7 Ways to Finance A Multifamily Real Estate Deal
Where do you find money to invest? People reach out to us often and ask, “Where do we find money to invest in real estate?” There are more ways to find capital than you can imagine. Let’s keep it real. No one wants to hear advice from people who have never invested before. Here are seven methods I have used to find money to finance real estate deals. We know these strategies work because they have worked well for us.
7 WAYS TO FINANCE A MULTIFAMILY REAL ESTATE DEAL
Good Old Savings
Your first couple of real estate deals can be done with good old savings. No mad science here. Your first deal may be best completed using your own hard-earned money.
Everyone is looking for a way to make a quick buck. Real estate or general wealth building is a slow race to start. However, the funds and investments you have can grow exponentially if you play your cards right. Be patient. Our advice is to first cultivate good money habits and use software such as Mint: Budget Tracker and Planner to tune into the monitoring of your income and expenses.
We have always believed in bootstrap funding our first deals before tapping into outside investor money. There is a responsibility that comes with caring for investors’ money. This responsibility helps you build your track record before you can use your reputation and investor resume to build more trust from people who may invest with you in the future. Using your own funds in a real estate transaction helps you feel better if the deal doesn’t work out as planned. In other words, your own money is at risk instead of the hard-earned money or savings of another person.
When I was working my W2 job, I was able to save 30% of my income automatically through retirement funds. An additional 10-15% was funneled into a saving account. Let’s look at some real numbers using these percentages of saving.
If a family makes $150K annually, that family should be able to save $50K a year. That is a good chunk of down payment money for an investment project in the $200K-$300K purchase price. This hypothetical situation is realistic in most markets across the country. This family may be able to buy a bigger property if they are able to use strategies such as house hacking or value-add.
Cross Collateral
Once you have just ONE property under your belt, you will be able to use this property as a chess piece on your Real Estate Investment board. In the past, we have taken out a Home Equity Line of Credit (HELOC) loan on our primary home to fund our deals. We have also done business with local credit unions with our portfolio of properties. We received one single line of credit from our growing real estate portfolio. The beauty of HELOC products is that when the funds are not drawn from the line of credit, interest may not be paid. I recommend all my investors get a HELOC loan on their primary or investment properties when possible. Ensure that interest will not be paid if the money is not drawn from the line of credit. Check with your banking institution for their specifications on HELOCs. Read the fine print, check twice and ask questions. Apply the HELOC strategy only to deals that have lower risk and higher yields than the interest being paid.
Cash Out Refinancing
HELOCs can help you accelerate your purchase game. So can cash out refinancing on your existing investment properties. All refinances are essentially cash out refinancing because a new loan (cash out) is being taken out to pay off your existing loan.
Did you know someone can take out more money in their new loan than was in their existing loan? When this happens, we have some cash back for ourselves in addition to paying the old loan. Yes, more will be owed on the existing project than was owed previously. However, if the interest rate has dropped significantly, the mortgage amount being paid per month could be the same or even less.
In addition, you could have working capital (cash in your pocket). We used this strategy frequently in our value-add projects. As we increase the value of a piece of real estate, the equity of the property increases. This enables us to force the valuation of the property to increase. Then we have more equity that we are able to collect by cashing out. Our rents also increase significantly. This allows us to increase our cash flow once we refinance with a larger mortgage. It is key to make sure after a cash out refinance, your cash flow for your whole portfolio is still at a comfortable level.
Roll in Commissions and Fees
This strategy is not part of my personal past experience. However, I have structured deals so that someone else within the deal has benefited financially. If someone is a real estate agent or a property management company owner, this can work to their advantage. There are other professions such as wholesalers, flippers and contractors, etc. that can become involved in a transaction like this. Someone can potentially propose a partnership to a buyer. The partner would then roll in their commissions or fees for an equity share in the real estate deal.
Why would this be an attractive scenario? There are multiple benefits. The money that is not touched cannot be spent. This can force some automatic savings as it goes directly into the deal. It may also lead to potential tax savings. An equity share has more tax benefits than straight cash via a 1099 form. You may also get a partner position in a deal, which is what you are working hard towards. The experience you gain as a partner in any real estate transaction is very valuable.
