12 Creative Ways to Fund a Real Estate Investment

Each investor has their unique criteria when they look for a real estate investment. But in certain real estate markets, competition can be stiff. Plus, due to Covid-19, demand for single family residential real estate properties is on the rise, especially compared to commercial or industrial properties.

So, when you find a deal that checks off everything on your list, will you be ready? Will you have the funding already teed up so you can quickly take the property off the market?

Whether you’re an experienced investor or if you’re just getting started, there are many ways to fund your next real estate deal, including co-investing, borrowing money, lending money, and other creative strategies. Most of these strategies will work with qualified plans as well as personal and business entities. Many can be accomplished with very small amounts.

Co-Investing

1. Personal Money / Other Retirement Accounts

One strategy is to co-invest from different types of accounts. For example, although the IRA owner is typically considered a disqualified person to the IRA, it’s possible to invest with both IRA and personal money. This allows you to partner your IRA funds with your personal savings, so your IRA income will be tax free or deferred, and your personal benefit, although taxed, will also have the pro rata share of tax advantages such as depreciation from the investment returns. Make sure you know the rules. For example, both entities should have the capability to perform the deal without the other.

You can also combine money from multiple retirement accounts for one investment. For example, if you co-invest from both a Traditional IRA and a Roth IRA, you can split the profits between tax-free and tax-deferred accounts. Or you can co-invest your IRA with your Health Savings Account (HSA) or small business account (SEP IRA, SIMPLE IRA, Solo 401(k), etc.).

2. Family Accounts

Another strategy is to co-invest with your family’s accounts, whether that be your spouse’s IRA money, your children or grandchildren’s education savings accounts (ESAs), or even your parents or grandparents’ retirement accounts.

Many investors combine money from multiple small accounts (children’s ESAs, HSAs, and Roths) to cover a down payment, while using owner-financing for the loan. If it is qualified plan money, the loan must be non-recourse, but if it is not qualified plan money the loan can be guaranteed.

3. Other People’s Accounts

You can also look beyond your family and co-invest with other investors. For example, you can combine your money with another person’s IRA, HSA, small business retirement account, personal money, or even with financing from their business to invest.

In one instance, my IRA partnered with an unrelated business, where the IRA had a one third interest in the project. The business owner guaranteed the loan and there was no recourse on the IRA. The purchase was smooth and profitable. In another instance, an IRA was used as a second mortgage to a business owner, who was short on rehab cash.

Borrowing Money

One of the ways investors can finance a deal without having the full amount personally or in their IRA is through debt financing (i.e. securing a loan), whether that be from a financial institution (such as a bank), an individual, the owner/seller, someone’s IRA, a business, or even a hard money lender.

4. Institutional

As of now (August 2020), institutional mortgage interest rates are exceptionally low (averaging under 3%), and there’s no crystal ball telling exactly how low they will fall before rising again. For many, this is a favorable environment for institutional financing. But of course, there are limitations for investors. For example, it is possible for your IRA to receive a loan, but it must be a non-recourse loan, because your IRA (or you personally) cannot serve as collateral for the loan or be the personal guarantor. The only recourse is the investment/asset that is being financed with the loan.

Institutional lenders have become more strict, especially on loans for investment properties. It is more difficult to get equity lines of credit on investment properties, and the loan to value is being reduced. Businesses and individuals, especially those hard hit by the pandemic find it almost impossible to get a bank loan. SBA is trying to alleviate the hardship as best they can. These institutional/bank loans seem to go through cycles. The 80s had the savings and loan fiasco, the 2008/9 recession dried up almost all real estate loans, and the covid 19 pandemic is straining the system again. Alternatively, in the 1970s and early 2000s, it was much simpler. If you could prove you were alive and had a job you were eligible for a loan.

5. Private Lending - Individual / Business / IRA

Loans do not have to originate from a financial institution. Any loan made to a self-directed IRA must be non-recourse, but the lender can also be an individual, their business, or trust. Private lending is more prevalent when banks constrict lending, but it is often necessary for people to keep their businesses open or to expand.

You can work out terms for a loan with a private investor / business for an agreed upon interest rate or rate of return and length of time. These loans are usually done much quicker than bank loans, but they usually have higher interest rates. Most are short term until the borrower can refinance at a lower rate and longer term.

