If you are a real estate investor / property flipper who wants to profit from selling your properties later it is always a good idea to finance your real estate acquisitions with your own money. You should have plenty of cash to cover the down payment and the renovations at least without being taking huge loans. Usually problems to real estate investors happen when the properties take longer to sell than expected. In a situation like this if your property investments are financed by credit and that too credit that comes with a high interest rate you can be in financial trouble.
If you do not have enough money to cover the purchase cost of your house along with renovation costs then you will have to apply for a loan. But if you are a property investor then your situation is different from that of a property buyer who intends to live in the house that he / she is buying. Most traditional housing finance companies in India will not financing home flipping (especially to first-timers) and if and when they do oblige, going this way can come with several drawbacks. Other sources of financing property investments include private financiers, hard money loans and other angel investors. Whichever path you take to fund your property investments do make sure that you know exactly what you are getting into.
Cash is King
When we say cash is king we do not actually refer to paper notes. Cash also means how much liquid money you have in the bank that can be encashed for acquisitions. A lot of new real estate investors in India land in financial trouble by buying a property for very little of their own money and borrowing from banks to purchase the properties. If you want to improve your chances of success as an investor in the property market you should aim to build up a sizeable cash balance before you begin investing in properties. Not only will it cushion you against problems when things do not proceeds as planned but it can also make it far easier for you to get loans in the future when you most need them.
20 Percent Down
If you are approaching a bank for a loan for buying property, most lenders who give the best rates and loan terms will require atleast a 20 % down payment. Some lenders will ask for less but it is actually in your best interests to put down as much of the initial down payment as you possibly can. Also the more money that you put down the less interest you will pay over the tenure of the loan. If you put down a sizeable down payment you will be able to secure a lower rate of interest thus decreasing your expenses and building up equity at a faster rate.
100 % Cash
Historically in the real estate investment space, the most successful investors who have made the most money avoided loans altogether and stick with straight money to fund their property investments. This strategy will reduce the risk of loss and lowers the break-even point by lessening expenses and most of all offers the biggest profit margins. Additionally and this is something that most loan applicants fail to realize – avoiding loans for purchase of property also means doing away with the closing costs associated with a loan which can sometimes run as high as 5 % of the purchase price of a property. If you have purchased a resale home then repairs and renovations to your purchased property can cost lakhs of rupees. If you are using loans to pay for all of that then you will end up paying lakhs more in interest.
Of course it takes a long time to build up substantial cash reserves and it is not an easy task to accumulate crores of rupees in the bank. But if you are serious about real estate investing, paying out of your own pocket for your property purchases is the smartest and most profit-friendly move. Below are the routes that a property investor can take to invest and flip properties in the property market in India.
1. Traditional Lenders
For most people the chances are that if they have ever taken a loan they have got it from a traditional lender like a bank or a Financial Services Company. These retail loans are the main sources of income for these companies and they love to close home mortgage deals.
Being Aware of Drawbacks
Most people choose to approach banks like HDFC or SBI for home loans because they are familiar names but using this form of financing can sometimes put you at a disadvantage. The drawbacks include:
Extended Closing Period
Most loans from banks take atleast a month and sometimes upto 3 months to close which can be a drawback for a real estate investor who has found a good property to invest in and has to invest the money fast to get a good deal.
Traditional lenders want to see reliable income which means steady paychecks for atleast 2 years. Reliable paychecks are exactly what most real estate investors are trying to avoid.
Traditional lenders look at current market appraisals of property to calculate the LTV (loan-to-value) ratio before giving out loans to individuals. They like to keep the LTV below 80 %. That is a bad deal for a real estate investor who is trying to buy distressed or under-valued properties. This can limit the loan amount.
The last point is the main concern that experienced real estate investors have with regards to traditional lenders. Real estate investors buying distressed properties require a loan to cover the purchase of the property as well as the renovations that are needed to spruce up the property and make it fit for selling a a higher price. With a low appraisal value it is impossible to get a big loan to cover both aspects. For e.g. if you want to buy a ₹ 4 Cr. property with estimated renovations of ₹ 40 lakhs. If you have 1 Cr. to put down as down payment for the property then you will need to borrow ₹ 3.4 Cr. But to achieve an 80% LTV the bank will only offer you a loan of ₹ 3.2 Cr. even though the property will be worth more than 4.4 Cr after you have fixed up the property.
