Investing in real estate is a great way to grow your wealth. Property tends to appreciate over time and has the potential to show great returns through rental income and future resale earnings. To start investing in property, you will need capital, and a lot. Securing financing is one of the most important milestones of any real estate project. Although most home buyers use traditional home loans to purchase a property, they have other financing options that residential and commercial real estate investors can explore.
Low-interest FHA loans, which are issued by private lenders and then backed by the Federal Housing Authority, work very well for projects like home piracy. Veterans, active duty service members, and their surviving spouses may qualify for VA loans, which have competitive rates and terms. If you already own a property, you may qualify for a HELOC or a home equity loan (or a “second mortgage”), which you borrow out of your current property value. And for fix-and-flips and BRRRR renewals, many investors opt for hard money loans, using the property itself as collateral rather than credit. Today, however, we will focus on a more personal type of loan. Maybe you’ve already tried taking the established paths above and gotten rejections, or maybe you just don’t like the risk involved in certain types of lenders. Although it is certainly a more socially risky proposition, this article will provide advice on how to ask your family and friends to help you finance your real estate project. Involving money in any relationship can complicate things and you should only seek this exit if you operate wisely, examine your investments, provide transparency, and prepare your investment thesis thoroughly. Do Your Research Before asking someone for money, spend some time developing your ideas. Research the area where you want to buy a property and ask yourself questions like: • ● What is the sale price compared to the sale price of other properties in the neighborhood? • ● What is the average monthly rental income or vacation rental income for similar properties in the area? • ● Has the population increased in recent years? If so, why? • ● Has the local government made significant investments in the area recently? (eg to infrastructure) • ● How is the crime rate and quality of the school district? ● • ● What kinds of businesses, retailers, and entertainment centers are already in the neighborhood? Are there any gaps that your idea could fill? You can find the answers to these questions and more simply by searching Google, driving around the area, virtually “walking” with Google Maps Street View, checking public records, or asking a local realtor. Prepare an investment plan Once you have done your research and analysis with useful applications and software, create an investment plan for yourself. This way, when you start to approach your network, you will be able to answer their questions and show that you have a totally baked idea. Because you plan to apply for a loan from someone close to you, you don’t need to make a formal appearance when pitching your idea. You can present your investment plan in writing, but you can also present your plan to your friends and family verbally. However, showing that you’ve done the fieldwork to examine this idea could serve as a powerful indicator of your seriousness on the project and how much due diligence you’ve managed to accomplish. It never hurts to go the extra mile and make a formal presentation complete with written investment research and supporting evidence of the claims you plan to make to your friends and family. Rehearse your speech Even if you don’t want to sound too contrived when introducing your friends and family, it’s a good idea to repeat your business idea out loud. This exercise can help you build confidence and shake off your nerves before approaching potential lenders. That means practicing how you express certain pros and cons, often playing with the pros and minimizing worries about the cons. However, you don’t want to lie. If something can really sink an investment, you must honestly ask yourself if this investment is worth the risk. Don’t be too quick to invest with your loved one’s money only to go broke and cause tension with those who love and support you. No risk-laden real estate investment is worth anything close to that bet. Establish the Potential for Return on Investment In addition to determining the income generated from these assets and the potential resale value, you have other costs that you, your friends and family should be aware of. Show that you have thought through all the details and considered the things that could reduce your return on investment. For example, you might consider purchasing a home warranty in case something goes wrong with the property and you don’t want to risk paying for each repair yourself. You can determine how much the property will eventually cost to sell by using a seller’s net sheet to compare the estimated sales price to the costs to sell. These include costs like renovation fees, loan repayment, property taxes, real estate commission, etc. Also note that you will have to pay capital gains taxes once you sell the property, unless you are in a transaction of exchange 1031 and reinvest the proceeds. from the sale to a similar property of equal or greater value. Explore Funding Options Once you’ve signed someone up and are willing to provide funding, make sure you understand the terms attached to that funding. You have to take a few different routes: Gifts If a family member or friend “gives” you money, that means you don’t have to pay it back. You can also avoid paying taxes on gifted money. Currently, an individual can donate up to $ 15,000 tax-free per year, but can also use the $ 11.58 million worth of lifetime gift tax exemption. When you give a gift of more than $ 15,000 to one person in a single year, you lower both the lifetime gift tax exemption ($ 11.58 million) and the federal estate tax exemption you receive upon death. This might not matter to most Americans, as their properties will not come close to that range. Even in the event you land well below your lifetime gift tax exemption, you must still report any donations that exceed the $ 15,000 annual exclusion. The IRS will want to follow up to make sure you haven’t donated your estate over time and missed paying estate taxes. Finally, a signed letter or document stating that the money was donated could be helpful in the future if your project is successful and the lender suddenly wants a share of the proceeds. Loans Loans allow the lender to set payment terms, interest rates, etc. You can work with an attorney to draft a “promissory note” detailing the terms of the loan, or you can structure the loan through a peer-to-peer loan that will act as an intermediary. Equity Offering equity to someone means that you do not have to repay the loan until you make a profit. However, this will also make your friend or relative a partially owned business partner in your company, so be sure to consult with an attorney. Establish a repayment schedule Show the people you are borrowing from that you have thought about how you will pay them back. Will it be monthly? Annual? Once the property is sold? How much will you owe them for each payment? Will they charge you interest? Think about these things in advance. Pro Tip: Before applying for personal loans to your loved ones, it is a good idea to make sure that your other debts, such as credit cards and student loans, are paid or at least substantially paid. Keep your network up to date Let your friends and family know where you are on your investment journey. You can do this through social media, with an email newsletter, or during informal conversations. Keeping your network up-to-date on your plans can get them interested in your goals, and it can also attract new investors. Finding financing for your real estate project can be difficult. Asking friends and family for money can damage relationships or cause them to end entirely if you do not respect their terms of repayment. You can avoid this by being upfront about the risks, managing the project wisely, keeping people informed with regular updates, and providing 100% transparency. That means including good news and bad news. Your loved ones are also likely to be more forgiving of ups and downs in your business plans. Ultimately, putting the rules of the loan agreement in writing can set clear expectations up front and avoid any drama in the future. Riley Adams is a CPA and author of the Young and the Inverted website, which focuses on financial independence and investing.