In the residential fix-and-flip market there has traditionally been four sources of leverage. A fifth option, crowdfunding real estate loans, has recently been added to the arsenal. Using leverage as a strategy to grow your real estate businesses provides a multitude of advantages:
- You can do more deals with more capital.
- You limit your downside risk to the amount of capital you put into each deal.
- You create win-win opportunities for investors which can open doors to other business ventures.
- You create an opportunity to scale your business allowing you to grow into other asset classes if you so choose. (i.e. Single family, multifamily, commercial, retail)
- You can turn your successes into positive referrals from your investors to help you further your business.
Let’s compare the different options.
Hard Money Lenders
These are typically localized “mom and pop” lenders who have a specialized skillset of underwriting deals in your territory. Rates vary per market but this is typically the most “expensive” capital. You can meet these lenders at local real estate investor meetings or by doing a search online. They are in the business of funding deals so don’t be shy!
Private Money Lenders
These are high-net worth family members, friends or close business associates who will lend you in exchange for a fixed return on their money. This capital is generally less expensive than a Hard Money Loan due to your personal relationship and credibility you have with the investor. If you’re going to go this route, you’ll want to make sure you are protecting your relationship by disclosing all of the risks of the project and by partnering with a competent attorney to help you draft loan documents.
Equity Partnerships
These are also family, friends or close business associates who prefer to be “owners” in your deals in order to take advantage of the upside potential. They may also be tradesmen such as your General Contractor who will help you finance the repair work. Depending on the profit split, the cost of this capital can end up being more expensive than Hard Money. Similar to private money, over-disclose the risks and find a good attorney to draft agreements.
Portfolio Lenders/Local Banks
These are small banking institutions who have a good understanding of the local real estate market. They make loans with their own capital which means they can develop their own underwriting standards. If you can find one of these to work with, they can provide the lowest cost of capital. However, they tend to have tight lending requirements and seek to partner with a very limited group of highly qualified redevelopers. Make calls into the small banks and credit unions in town to see if they make these types of loans. Put together a complete business plan and be prepared to go through a lengthy diligence process. It can be a lot of work but will be worth it if they extend credit to you.
Crowdfinancing
This is the new kid on the block. Here, you post your rehab loan deal online and a “crowd” of otherwise unassociated individuals invests in your deals in exchange for a return on their investment. The cost of this capital is generally in line with Hard Money or Equity Partnerships depending on how the deal is structured.
Most experienced redevelopers are familiar with the first four options but have little to no experience with crowdfinancing. Here are 5 things to know about crowdfinancing when considering whether it may be a good source of funding for your deals.
Experience
Do you have any? Most crowdfunding platforms, due to the nature of it being a new market, require that the deals they accept are from qualified teams. A track record of experience helps mitigate risk, but also provides the needed narrative for investors on the platform to become comfortable investing in a deal with someone they don’t know personally. If you don’t yet have experience, it can still benefit you to develop a relationship with a platform so that as the experience comes, you’ll be ahead of the game on getting approved with the platform.
Debt vs. Equity
How will the deal be structured? There are pros and cons for both. Generally speaking, the pros and cons are similar to going Hard Money versus Equity Partnership. The difference is that in a traditional equity partnership, your partner may bring more value than just capital. For example, a local equity partner may bring local connections to contractors, lawyers, or even buyers. Crowdfunding companies may not be able to bring these additional intangibles. That said, they are likely bringing other benefits such as managing and attracting a large group of investors. Understanding what value beyond the capital they bring is important – especially if the cost of this capital is greater than a debt structure.
Time to Fund
Time is of the essence when putting together financing for a fix-and-flip deal. It is important that you understand how the crowdfinancing company will underwrite your deal and get it funded. Do they pre-fund the deals using their own capital or will the deal have to fully fund on the platform first? If the latter, how quickly a deal will fund will be a function of how strong the platform’s investor network is. Get to the bottom of this one before relying on crowdfinancing for a deal.
Management Team
This is important as it requires a strong team to underwrite, make a decision and service your loan after it is funded. Look for experienced professionals on their management and advisory board to ensure you will get the service you expect through the lifecycle of your project.
Long-term Strategy
Investing time to develop a relationship with a crowdfinancing platform is similar to developing a relationship with any other funding source. The first few deals require more work for both of you. However, once a relationship is formed, the initial investment pays off as future deals are able to go smoother. You should ensure that the crowdfinancing platform has a strategy to continue to fund your type of projects now and into the future. Otherwise, the initial time you invest may not pay back when the platform has less desire to work on your type of deals.
Using leverage is imperative for anyone who wants to grow their business. Crowdfinancing is a new and exciting method of financing your deals and has the potential to help you scale your fundraising efforts.
To learn more about how Upright can help you use crowdfunding, send us a note at info@upright.us.
