If you want to invest in real estate, you need to get a sense of all your funding options before you get started. The truth is, there are many options beyond getting a conventional loan. One of those options is private funding. With that in mind, below is a guide to private funding for real estate. Read on to learn what private funding is, the pros and cons of using this kind of financing, and advice on how to find private funding for your next real estate deal.
What is private funding for real estate?
in real estate, the term "private funding" refers to a specific type of funding that doesn't come from an institutional bank or lender. Rather, the funding is given from the investor to the borrower based on their relationship. In fact, it's possible that a private money lender could be a friend or family member. However, that doesn't necessarily always have to be the case. Sometimes private money lenders can be companies like private equity funds, which use money from accredited investors to back various projects.
In the case of real estate investment, private funding can be used to fund a long-term loan for a rental property or a rehab loan for a fix-and-flip buy. It's also possible to get a private lending bridge loan in the case of new construction. As you might be able to guess, private money is often much more flexible than a bank loan.
That said, it's also important to draw a distinction between private money lending and hard money lending. Like conventional lenders, hard money lenders typically have their own set of criteria for who will be approved for a loan. If you don't need that set of criteria, odds are you will not be approved. On the other hand, with private money lenders, the criteria for approval and the terms of each loan are worked out on a case-by-case basis.
What are the benefits and risks of using private funding in real estate?
Like any type of funding, private money has its unique benefits and risks. To that end, we've listed them out for you below. Read them over to get a better idea of whether or not it makes sense to go after private financing when trying to fund your next investment opportunity.
Benefits for the investor
Truthfully, there are many benefits to being a private investor. First and foremost, it's a truly passive way to generate income. In this case, you don't have to do any of the work of finding the property, buying the property, or managing the property. Instead, odds are good that all you'll have to do is put up the money up front and then sit back and collect your returns.
Additionally, this form of lending is said to have some of the highest returns that are available. Often, the interest rates on private loans are much higher than what you would find with a traditional bank loan. Most of the time, they are even higher than what you might expect from a hard money loan.
Benefits for the borrower
There are also some big benefits to choosing private funding as a borrower. Here, the biggest benefit is that there is a lot of flexibility in approval standards and loan terms. Usually, individual investors and fund managers are willing to look at borrowers who have been denied traditional financing. For example, if your credit score needs some work but you have a good amount of real estate investment experience, you may be a good candidate for private funding.
Risks for the investor
That said, investing in a private fund or a private money loan is not without its risk. On one hand, there's no guarantee that you will see returns. If the borrower you choose to back is not as savvy as you thought, there is a possibility that the investment could lose money.
On the other hand, though most private money loans use the home as collateral, if your borrower does default on the loan, it's up to you to take them through the foreclosure process. This can be both costly and time consuming on your part.
Risks for the borrower
On the borrower's end, the biggest risk of taking out a private money loan is that the interest rate is so high. Ultimately, if you're able to qualify for an investment loan from a traditional lender or hard money loan, you may be able to get a better deal overall. After all, your foreclosure risk will likely be the same no matter what type of financing you choose.
How do you find private funding?
Now that you have a better idea of the benefits and risks of private funding, the next step is to go about learning how and where to find it. Truthfully, everyone's journey to finding private funding will be different. However, we've laid out a few common strategies for you to try. Keep them in mind as you go about searching for funding for a future real estate deal.
Build a network
As mentioned above, approval for private funding is mostly based on your relationship with the investor. With that in mind, you're going to want to start searching out possibilities within your existing network of family, friends, and acquaintances. In this case, you'll want to look for someone who is knowledgeable about and interested in real estate.
However, you're also going to want to take the opportunity to expand your network. You can do so by joining local real estate investment clubs, visiting your local chamber of commerce, or by attending real estate conferences.
Sometimes finding private funding can be as easy as looking online. Most private equity funds advertise online and have an established online presence. However, if you're going to go this route, be sure to be prepared. That means having a solid real estate investment business plan and having your pitch down cold.
Since private equity funds are only open to accredited investors, this is one instance where you're dealing with the big guns. You're going to want to be able to show that you have an excellent working knowledge of the current real estate market in your area and an established track record of profitable deals.
Make cold calls
if you don't think you're quite ready for a private equity fund, you can try reaching out to individual investors in your area to see who might be interested. In this case, you can find the investors by searching public records data or by buying a list from a data broker.
Once you have a list in hand, the next step is to get cold calling. When cold calling, you’ll want to be friendly yet also keep the conversation short and to the point. In addition, it's important to keep the focus of the conversation on how you can be of benefit to the investor rather than the other way around.
Try direct mailing
If making countless phone calls isn't for you, the other option is to try direct mailing. As the name suggests, direct mailing involves sending a piece of promotional material to potential investors through the mail. Again, with this route, you're going to want to focus your mailing on how you can serve the investor rather than how they can help you.
Is private funding right for you?
At the end of the day, private funding is not for everyone. While securing this type of financing can often mean getting the benefit of flexible loan terms, that flexibility often comes at a much higher interest rate. With that in mind, it's important to weigh the risks and benefits before you make your final decision on whether or not private money is right for you. Use this guide to help you make that decision easier.