FHA or VA loans can be used to hit two birds with one stone.
Low credit score requirement (at least 580) and a low down payment (ranging from 3.5%-10%) makes this an attractive option for first time homeowners. With these loans, you can get a multifamily dwelling of up to 4 units, provided you occupy 1 unit as your primary residence and rent out the other 3.
Compared to a hard money loan, you have to comply with stricter requirements when applying for an FHA or VA loan. The lender will look at your financial and work history to determine if you qualify.
When examined versus a conventional loan, there are mortgage insurance premiums that you have to pay upfront (1.75% of the loan amount). Fortunately, this cost can be rolled into the life of the loan so it isn't too burdensome for you.
Getting real estate financing from conventional lenders can be tough, but not impossible. As long as you're able to provide sufficient documentation and meet their lending criteria, banks and conventional lenders can help you out in giving you access to real estate investor funding.
Conventional loans generally have low interest rates and longer loan terms (up to 30 years) compared to hard money. They are government-regulated, which means they have sufficient protection for borrowers against usurious lending practices.
A credit score of at least 620 is required to be even considered for approval. You have to submit a ton of documentation, including tax returns and pay slips. The bank is also going to look at your work history and debt-to-income ratio.
Probably the biggest disadvantage of getting a conventional loan is the time it takes to get approved (at least 30 days), so the opportunity may have slipped through your fingers by the time you get access to funding.
Real estate investing can be intimidating, but as shown above, there are plenty of ways for you to gain access to funding in your first foray into this field. You can partner with potential investors, invest in a real estate fund, and get financing from traditional or private lenders.
If you're looking for a property to jump start your investing journey, look no further than Property Leads! We provide the best leads that no one else is offering, allowing you to beat the competition and get the best deals!
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