Getting into the real estate development business is no child’s play. You need to take care of a lot of things. For instance, you need to figure out what sector you want to step in, how you want your investment portfolio to look like, who all do you want to work with and most importantly how you are going to raise the money.
Financing and raising investment is a huge task, especially when it comes to big projects like real estate financing, it is peculiarly difficult. It is neither feasible nor smart to put your own money into the project, therefore, pitching investors and outside funds become necessary.
Along with some equity investments, you can also opt for debt financing. The key is to find and maintain a perfect balance between the two. In this article, we will discuss some popular ways for real estate financing.
Crowd Funding
Crowd funding is a new way of raising money for development projects. Developers use digital platforms to reach out to people and collect money. In simple terms, crowd funding means collecting small amounts from a large number of people.
Crowd funding is a very popular investment option among new investors as it does not require a large sum of money. Therefore, it is a quick and easy method to get the requisite real estate financing for your new project.
What makes crowd funding interesting is the fact that it does not require any direct contact between the investor and the developer. You can simply gain funds from numerous small investors without any hassle by means of a website or social media channels.
However, there is no guarantee that you will be able to raise all the money that you require as most investors are only willing to spend a nominal sum of money in the project. Furthermore, it is kind of tricky to fit into the narrow parameters of various crowdfunding platforms.
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Real Estate Financing by Means of Equity
Equity financing is one of the most popular ways of raising funds since time immemorial. It involves giving up ownership of a part or share of your real estate project to another person.
Equity financing is similar to crowd funding in the sense that just like crowd funding, many people will contribute small amounts towards your real estate project. In exchange for their contribution, they will get a small share in the project.
The investor, therefore, becomes a stakeholder in your project. It means that the investor will be an active participant through all the stages of your real estate development project. They will have a say in the day-to-day business affairs of the project.
In addition to this, the investors or the shareholders will also receive a part of the income that you earn out of your real estate project. This income is proportional to their share of ownership in the project.
In case of sales, the investors will also receive a percentage of the profits earned out of the sale of the project. Therefore, you can say that equity financing is an expensive affair.
Real Estate Financing via Debt Crowdfunding
Borrowing is one of the best methods to fund your real estate project. In the case of debt crowdfunding, you do not borrow the money from a bank or any other financing agency. You basically borrow money from a lender, who will, later on, distribute your debt to a number of private investors. This is known as debt syndication.
The lender will thoroughly analyze and evaluate your real estate project before making an investment. The lender will also charge a nominal amount as a fee, which will then be distributed among the various investors who will have a stake in your borrowed amount.
The loan generally comes with a higher rate of interest, higher than what banks would normally charge. However, it saves you from the lengthy and bulky documentation process involved in banks. It is a good way to raise money when you do not possess any collateral to offer.
Borrowing from a Financial Institution
The traditional method of taking a loan from a bank or a finance company never grows old. It is one of the safest and most reliable options for funding your development project without the risk of losing ownership of your asset.
In order to be able to take a loan from a financial institution, you must be able to satisfy the three C’s of borrowing- Character, Collateral, and Capacity.
For establishing your character or credibility with the bank, you must possess a good track record with the bank in the past. This can mean having a good credit score. A good credit score comes with timely bill payments and being disciplined with your borrowings.
Collateral means having something to keep as security with the bank. In the case of real estate financing, the project in itself can serve as collateral.
Last but not the least, you must have a stable source of income that you can use for the repayment of your debt.
If you satisfy all these conditions, you can proceed to take a loan from the bank. If you have an exceptionally good credit report, you can take a loan at a very low-interest rate.
A loan from a bank or a financial institution will ensure financial discipline as it comes with a fixed and timely repayment procedure.
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Peer-to-Peer Lending
Technology is revolutionizing our world. With the advent of technologies such as Blockchain and ML Algorithms, many peer-to-peer lending platforms are rising to prominence.
These platforms are a good and secure way of raising capital for real estate financing. It allows developers to raise money directly from investors. The process involved is very similar to that of debt crowdfunding.
These platforms do not involve the bulky documentation work and the lengthy approval process involved in borrowing from banks. It comes with a lower loan-to-value ratio as compared to other real estate financing options.
It comes with the flexibility of borrowing as per the need. It means that you can borrow as much you need and whenever you need it. Every payment and repayment will be recorded in the form of a ledger on these platforms.
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Credit line agreements
Popular among those developers who already own one or more properties, Credit line agreements are a great real estate financing option. If you have complete ownership of the said property or if you have significant equity built up on your property, the bank will issue you a line of credit on the said property.
However, you must ensure that there is no pending credit on the property. The bank will do a careful evaluation of the property and a few other assessments before extending a line of credit. This line of credit will be secured by your initial property.
It is a great but risky financing method. This is because of the fact that in case your current real estate project fails to work according to the plan, then you will also risk losing the first property that you are using as a mortgage. Debt repayment in such a scenario will be an expensive task.
Takeaway
Raising funds for real estate financing is full of challenges. It involves a lengthy procedure, bulky documentation, and a lot of other hassles. Today there are numerous financing options available in the market.
Some of the common methods used for real estate financing are crowd funding, equity financing, hard money debt financing, borrowing from banks, line of credit, and peer-to-peer lending.
Each of these methods has many pros and cons attached to it. You must carefully evaluate your needs and what each method has to offer before making a decision. Choose the one that satisfies your needs the best.
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