For most people, real estate probably represents a pretty large chunk of one's net worth. Buying a house usually requires a lot of cash and the investment is fairly illiquid. In June 2020, according to the National Association of Realtors (NAR), the blended average home price was greater than $295,000 in the United States. Considering the median net worth of American households is just under $122,000, buying a primary property can seem out of reach and buying an investment property can seem almost impossible.
What is "Real Estate Financing?"
Real Estate Financing describes the way homeowners secure funds to acquire a target property. There are a ton of different financing options but typically, they fall under one of two buckets:
- Debt Financing occurs when a person or company borrows money to pay for the property. The financing is subject to certain underwriting criteria and will carry an interest on top of the principal payment. Since interest rates are at historic lows, debt can be an effective way to acquire an investment home to generate income.
- Equity Financing occurs when third-party investors purchase shares in the company holding the investment property. This type of financing is usually only available to Institutional Investors but can be a way to achieve diversification.
What are some examples of Debt Financing?
This list won't be exhaustive but will include some of the common forms of debt financing for Real Estate Investors:
- Mortgages are one of the most popular ways to finance the acquisition of a real estate investment property. A Real Estate Investor can apply for a mortgage with their local bank or an online lender and, after the lender verifies the Investor's debt, income, and assets, the lender will underwrite the loan and provide a fair interest rate to the Investor. Mortgages typically take up to 50 days to close on average.
- Hard Money is an option many house flippers like to use. With significantly fewer paperwork requirements compared to a mortgage, hard money is a good way to get money fast. Lenders look at an Investor's success history and will frequently charge greater than 10-15% interest rates in addition to lender fees given the heightened risk.
- Home Equity Line of Credit (HELOC) is a form of debt financing that allows homeowners to borrow against the equity they've built up in their homes. Lenders will collateralize the loan by claiming a stake on a portion of an Investor's equity. HELOCs can be useful but Owners should be careful in the event that they are borrowing a sufficiently large percent of their underlying home's value. In the 2008 Financial Crisis, many homeowners were underwater when they borrowed more than 100% of their home equity.
What are some examples of Equity Financing?
As with the debt financing section, this list will not be exhaustive but will include some common forms of equity financing.
- Real Estate Private Equity is a type of financing that describes a single fund or group of investors who pool their money together to own shares in a company focused on acquiring properties. Many private equity investors have capital allocation requirements which means that a single unit residential property is often out of the question.
- Crowdfunding is a type of financing where Property Owners sell shares to the general or accredited public to acquire a property or many properties. We discussed some of these options in our article on Active Real Estate Investing.
Nophin's revenue-based financing can be a better option
Though Debt and Equity financing options are popular, they come with drawbacks.
- When financing with debt, it can take an exorbitant amount of time to close and can come with high interest rates. This means Property Owners may end up losing the deal they have dreamt of closing.
- When financing with equity, Property Owners may need to give away a large chunk of the holding company and thus miss out on a significant amount of future appreciation. On average, properties appreciate ~3.5% each year so that leaves a lot of money on the table.
Nophin is trailblazing a better option: Receivables-based financing for Property Investors. Receivables financing is not counted as debt so it does not impact a Property Investor's outstanding loan balance. Receivables financing also requires no equity collateral so Property Owners are free to gain the appreciation benefits.
We are excited to offer this new type of financing. We know that life happens and sometimes having an extra cash cushion can make the difference.