Many people want to enter the real estate world, but they worry about not having enough cash for the first deal. Due to this reality, people often ask me how to attract investors for real estate. That is, if I can’t pay for a deal on my own, how can I bring in outside investors?
Rather than focus on attracting investors, people should first find a reliable hard money lender. Hard money loans will finance the vast majority of a good deal. Once you secure this financing, you can use different strategies to find investors to cover the difference to make the deal happen.
In the rest of the article, I’ll dive into the details of attracting real estate investors. Specifically, I’ll cover the following topics:
- Why People Think They Need to Attract Other Real Estate Investors
- Option 1 (No Investor): Find a Really Good Deal
- Option 2 (Investor): Find a Good Deal and Bring in an Investor
- How to Attract Investors for Real Estate
- Additional Considerations to Attracting Investors
- Final Thoughts
Why People Think They Need to Attract Other Real Estate Investors
New real estate investors quickly realize the shortcomings of traditional financing. When you apply for a traditional mortgage, you need to demonstrate A) solid financial health (e.g. credit score, debt-to-income ratio, employment history, etc.), and B) a property in good condition.
Unfortunately, many new real estate investors may not meet the personal financial criteria to qualify for one of these loans. But, more importantly, traditional lenders require minimum property standards for mortgages. If you want to buy a distressed property to flip, it won’t meet these strict standards.
As a result, many new investors – mistakenly – conclude that, if they can’t qualify for traditional financing, they have one of two options to make a deal happen. First, they could personally fund the entire deal. However, most people don’t have enough cash sitting around to take this approach. Accordingly, people believe they need to attract investors to finance a deal.
Hard Money Lenders as a Partial Alternative to Investors
While you certainly can bring on investors to finance a deal, a far better option exists: hard money. These lenders base their loans on the “hard” asset, that is, the property itself. More precisely, hard money lenders look at what a property will become following a renovation.
Hard money lenders commission appraisers to conduct what’s known as an after-rehab value, or ARV, appraisal. These appraisals review both market comps and the detailed contractor bids for what a rehab will entail, and they use this information to estimate what the property will be worth. Then, most hard money lenders will issue loans based on some percentage of this ARV. For instance, at The Investor's Edge, we will loan up to 70% loan-to-value, or LTV, on the ARV.
In other words, if an appraiser determines ARV to be $300k, we’ll loan up $210k ($300k ARV x 70% LTV). If this sum covers all of a deal’s costs, you can completely finance a deal with the hard money alone – no need to bring on investors. If not, you’ll need to find a way to cover the difference between the hard money loan and total budget. In these situations, attracting investors can be a good option.
Option 1 (No Investor): Find a Really Good Deal
You have to find a really good deal for a hard money loan to cover 100% of the costs. And, to understand these numbers, it’s important to have a solid grasp of the major costs incurred during a flip:
- Acquisition: The cost of actually purchasing a distressed property, to include the purchase closing costs.
- Direct rehab: The cost of labor and materials used to renovate the property.
- Holding costs: The indirect costs associated with owning a property during the rehab period (e.g. property taxes, utilities, insurance, landscaping, etc.).
- Loan interest: What the hard money lender charges you for the privilege of using their funds.
- Transaction: The costs related to selling the renovated property (e.g. agent commissions, title fees, etc.).
If you add all of these costs up and they are less than the hard money loan balance, it’s an outstanding deal. And, as a result, you can execute the deal without an investor, instead using hard money alone.
Finding Great Deals by Driving for Dollars
To find great deals that meet the above criteria, I absolutely love a strategy I call “driving for dollars.” Simply put, you hop in your car, drive around some neighborhoods, and identify homes that look like potential deals. You may find a distressed property or one that looks abandoned. Regardless what type of property you’re seeking, driving around for a couple hours every week will help you find plenty of opportunities. And, we’re so confident in the potential of this technique that we’ve built a Driving for Dollars app to help!
This app helps achieve two major objectives: 1) find potential deals, and 2) connect with motivated sellers. With respect to the first, the app tracks your progress through a geographic area, helping make sure you don’t miss any streets – or potential deals! Second, the app seamlessly integrates with our Investor’s Edge database of over 160 million potential deals, which gives you the ability to connect with the owners of homes you identify while driving for dollars.