IRA or 401K
Did you know that you could access your IRA and 401k to invest in real estate? If you have a 401k account with your current employer, you can borrow up to $50K from it as a loan. You must check with your company’s 401k policy to make sure this is allowed. You will then need to pay yourself a fair market interest rate (prime +1%) and pay it back in five years. There are some special provisions in the CARES Act that allow you to have access up to $200K if you can prove a hardship related to COVID-19. Watch our interview with retirement fund expert, Naomi Hanson-Galema, on this topic.
While the above benefits are somewhat great, the power of retirement accounts shows up when you leave your existing company. Instead of rolling your old 401k plan into a Traditional IRA account, as many major financial magazines advise, we invite you to explore Self Directed IRAs and Solo 401k vehicles in which to roll your retirement savings. There are initial fees to set up these vehicles but the benefits outweigh the costs.
Your retirement funds are now no longer limited to traditional investment vehicles such as mutual funds and stocks. These funds are now open to higher yielding and possibly higher risk alternative investments such as passive syndication, notes and precious metals. If you want more control over what you want to invest in, this strategy may be for you. For more information about these vehicles and conversions, watch our interview with John Park, the CEO of PGI SelfDirected, on this topic.
One big rule to make sure you follow while using these accounts is never send yourself any profit or money generated from the retirement account. That is a taxable event. Keep your books tight. Also, do not ever use these funds for active deals in which you are directly involved. Any retirement vehicles prohibit self dealings.I set up a Solo 401k when I left my first company after 10 years of employment. I have invested this money passively to apartment syndication deals led by other investors. This was a source of learning as well as a great financial return for me. Instead of gaining just an average of 8% return, my investment is on a path to generate a 13-17% Internal Rate of Return (IRR).
1031 Exchange
A 1031 Exchange is named after Section 1031 of the U.S. Internal Revenue Code. This code allows someone to avoid paying capital gains taxes in a like-kind and equal or greater value real estate transaction. In other words, when an investment property is sold, the proceeds from the sale can be reinvested into another property that is comparable. For example, the proceeds from the sale of a four-plex can roll into the purchase of a 12-unit apartment building. Strict time limits are imposed by this code in regards to the date of sale of the first property and the date when the second investment property is located for purchase. This is a very powerful strategy when used in combination with leverage. Just think, if someone can defer ONE dollar of tax and get a 75% loan-to-value leverage on that dollar, the purchase power is now FOUR dollars! HUGE! This is how people are buying large apartment buildings by themselves. Years of real estate portfolio accumulation and 1031 Exchanges really add up. Now, because it is such a powerful vehicle, there are some restrictions to it. You have to identify your replacement properties in 45 days and finish the transaction in 180 days. The 45 day rule is what makes the exchange somewhat tricky to pull off. A third party facilitator is necessary to ensure everyone conforms to the rules of a 1031 Exchange. We have done four 1031 Exchanges in our real estate investing career.
Here is an interview with 1031 Exchange magician, William Exeter, CEO of Exeter 1031 Exchange Services.. Watch it here to learn what you need to do to execute this correctly.
Raising Capital From Investors
Lastly, someone can leverage other people’s money to buy real estate. I would recommend doing this only after you have reasonable experience and are confident you will not lose that money. There is a lot of sideline cash at any given point of economic cycles. There are always investors that have cash in hand but no time or resources. Your first couple of deals will likely be funded by close friends and family unless you have a vast network of investors to contact about your opportunity. We believe in the saying, “Your network is your net worth.” You can work with one or two individuals by bringing deals to them that make sense and ask to operate the deal as partners. We did that when we first started after we had a few success projects under our belt using our own money.
If someone is doing good work, their reputation precedes them. Soon, successful investors will have a following of other investors willing to hand over their money to fund the next deal. Growing a following or a tribe organically is a fantastic way to start. Marketing and creating a brand for yourself can potentially attract more investors. Partnering with reputable operators is another key to success. You might have to give out more shares up front, but the long term return is well worth it.
Paying a fee to join a network or a mentoring group is another way to level up in many different ways including education and building relationships. We have raised millions of dollars through our syndication efforts. When someone is raising money, all legal processes must be followed. Providing excellent customer service to your investors with frequent communication and solid financial returns is key. Anyone can grow exponentially through this method of raising capital, but the responsibility is enormous.
By now, you have found one or two ways within my experiences to find capital to fund your real estate investment. As always, we are happy to connect with you and offer advice on your strategies. Please feel free to schedule a call with use here.