Real Estate Investors Terminology. This week we look at Financing Cost and how to determine this value.
A successful in Real Estate Investor has a good understanding of the key terms that Real Estate Investors use, what they mean, and how the values for the terms are determined. Once these keys terms are understood, then the Real Estate Investor can begin to understand and be successful in the Real Estate Investing business.
As a reminder, over the next several blog posts I will be digging deeper into the key terminology, explaining the meaning of them, and how they are determined. The last post in this series will bring it altogether to look at the potential profit or loss of a Real Estate Investment.
The terms we will be discussing are After Repair Value (ARV), Initial Purchase Cost, Repair Costs, Financing costs, Transaction costs, Buying & Selling costs, Holding cost, and Profit/Loss. Each of these terms is important and can have a big impact on the ability of and Real Estate Investor to make a profit. The potential profit or loss in a Real Estate Investment can be calculated by this formula:
After Repair Value – repair cost – financing cost – transaction cost – buying and selling costs – holding cost – initial purchase price = potential profit/loss
Financing Cost
This week will be discussing the cost to finance the purchase and renovation of a property. We will also talk about sources of money to finance both the purchase and renovation cost. When I first started to think about Real Estate Investing, obtaining the money to fund my investing was my biggest worry. I have previous experience in small renovation of my own property but never had to go out buy a property, renovate it and then sell it in a timeframe and at cost level to make money. Where was I going to get the money to fund the purchase and renovation was a worry. Not anymore!
I have to make one comment before I talk about financing cost. I absolutely hate the phrase “Other People’s Money” or I should say I hate the way the phrase is used. When I hear someone using the phrase with a very nonchalant attitude and generally giving the impression there is very little responsibility is things don’t turn out alright, then I get mad. It paints the wrong picture of Real Estate Investing.
There is nothing wrong with the term “Other People’s Money” when used correctly and responsibly. People with money are looking for ways to invest their money to make a decent return on their investment (ROI). This is what makes our economy go. Generally, people with extra money will invest in Real Estate, Stock Market, and other investments. They don’t want to leave it in a savings account earning a small return on their investment. However, investors also want as much security as reasonably can be obtained while still making as good a ROI as possible. The larger the risk, the higher the expected ROI. The security a Real Estate Investor should be offering to an investor will be a subject of a future blog.
Financing cost is the amount of money a Real Estate Investor has to pay a lender in terms of interest and points in order to secure funding for the purchase and renovation of the property. It takes time to buy, renovate and sell property. The typical length of time is about six months. This may be shortened or lengthened by the amount of the renovation that has to be done and how long a property is on the market. We will assume six months for this blog.
As an example, the Real estate investor borrows $100,000 for six months at 10% interest non-annually. The investor will owe 100,000 * 0.1 * 6 /12 = $5000 dollars. Most investors will only pay for as long as they are using the money. If the renovation takes two months longer than expected, the financing cost will go up. It will be 100,000 * 0.1 * 8/12 = $6,666.67. Hence the old adage “Time is money”. You can see where the time a project last needs to be managed carefully!
Before starting this business, I worried about where the money would come from. However, a coach and friend of mine helped me realize money is easily obtained. There are three major sources of money. They are Hard Money Lenders, Private Money Lenders, and banks.
A Hard Money Lender can be found on the internet just by searching for “Hard Money Lender”. A number of them will be returned on your search. These institutions specialize in loaning money for Real Estate Investment projects. They will charge a high interest rate and will not typically loan the full amount you need. They will loan a high percentage of the total amount. Typical rates of interest are around 12%.
A Private Money Lender is typically an individual lender. They may have extra cash on hand and are looking for a short-term investment for their money. They don’t want to invest it in the stock market or leave it in a bank. They can be found by networking with friends, business acquaintances, or family member that know what business you are doing and that you have investment opportunities available where they can make a good return on their investment. You will be surprised how many people are interested in loaning money. Typical interest rates will be 8-10%.
Banks are always a good source of money as well. However, they are less likely to loan on a property that needs renovation and the time to get the loan is longer. Right now, typical interest rates are about 5%.
In summary, obtaining financing for the property purchase and renovation is not difficult. You will need to provide the lenders security that they will get their money back. (Subject of a future blog). The finance cost needs to be figured into your overall profit/loss.
Next week I will discuss Transaction Costs