Real estate investing funding comes in many different forms, depending on the type of deal. Here are a few of the major types of funds available to investor for their real estate deals.
Real Estate Transactional Funding, also known as Transaction Funding, Transaction Funds, Transactional Funds, Short Term Funds or Flash Cash, is a relatively new industry that allows double closings (also known as back to back closings or simultaneous closings) to be completed without the investor in the middle having to bring any money to the table. Transactional funds are used in short sales, REO, foreclosure and wholesale flips.
The brilliance behind transactional funding is that the collateral for the money is the transaction itself, not the investor’s credit, income or ability to borrow money. Therefore, the funds are not a loan at all. In fact, the financial picture of the investor has no bearing on the issuing of the funds whatsoever. For most transactional funders, the basis of funding the transaction involves whether or not the new buyer of the property already has their purchase money in the escrow account of the closing company. This reduces the risk for the transactional funder to almost zero. However, due to recent title seasoning requirements by some mortgage companies, some transactional funders have begun allowing investors to pay them back within 30, 60 or even 90 days. This does shift tremendous risk onto the transaction funder, so to compensate, these brave new short term funders require that the new buyer have at least a 3% non-refundable deposit and the total profit for the investor reach a minimum of 10% of the end buyer sales price. Clearly, as the real estate industry continues to change, so too does transactional funding.
The reason why transactional funding is necessary when trying to complete a back to back closing is because most closing attorneys and title companies now require that each closing stand on its own two feet. In other words, let’s take the example of a short sale investor who has managed to negotiate a terrific deal with a lender and the agreed upon short payoff is $100,000. Next, let’s assume this short sale investor has also managed to locate a new buyer willing to pay $120,000 for the same property. Under this arrangement, the investor’s goal is to make the money in the middle which would be $20,000. In order for the investor to get paid however, he must first buy the property for $100,000 and then afterwards, re-sell it to the new buyer for $120,000. Years ago, many title companies and closing attorneys would use the new buyer’s purchase money ($120,000) of the 2nd transaction to payoff the agreed upon short sale of $100,000 of the 1st transaction. Some in the real estate community refer to the 1st transaction as the A to B closing and the 2nd transaction as the B to C closing. These days, closing companies are now being asked to have each transaction stand on its own two feet, as opposed to using the B to C funds to pay off the A to B transaction.
Most investors do not have a spare $100,000 laying around in a bank account to cover the A to B closing. And it is here that an entire industry has been born. So back to our example, in order for this short sale investor to make the $20,000 in the middle, he will need to use $100,000 in transactional funding. With the 1st transaction on its own two feet, now the investor can re-sell the property to the new buyer either the same day, or in states like California, the very next day.
When it’s all said and done, this short sale investor will make slightly less than $20,000 (because all transactional funders charge a fee to use their money for that short period of time.) The fees can range from 2% on the low end to as much as 5% or more for riskier deals. In addition, many also charge a flat processing fee in the $600 range. Fees vary based on states (California is usally more expensive because the funds are tied up a few days longer), funding amounts (many charge a $2000 minimum on any deals below $100,000 and increase above $1,000,000), track record (if you are working with the transactional funder for the first time, they may charge slightly more than on future deals) and the length of time the funds are in process (with the advent of the 30,60 and 90 day fundings, the percentage increases as the length of time the funds are tied up increases).
The other extremely valuable service some transactional funding companies offer is providing proof of funds letters for real estate investors. Whether the investor is doing a short sale deal, buying a foreclosure or REO or simply making an offer to a property owner, sellers sometimes require a pre approval letter or a proof of funds letter to go along with the offer. Since some investors are unable to qualify for a loan, obtaining a pre approval letter is not an option, and since many investors do not have hundreds of thousands of dollars sitting in there bank account, in the past, the proof of funds letter was not an option either. However, with transactional funders, they can make the proof of funds letter a reality for any investor. For this privilege, some may charge a one time set up fee as well as require the investor to use their transactional funding services. These requirements are insignificant when you consider the power of all investors having the ability to provide a proof of funds letters on any offers they make.
In conclusion, transactional funding shows the awesome power of capitalism. For decades, one of the largest barriers to entry in real estate investing was being able to show a proof of funds letter to buyers as well as have the funds to close on a transaction. Transactional funders have broken down these gargantuan walls and have opened up real estate investing to anyone with ingenuity and the initiative to succeed.
Hard money funding was created to assist real estate investors, that could not qualify for conventional financing, in the buying of property. You would utilize this form of funding if you didn’t have a buyer already in place to purchase the property, as in the case of Transactional Funding. Hard money loans typically require very little documentation in order to qualify for the money and usually base their decision on whether or not to fund the deal on the value of the property as opposed to the credit or loan application of the borrower. On your very first deal with a hard money lender, they may pull your credit or required you fill out a simple one page loan application, but that oftentimes is a formality and they will fund the deal regardless of what was written or discovered on your report. What protects a hard money lender’s investment more than anything else is that you are purchasing a property at a huge discount to the value.
Most hard money lenders provide the funds to complete the purchase including any closing costs without the use of a down payment and will also provide additional funds for property improvement on a draw basis. These terms can be very helpful if you do not want to put any of your own money into a deal. This is not always the case however, as some hard money lenders actually require a small investment in the deal from the investor so that the lender knows you have some of your own “skin in the game”.
Another aspect of hard money that is beneficial is that they usually do not report the loan to the credit bureaus. It provides an extra level of credit protection in the event one’s immediate short term cash flow needs exceed current means. If a hard money loan’s monthly payments are not being reported to the credit bureaus and a payment falls behind by 30 days, your credit wouldn’t immediately reflect a negative item. Keep in mind however, as loan payments fall further delinquent, many hard money lenders can easily begin reporting negatively to the bureaus. This feature is usually only helpful when experiencing a short term cash flow problem.
Another important feature many hard money lenders allow is the signing of a mortgage Note in an entity’s name, as opposed to one’s personal name. When a mortgage Note is not signed personally, the extent to which the hard money lender can seek recourse is usually on the entity only, not the individual person. This creates an added level of protection as a borrower. Once you have borrowed and subsequently paid back in full a few hard money loans, your working relationship with your hard money lender may be strong enough to allow you to sign the Note in your entity name, as opposed to signing personally.
Further, hard money lenders they tend to loan their funds very quickly. Once you have a working relationship with a hard money lender, you may be able to have the deal closed within in a matter of days.
The main drawback to Hard Money funding is that most Hard Money Lenders will not lend any more than about 70% of the realistic value of the property. Further, hard money lenders tend to value the property extremely conservatively so their 70% is more like 60%-65% of the real world as is value. Therefore, to qualify for Hard Money, you need a really good deal.
Transactional Funding and Hard Money are the two main ways real estate investors get their deals funded.