A common question I hear from aspiring real estate investors is:
How should I raise money for my deals?
This may be one of the most important questions you will face. It was for me when I started. How you raise financing, in addition to which deals you put it into, will directly affect your risk exposure and overall profitability.
You can raise money two ways: use your own money or use other people’s money.
6 Options to Finance With Your Money and Credit
This is how many investors begin their careers, financing using savings or loans. This is generally riskier, and I encourage those I coach to use personal funding sources only as a last resort.
- Standard loans
- Self-directed IRAs
- Home Equity Line of Credit (HELOC)
- Adjustable-Rate Mortgage (ARM)
- Hard money loans
8 Options to Finance With Other People’s Money and Credit
Using other people’s money opens a wide variety of opportunities to fund and finance deals. As we’ll see later, this can manage your risk while generating a lot more profit.
- Seller financing
- Private funds
- Subject to existing financing
- Leverage other property assets
- Double closing
- Sandwich lease
- Crowdfunding or peer-to-peer lending
Deciding How To Fund Your Deals
If you aren’t sure about using other people’s money to fund your deals, let me share an example of what a flipper could do.
An investor finds a house to fix and flip. She has $125k in the bank. The home sells for $75k and will cost $25k to repair, hold, and close. The after repair value (ARV) is $125k. The profit margin will be $25k. How does the deal look if she uses her own money or someone else’s money?
Example 1: She uses her own money.
The investor invests $100k of her own money into the home. The sale goes through, the home gets repaired, and she is able to realize a profit of $25k four months later. The return on investment (ROI) for this deal is 25%. $25k profit / $100k investment.
One important question. What would have happened had something gone wrong with the deal? Maybe more repairs were needed, the market slumped, or she had an unexpected medical bill. This could have jeopardized the entire deal, especially if the investor couldn’t raise extra funds in time. Was the risk of $100k worth the 25% return? One goal of real estate investing is to minimize your risk while maximizing returns.
Example 2: She uses other people’s money.
This time, the investor invests $10k of her own money, while using private money to raise the remaining $90k. She offers her lenders a 12% rate, which adds $3,600 to the total costs. The investor has now risked $13,600 instead of $100k. Again, the home is repaired and sells at $125k, earning the investor $25k four months later.
Here is the difference. The investor netted a less total profit, the $25k from the sale minus the $3,600 extra, making a total of $21,400. However, the ROI changed from 25% to 157%! This happened because instead of risking $100k to make $25k, the investor risked the original $13,600 to make $21,400. ROI increases and total risk exposure drops dramatically, from $100k to $13,600.
The bottom line is that using other people’s money can increase ROI while lowering your overall risk. You can also put your uninvested money into other deals.
3 Tips to Position Yourself to Raise Capital
In order to use other people’s money, you’ll need to position yourself properly. Here are three tips I recommend novice real estate investors work on to raise money.
#1. Build credibility. This is one of the hardest parts for novice investors. I recommend new investors connect with a local pro. Find a mentor, or if you have an upcoming deal, form a partnership. Completing a profitable deal with a local pro will pump up your credibility. You get to leverage their experience and connections while learning how to do a deal right. Contact me and I will help you raise money for your next deal.
#2. Make a pitch. Part of real estate investing is learning to sell yourself. A good pitch (and good marketing) will build confidence in you and your abilities. In the beginning, you’ll be talking to many potential lenders. A clear pitch that describes your goals, skills and the benefits of working with you is really important. Find a coach to help you nail your pitch.
#3. Network. Raising money requires the right connections. Get out there and meet other real estate investors. Here in Austin, we have the Austin Real Estate Networking and Investing Club, among other meetings. Make friends with other investors, bankers, and anyone else in the real estate world you can. The more people you know the better.
Other People’s Money — An Important Tool in Your Toolkit
The most successful real estate investors use capital from many different sources. Learning how to find, secure, and effectively use other people’s capital is crucial for success. More money will give you more options and can lower your risk while increasing ROI. Good luck!