Borrowing money from private money lenders will remove all the problems of working with traditional lenders but the convenience comes at a cost. In a nutshell these are people who have money to invest and they are investing in your home flip. Their investment return is the interest that you will pay them. So it is in their best interest to charge you the highest possible interest rate. That means that you will have to hone your negotiating skills because its in your best interest to score the lowest possible interest on your flip loan.
Private lenders can be anybody – from a stranger to your family and friends circle. There are many people who want to invest in real estate without doing any of the hands-on work. These are people who can be tapped on for loans. Once the lender is found, the process moves at breakneck speed compared to the process with a traditional lender and the loan can close in a few days as opposed to a month or more with other lenders.
Private loans also work in a similar manner to traditional loans wrt. The specific loan amount, a preset interest rate and a first-position lien (outstanding) on the property. But like traditional lenders the rate of interest set by private lenders can fluctuate widely depending on the deal that you negotiate.
Private lenders can also charge points viz. upfront interest payment in order to lower their investment risk. Points are calculated as a percentage of the loan balance amount. 1 point equals 1 percent. So one point on a 1 crore loan would be 1 lakh. So a private lender might charge 10 % interest plus one point. The point is liable to be paid at closing and the 10 % would be paid over the life of the loan.
Profit Sharing Deals
Some private lenders may be open to loan you seed capital in return for a part of the profits when you sell the property. These lenders would act more like partners. In a situation such as this they would charge much lesser interest rate in exchange for a part of the proceeds of the profits from the future sale of the property.
Do remember though that if you are a new investor and do not have much to show for in terms of experience in flipping and proven success in this field, you may find it difficult to interest private lenders who generally only work with individuals who have shown past success in their chosen fields. This kind of deal is more common when the lender is amongst your family or friends circle. As always to ensure that professionalism is maintained at all times, have an experienced lawyer draft your loan and profit-sharing agreements.
Hard Money Lenders
Hard money lenders are also called Asset-based Lenders. These type of lenders focus more on your property than on your income or credit score. Like other types of lenders they will first secure a first lien on your property. Because they specialize in flip loans they will first of all do their own research on the property that you are purchasing and first of all ensure that the property is likely to sell quickly so that they can recover their money back fast.
With such a narrow and intense focus on the property hard money lenders may overlook down payment issues (like a down payment that you have borrowed) as long as you have a substantial amount of money to make a down payment yourself. They will be more concerned about whether you will be able to sell the property quickly for a sizeable profit. So loan terms will always be more favourable for experienced property investors as opposed than first timers. I know its an unfair world!
Hard money lenders are probably the easiest source for quick flipping loans but it’s also a more expensive option.
Hard money loans for flipping houses have to be repaid within one year generally. The interest rate is relatively high going as much as 18 – 20 % along with the points. The points can be paid not during the closing of the loan but when the property is sold. These are usually interest-only loans which means that you make only the interest payments monthly and pay back the principal in one lump sum amount when your flip property is sold. In certain cases, you can negotiate terms with the lender whereby you make no payments until the house is sold and the interest amount simply accumulates and gets added to the loan balance.
Pros and Cons
The pro side of working with a hard money lender is this:
- Quick approval based on the target property
- Helps you get cash quickly because of shorter application and verification process timelines
- Greater flexibility such as interest-only or deferred payments schedule
- Able to borrow money inspite of not-so-stellar credit score
While it may sound like a dream come true but there are some drawbacks:
- Expensive loans that eats into potential profits leaving you with less cash for future flips
- They offer relatively low LTVs hovering on 50 – 70% of the after renovation value (ARV) leaving you short on funds
The above three types of lenders are the most common borrowing options available for any property buyer in India whether buying property for end use or to invest in property for a successful flip.