Real estate investment requires capital to get started. So, what do you do when you’ve found the perfect opportunity but don't have the capital?
Table of Contents - Finance Corner: Equity Partnership or Hard Money Loan?
- What is an equity partnership?
- Benefits of an equity partnership
- Risks with an equity partnership
- What is a hard money lender?
- Benefits of using hard money
- Drawbacks of hard money
- Most hard money loans have short payment windows, requiring payback within one to five years.
- Understand the place of equity and hard money loans
- Equity Partnerships vs Hard Money - Real Estate in 60 Seconds
There's always the traditional lending option, which takes time and comes with a lot of strings attached. Instead of working with a bank, you can turn to alternative sources for the capital you need. Two avenues you might want to explore for funding your next investment are equity partnerships and hard money loans.
What is an equity partnership?
Equity partners invest in your property in exchange for partial ownership. This ownership percentage allows them to take part in property activities. They receive a return on their investment, including cash flow, loan pay-down, appreciation and depreciation. There are a couple of types of equity partnership models depending on each partner’s level of investment and involvement:
50-50: This is the simplest partnership. Each partner invests an equal amount of money and effort into the venture. They receive equal benefits from returns.
Real equity and sweat equity: In this scenario, one partner has the capital to invest while the other has the managerial skills. The general partner or investment manager handles daily operations. The limited partner contributes the funds in exchange for a return on investment. The rate of return between the general partner and the limited partner is negotiated between them.
Benefits of an equity partnership
One of the main reasons to form an equity partnership is to pool capital for your investment. If you do not have enough money, your equity partner will also invest to help meet your goal. Having a partner means you can seize excellent investment opportunities you may not have otherwise been able to afford.
Even if you do have the money for an investment, an equity partnership is appealing because it mitigates risk. If the investment is unsuccessful, your partner's money is helping to defray your loss. Additionally, a partnership mitigates your legal liability.
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You may want a partner who knows a complex topic or a skillset you lack. He or she might be better suited for navigating zoning permits, real estate deals or property management. Partnering with an experienced investor or professional can save you the money you’d be paying others.
An equity partner offers shared responsibility for all aspects of the investment. With a partner, you know you don't have to navigate the process alone. You can consult with and confide in your partner as you grow your business.
Risks with an equity partnership
Some equity partnerships are born from convenience. If two friends or family members agree to go in on an investment together, they may assume a handshake deal is enough for protecting themselves.
All partnerships, regardless of who they're between, must be formalized. There should be a legally binding partnership agreement outlining each partner's role and responsibilities. If one partner is no longer contributing capital or is not taking on a fair share of the sweat equity, the other partner may need legal recourse.
Before beginning an equity partnership, reflect on your reasoning. Why are you considering a partnership? Who is your partner? Do the benefits outweigh the risks? Just as you analyze your properties, make sure you analyze your partnership.
What is a hard money lender?
Hard money lenders lend money based on collateral. Unlike traditional lenders, they don't use measures like a credit score to determine whether they can trust you to repay a loan. Instead, their security comes from knowing they can seize your collateral if you don't pay.
Hard money loans can help in the short-term, like for a flipping project. You’ll only own the property long enough to resell it, so the loan is repaid within a year or so. If you use hard money for long-term property investment, you'd want to refinance sooner than later for a better deal.
Benefits of using hard money
Approval for a hard money loan is easier, especially for investors with bad credit histories. Hard money lenders just want to know that you have collateral for the amount you're borrowing. If the lender has to take your collateral, the lender needs to be able to sell it fast and regain the full amount of the loan.
Hard money loans arrive much faster than traditional loans. Hard money lenders are only concerned with your collateral and not your lending history, so there is less paperwork involved. Lenders aren't planning to take your collateral and would prefer you to repay your loan, but they don't need to evaluate you as thoroughly as a bank does. Once you have a relationship with a hard money lender, loans can arrive even more quickly.
Hard money lenders can usually set their terms, allowing them to evaluate loans on a case-by-case basis. This gives you more room to negotiate. If you want to alter your repayment schedule or change a detail of your investment, you can simply talk to your lender. A traditional lender has corporate policies that limit your flexibility.
Drawbacks of hard money
Hard money loans are expensive. Their high-interest rates usually reach beyond 10 percent. You'll likely pay five points or more in origination fees. Even if you have poor credit, it's worth exploring a traditional loan to see if you can get a better deal.
Hard money lenders may also be more conservative than traditional lenders. Loan to value ratios is usually between 50 and 70 percent. Their valuation of your property may be lower than what your bank would claim.
Most hard money loans have short payment windows, requiring payback within one to five years.
There's also the heart of the hard money loan you have to worry about: If you are unable to repay your loan, you lose your collateral. Depending on what you used as collateral, this could be devastating.
Understand the place of equity and hard money loans
If you're looking to invest but don't have the capital, equity partnerships and hard money loans are two options that will help you close quickly. These avenues shouldn't be used as your primary means of funding your investments, but as another tool in your toolkit to help you grow your venture.
Equity Partnerships vs Hard Money - Real Estate in 60 Seconds
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