Tailoring Your Financing to the Real Estate Investment Lifecycle
Building a profitable real estate portfolio isn’t exactly a linear process. Where you are in your journey and your goals for each project determine if you need to follow each step precisely. You may not have to be so exact with every property.
The key is understanding the various stages of the real estate investment lifecycle and the financing options available at each stage. When you know how it works, making informed decisions and aligning the required capital to start and finish each project, from acquisition to exit is easier.
What is the real estate investment lifecycle?
Real estate investment has a multi-step process. It begins with the purchase of a new property. The final step is earning recurring income through rentals. It consists of:
- Selling/renting assets
The type of real estate loans you’ll need — and which loans you’ll be eligible for — depends on factors. These include the stage of development, the value of the property, and future income potential in the case of rentals. Let's dive into what you need to know about each stage.
This is the first step in the investment lifecycle. You’ll find the property you want to purchase at below-market value or at a discount. Financing is critical in the acquisition phase for real estate investors. Especially if you require a loan to buy a property or simply prefer not to use your assets.
Several financing options are available for properties that generate rental income. These include real estate loans, hard money loans, and DSCR loans.
Do you want to flip a house or buy property to build your portfolio? Investment properties usually need some work to increase their value and yield a profitable return. At this stage, the financing options include construction, fix and flip or bridge loans, or mezzanine financing.
The operation stage involves leasing rental units, ongoing maintenance, tenant servicing and management. This stage includes anything required to keep the property running profitably and efficiently.
Some of the financing options for the operational stage of the real estate investment lifecycle include long-term real estate loans and other forms of working capital financing like lines of credit.
The final stage of the real estate investment lifecycle is selling the property for a profit. Typical financing options for the exit phase are short-term financing, like a bridge loan, to cover closing and other costs associated with the sale.
Financing options for every step of the real estate investment lifecycle
As seasoned real estate investors already know, traditional financing isn’t always what you need for investment properties, especially when speed is often the most critical factor in initiating and completing a deal.
From the acquisition stage to refurbishing and getting the property on the rental or sale market, the time it takes to secure a loan from a traditional bank can stop the investment cycle dead in its tracks.
Let's look at some financing options for each step of the real estate investment cycle.
Private lenders offer loans to real estate investors. They have less stringent application and approval guidelines than banks and can offer quicker access to funds.
Hard money loans
Hard money loans are short-term loans for real estate acquisition. They’re called “hard money” because they’re secured by the property instead of the borrower’s personal assets and credit profile.
Hard money loans are approved quickly, making them ideal for investors who need to move quickly to secure a property.
Fix and flip and Bridge Loans
If you're a real estate investor looking for short-term financing to buy, renovate, and sell a property, a fix and flip or bridge loan could be a good option for you.
Fix and flip loans are designed for investors who plan to purchase a property that needs work, make the necessary renovations, and then sell it quickly for a profit. These loans typically have higher interest rates and shorter terms than traditional mortgages because they are considered higher-risk loans.
Bridge loans are designed to bridge the gap between purchasing a new property and selling an existing property. These loans are often used by investors who want to buy a new property before their existing property has sold, and they need funds to make a down payment on the new property.
DSCR rental loans
If you're looking for financing to purchase a rental property, a DSCR rental loan could be a good option for you. DSCR stands for debt service coverage ratio, which is a measure of a property's ability to generate enough income to cover its debt payments.
A DSCR rental loan is designed for investors who plan to buy a property and rent it out to generate income and are typically obtained through a private money lender. Unlike fix and flip or bridge loans, which are typically short-term loans, DSCR rental loans are longer-term loans used to finance the purchase of rental properties.
When applying for a DSCR rental loan, the lender will evaluate the property's income potential to determine whether it can generate enough cash flow to cover the loan payments. The lender will also evaluate your creditworthiness and financial stability to ensure that you have the ability to make the loan payments.
One of the key factors in securing a DSCR rental loan is having a strong debt service coverage ratio. This means that the property's net operating income (NOI) should be at least 1.25 times greater than the loan payments. A higher DSCR ratio indicates that the property generates more than enough income to cover its debt obligations, making it a more attractive investment for lenders.
Construction loans provide funds for the development and refurbishing stage of the real estate investment lifecycle. They can be used to build a new property or to renovate existing homes and buildings.
Construction loan payments are typically disbursed in stages as the development progresses and are usually short-term loans.
The most common financing option for holding a property is to generate rental income from tenants. This income can be used to pay off any outstanding property debt or fund new investments.
As a real estate investor, you can take advantage of a property's equity by securing a new loan with potentially better terms. Refinancing allows you to lower monthly loan payments, lock in a lower interest rate, or generate cash for other investments, depending on the new loan's terms.
One way to access the equity in your rental property is through cash-out refinancing. This process allows you to exchange your existing equity for a cash loan in exchange for a new loan that includes the remaining balance on the property and the established equity value at the time of refinancing.
The bottom line
Overall, financing plays a critical role throughout the real estate investment lifecycle. Investors must carefully evaluate their financial options at each stage of the lifecycle to ensure that they have the funds they need to acquire, develop, operate, and sell the property.
By understanding the real estate investment lifecycle and its relationship to financing, investors can make more informed decisions about their real estate investments and maximize returns.