By: Emile L’Eplattenier, Fit Small Business
Updated: July 31, 2017
When you’re first starting out in the real estate business, securing the capital you need to grow is a critical concern. Luckily, no matter your financial situation, there are a variety of options available to help new entrepreneurs shoulder start-up costs. We’ve outlined the most common ones below.
Hard Money Lender
Hard money lenders are a financing tactic often used by real estate investors. Rather than coming from a bank, the funds for these investments come from a private individual or group. Because these loans do not need to go through any corporate procedures, they often have looser qualifying requirements and can be secured faster. Additionally, private lenders may be more open to backing risky projects.
With that in mind, investors should be confident in their ability to pay back the loan quickly before signing on the dotted line. Hard money loans often have extremely high interest rates and require a sizable down payment or personal collateral. They also have much shorter terms than traditional loans, averaging only a year or two.
Microloans are typically geared toward newer businesses or startups that need capital to generate further growth. As the name suggests, these loans are smaller than what’s usually offered with traditional bank financing. Lower balances mean that microloan programs are less strict in terms of their qualifying requirements like credit score, which can be a comfort to those concerned about borrowing above their means.
However, microloans may not be a good fit for everyone. Though these loans can go up to $50,000, the average loan is only about $13,000, so it’s important to gauge overhead costs accordingly. Also, their interest rates are typically higher than those offered through standard loan programs.
Real Estate Crowdfunding
In the past, investing in real estate was limited to those with deep pockets, but since the passage of the 2012 JOBS Act, crowdfunding has become a way for investors to diversify their portfolios at a much lower cost. Rather than having to search out and restore properties on their own, investors can browse crowdfunding platforms to select from a list of available investment projects in which to participate. They then have the opportunity to finance shares of the property at a low cost—sometimes as low as $1,000—and collect a portion of the profits or rent payments once the project has been completed.
That said, this type of investing does come with elevated risk. Investors have much less control over the outcome than they would in a traditional fix-and-flip scenario. Be aware that there could be a longer wait for return on investment, depending on how each deal is structured. Additionally, know that if the project fails, it’s the investors who will shoulder the loss rather than the builder.
SBA loans are so-named because the Small Business Association offers a guarantee of repayment to banks that are willing to underwrite loans for new entrepreneurs. The guarantee lets banks become more willing to take risks. While the affordability of a loan will depend on an investor’s unique situation, generally these loans have higher borrowing limits—up to $2,000,000. SBA loans also come with longer terms, lower down payments, and protection against balloon payments, which can help businesses maintain a stable cash flow.
It’s important to note SBA loans can’t be used to invest in real estate but can be used to start a real estate business, such as a brokerage or property management fund. Unfortunately, the security that SBA loans offer comes at a cost. In addition to being subject to high fees, investors must have a high credit score and be able to show significant profit on their tax returns in order to qualify. The application process is also lengthy and requires the borrower to put up personal assets as collateral.
If applying for a loan is not for you, a rollover as business startup (ROBS) provider may be the best choice. This method of financing allows small business owners to draw funds from existing retirement accounts without incurring tax or withdrawal penalties. Because the money is their own, there are no debt payments, leaving them free to invest the full amount into business growth. Also, in the event that the business should fail, this leaves no negative impact on their credit score or other assets.
Before committing to a ROBS strategy, an investor must be sure to weigh the risks. On the one hand, they can only draw the amount of money in their existing accounts, which means their available funds may be smaller than they would be with a loan. In line with that, if the investor decides to invest the entirety of their retirement funds into the business, and the business fails, they could be left without security in retirement. Similar to SBA loans, ROBS cannot be used to invest in real estate.
As with any investment, each scenario comes with a unique set of advantages and disadvantages, so be sure to do thorough research before deciding which option is best for you.