Real estate equity financing entails taking some form of risk. While the most common form of real estate financing is debt, there are also other options that can help you fund your project. The type of real estate project you are working on will dictate the type of real estate equity financing you need. Some examples include Peer-to-peer lending, 203K loans, and Senior debt.
Common equity is the most risky portion of the capital stack
Common equity is the riskiest part of the real estate equity financing capital stack, but it also has the highest potential rewards. Investors who invest in this part of the capital stack are owners of the asset and receive a share of recurring cash flow from the asset and a percentage of the profits from any sale. In turn, common equity investors receive a high return on their investments.
The riskiness of a common equity investment depends on several factors, including the amount of capital needed to make the investment, complexity of the project, in-place rent roll, and cash flow. The risk is magnified by the attributes of the asset, which are the basis of the investment. Passive investors generally enjoy less protection, but have unlimited upside potential.
Common equity investors are usually the last to be paid back, but they have the highest potential for profit. They own a stake in the joint venture, which means that they will receive the largest share of the profits when the property is sold. Common equity investors can make a large profit if the property appreciates.
Peer-to-peer lending
Peer-to-peer lending allows you to find money from strangers who have similar financial needs and goals. This type of lending has many advantages, but it can also pose significant risks. In addition to the risks of default, many peer-to-peer borrowers have low credit ratings. This means that lenders need to be aware of the risk of default before lending money. Also, government-backed insurance and other government protections are not available for these loans. Some jurisdictions prohibit peer-to-peer lending while others require companies to follow strict investment regulations.
Peer-to-peer lending addresses this problem by making the lending process transparent. Lenders and secondary buyers can access detailed information about individual loans without having to personally know the borrowers. In addition, peer-to-peer lending companies must publish a prospectus detailing their offerings, which is publically accessible on EDGAR.
Peer-to-peer real estate lending also requires good credit. While the requirements vary, most P2P lenders require a credit score above 600. They may also consider the borrower’s income and debt-to-income ratio. This information will impact the loan rate and terms.
203K loans
A 203K loan is a type of equity loan backed by the federal government. It enables you to purchase a home and then renovate or repair it. The FHA allows borrowers to purchase 2-, 3-, or four-unit properties. While you will need to live in one of the units, you may be able to rent out the others. This income will help you meet your monthly mortgage payments.
Although the 203K loan has more requirements than a standard FHA loan, most buyers qualify for it. However, you need to keep in mind that the loan amount must be significantly lower than the pre-approval amount for a standard mortgage loan. Otherwise, the lender may charge you higher interest rates and fees. Also, the professional who is handling your loan should have experience in these types of transactions. Look for a lender who has handled at least two or three 203K loans in the past year.
Before applying for a 203K loan, make sure that the home has at least a year’s worth of repairs. A 203K loan can help you make repairs and renovations before closing. Many sellers will not allow you to begin construction before the sale, so make sure that you’ll be able to complete the project before closing.
Senior debt
Senior debt is the lowest form of equity financing for real estate. It is secured by a first lien on the underlying property. If you default on your loan, the lender can foreclose on the property and receive the cash proceeds. While senior debt offers the lowest risk, it can also yield the lowest return.
There are several types of senior debt. One form is the conventional senior mortgage, which provides 75% loan-to-value. Another type is mezzanine debt, which is used to supplement other recorded debt. However, mezzanine debt is also available to provide the additional leverage that is needed for real estate investments.
The capital stack provides an overview of the different claims that investors have on an asset. It also creates a hierarchy of power. Senior debt holds a claim on the principal and building. It also retains the right to take possession of the property if the borrower defaults. In addition, senior debt is preferred debt, which offers higher interest rates.
Subordinate debt, on the other hand, provides flexibility for commercial real estate investors. It allows for varying risk levels and high returns. While the subordinate debt is a lesser form of equity financing, it can provide investors with a buffer of equity if the property undergoes a downturn. According to NCREIF, a real estate investment portfolio with a 25% equity cushion is expected to generate an annualized return of 5.7% to 6.9%.
Local investment groups
Real estate investment groups focus on real estate and are a great way to network with others and learn from their experiences. There are many different ways to structure your REIG, and you can choose how much you want to invest, as well as how much you can spend. These investment groups can be local or national, and you can even create one of your own.
Another option is to work with a real estate investment and asset management firm. This type of firm is typically smaller in size and is focused on investing in non-institutional quality properties. They often partner with other larger real estate owners. These investment groups will bring local expertise and capital to your real estate investment.
SACCOs
Real estate equity financing through SACCOs is an alternative lending method. Members pool their money to make investments in real estate. These loans come with low interest rates and can be used to expand an existing business, purchase land, or build residential houses. To maximize the benefits of SACCO loans, members should have a prudent long-term investment plan. By diversifying assets, SACCO members can build impressive wealth portfolios.
Kenya’s Savings and Credit Cooperative Organizations (SACCOs) are responsive to the needs of their members. As a result, they are well positioned to provide financing for real estate projects in Kenya. In addition to providing loans, SACCOs can provide equity financing through joint ventures and wealth-generating investments. This could be a key selling point for developers.
SACCOs offer loans and savings accounts for members. The loans are typically three to four times the amount of members’ deposits and are usually guaranteed by other members. They are typically cheaper than bank loans. The savings they offer are also lower than other lenders, and SACCOs pay dividends to all members.