More precisely, with Investor’s Edge and the Driving for Dollars app, you can market instantly to homeowners via printed postcards with pre-filled addresses or automated voicemails. This system lets you efficiently bridge the gap between a potential deal and putting a property under contract.
Option 2 (Investor): Find a Good Deal and Bring in an Investor
Realistically, most deals you find will be good but not great. Rather than cover all of the costs, a good deal means that a hard money loan covers the vast majority of a deal’s budget, with you needing to find another source of financing to cover the difference.
For example, assume a property has an ARV of $300k. The Investor's Edge would loan you $210k on this appraisal. But, let’s say that the total deal budget comes to $220k. In this situation, you’d need to find an additional $10k – above the hard money loan – to move forward on the deal.
If you don’t have this cash yourself, you may consider bringing on an investor to contribute the remaining funds. Broadly speaking, you can structure this investment as either a debt or equity deal. Both of these options come with their own unique considerations:
Debt Investors
One of the two primary options for structuring an investment is debt. That is, someone lends you money, and you return that money plus interest. In other words, you pay someone a return for the privilege of temporarily using their money.
For example, say you find a deal with total costs of $100k and a projected exit value of $130k, bringing you a $30k profit. And, assume you secure a $90k hard money loan and need an additional $10k to make a deal happen. An investor could lend you that $10k, charge you interest, and have you repay that $10k plus interest. In this situation, you receive the funds necessary to make a deal happen, and the investor collects a higher return than a bank would offer.
And, when it comes to interest, I recommend offering a slightly higher rate than your hard money loan. When an investor lends you money on top of the hard money loan, that investor holds a second-lien position on the underlying collateral – the home. That is, if the deal falls apart and the home goes into foreclosure, the debt investor would get paid out after the hard money lender (i.e. the first-lien holder on the collateral). This means debt investors assume higher risk than the hard money lender, meaning they should receive a higher interest rate to compensate.
For example, let’s say you secure the $90k hard money loan at 8%. As such, you and a potential investor agree that 10% is a reasonable rate for the $10k investment. If you sell the flip after six months, that means you’d owe this investor the original $10k loan plus $500 in interest ($10k loan x 10% x 6/12). Now, instead of a $30k profit on the deal, you deduct interest and collect $29.5k.
NOTE: Though beyond the scope of this article, debt financing also has a tax advantage, as you can deduct interest payments from your taxes. Consequently, this tax advantage reduces the effective interest rate you pay on debt financing.
Additional Debt Considerations
Before opting for a debt structure, house flippers should consider two additional items. First, make sure to design any debt repayment plan for after a house sells. That is, agree to repay the investor’s loan plus interest with the proceeds from the flip sale. That way, you don’t have to worry about regular debt service when projecting a deal’s cash flows.
Second, house flippers – and real estate investors, in general – need to understand that, even if a deal falls through, you’re still liable for the debt. From the house flippers perspective, this increases risk. Regardless of whether or not you successfully complete the deal, you’re still on the hook for the loan.
Equity Investors
Next, you can structure an investment as equity, or ownership, in a deal. In this situation, an investor doesn’t lend you money. Instead, he or she puts money into the deal and, in doing so, buys an actual ownership interest in the property. As a result, this investor will collect some percentage of the deal’s profits based on that ownership percentage.
For example, let’s say that, in return for the above $10k investment, you give the investor a 20% stake in the deal. Without a special profit allocation, that ownership percentage will translate into a 20% share of the profits. In this situation, that means that, if you earn a $30k profit on the deal, you’d owe $6k of that to the equity investor ($30k total profit x 20% interest). Now, instead of collecting $30k on the deal, you’d end up with $24k.
Additional Equity Considerations
At face value, this example makes it seem that equity is a far better choice for investors than debt. Instead of earning $500, this equity investor would earn $6k – $5.5k more.
But, equity investments come with far higher risk from the investor’s perspective. With debt, the house flipper must repay the investor, regardless of outcome. Conversely, a house flipper is not liable for an equity investment if a deal falls through or closes for less than projected. For instance, let’s say that the housing market drops significantly during this rehab. