Getting Started In Real Estate Investing – Phase 2 Financing Set Up
In our continuing series, Getting Started In Real Estate Investing the Equity Builders Way, we have thus far covered having a real estate Focus, and now we are moving on to financing, or how to pay for the investment. There are many schools of thought on how to pay for a real estate investment and you must decide what is best for you. It is imperative before looking at property that you establish how you will come up with the needed funds.
- Cash: This is the most common and most lucrative way to get the best deals. Cash is king and the reason people are able to get the stellar deals they are getting is because financing options are difficult right now. So money talks louder than any person buying a property subject to financing.
- Seller financing: second most common and lucrative venture. Sellers know you are leveraging the sellers financing to your benefit and as a result you get the leverage and in turn they typically will want more of a premium for the price. As the ole saying goes “it is either price or terms”. When terms are important to you then you may pay a little more for the price, but if you have the leverage of financing, it is often a great way to go. It really boils down to the returns so run the numbers (we will discuss in future post) and see what makes the most sense.
- The fastest growing method of buying property is in a self-directed IRA: This is where you can actually use the money you have in certain retirement accounts to purchase the property. Most people did not know you can do this but it is done every day by seasoned investors. Simply put, you direct your IRA to make a purchase of a particular piece of real estate. The investment is held in your IRA, the cash flow and capital gains when sold go back into your IRA. (What a great tool to build for retirement).
- A bank Loan: This has been a very common one. Today with the global economy you will need a 20% down payment and good credit and as long as you have that you can get some great terms on a loan and a great price on the property (foreign investors, sorry this one is more of a challenge for you at this point in time) but it too will come back.
Historically there have been a number of other creative financing methods as well. As they require massive diligence and are not really prevalent in today’s economy, we will save them for later posts as they become more widely accepted again.
On the aspect of paying for a property, we also consider leverage. Leverage, of course, is the ability to borrow money. This borrowed money actually gets invested and gains returns such as cash flow and capital growth (appreciation). Pretty cool concept when you can gain benefits from money that was simply borrowed.
Using leverage to buy real estate investment property is a beautiful thing. It has made many people millionaires. Unfortunately it has also brought a lot of people to their knees. Leverage is a massively powerful tool. As with any powerful tool, it needs to be respected and properly used. When used properly it can and will make you wealthy. When used quickly and haphazardly it can cause accidents.
When the real estate market is at its suspected bottom and has really nowhere to go other than up, leverage, even in a higher capacity, can be very powerful. When leverage is used in high capacity in a real estate market that is not at the bottom, it may become more dangerous. Let me explain.
Many people in 2003 to 2006 here in the U.S. were using leverage at the rate of 95 to 100% of the value of the properties they were buying. Because these people were not diligent in their research into best locations (Post: coming up in phase 4) they borrowed most of the money to acquire their investment property. When the bubble burst, property values dropped and they were stuck owing massive mortgages on properties that no longer had the value. In other words, they are now upside down on their mortgages. They got out of real estate investing all together as they now have a negative taste towards real estate. “Luckily, you are reading this now and becoming purposeful so this will not happen to you”.
Moral of the story, use leverage wisely. The better positioned the market is to grow, the safer the use of leverage is. The more balanced a market becomes, the less leverage you want to use.