Many individuals turn their self directed IRAs into a mini bank and do private lending.

6. Hard Money

Similar to loans from financial institutions, private individuals, or someone’s IRA, it may be possible to work out terms with hard money lenders that provide loans based on value and may be non-recourse. Hard money lenders generally offer short term loans with high interest rates and points.

For example, in 1981 and 2010, hard money rates could be 5 points and a 18% interest rate. Those loans have significantly been reduced over the last decade to approximately 2 points and 8%. It is dependent on economic times and conditions.

Lending Money

A more passive way to get into real estate may be to lend money to other real estate investors, whether that be an individual, a business, or a self-directed account such as an IRA or HSA.

7. Lend to Another Investor

Your account (IRA, HSA, ESA, 401K, checking or savings, etc.) can act as the bank for another investor, whether that be a real estate flipper who’s looking to rehab a property or a buy-and-hold investor who may need a loan short-term until they can refinance with a bank.

It is also a very good way to learn the business if you loan to an established successful real estate entrepreneur, developer, rehabber, etc. You can see the process from start to finish. If you lend to home occupants, there are rules and regulations you must follow. Since 2012, I have limited my lending to business entities instead of homeowners because of the complex rules.

8. Lend to a Business

Similarly, you can “be the bank” for a business. For example, the business may want to purchase another building, develop land, or even attain new equipment (i.e. bulldozer, trucks, office furniture, forklift, etc.) to expand.

9. Lend to Someone’s Self-Directed Account

Or you can even lend to someone else’s retirement plan or other self-directed account. For example, someone’s retirement plan may want to buy another property, buy appliances, or make improvements to a plan-owned building, etc.

In any of these instances, your account would be negotiating the terms of the loan, and the documents securing the loan can be promissory notes, mortgages, deeds of trust, UCC forms, etc.

Real estate loans are my favorite because of the security. It is hard to steal, I know where it is and it doesn’t move, there are public records, etc. Lending to IRAs with property is another favorite because there are only a few banks that make it easy for an IRA/401K to borrow. That said, you should understand the laws and risks associated with lending before you venture into this area.

Other Creative Strategies

10. Wholesale a Contract

A more creative strategy may be to wholesale a contract for half the ownership in the property for 95% of the cost.

Essentially, I sign a contract for $100k, put down $1k, and then I sell 50% of the deal for $95K, closing on the property in both names as 50% owners. Both owners split the cost of the rehab. For example, a $50k rehab would be $25k each. I have $5k in the purchase and $25k in the rehab, totaling $30k. My partner has $95k and $25K for a total of $120k. Rent nets $2,500/month, which is $1,200 each or 12% return ($1200 x 12 months / $120,000 cash in), and I get $1,200/month or 48% return ($1200 x 12 months / $30,000 cash in). Or, we could sell it and split the profit 50/50. This is a win-win scenario either way.

11. Join an Entity

If you’re looking to avoid the management headaches that come along with owning real estate, another strategy may be to purchase an interest in an entity (LLC, Limited partnership, corporation, etc.) that buys real estate, such as apartment buildings, shopping centers, veteran housing, student rentals, office and retail space, etc.

This allows your plan to own real estate but depending on the entity it may limit your risk and exposure to losses. Plus, it may provide more liquidity.

12. Invest in a Fund that Buys Real Estate

Similarly, you can purchase an interest in a Real Estate Investment Trust (REIT), private or public, that buys apartment buildings or commercial real estate. This too may limit your risk, provide more liquidity, and you won’t have to deal with day-to-day demands.

All these different types of investments can be extraordinarily successful or a catastrophic failure. Knowledge is by far the most important factor. Knowing those who you work with and their ethics is also important. I have seen successes and failures in every different venue, and knowledge or lack thereof is the common denominator. It’s not so much the investment but your understanding of it. Learn something new each day, and at the end of the year there are more opportunities for success.

Personally, I have focused on buy-and-hold real estate deals, but I venture into lending and partnerships as times and circumstances change. I was a control freak when I was younger, but I have learned to work with others to conserve time and limit lifestyle changes.

Ultimately, the ideal type of funding depends on your goals as an investor, when and where you are starting from, and your interests (how active vs passive you want to be, time commitment, risk tolerance, level of return, etc.) While looking for your next real estate investment, do any of these strategies stand out to you?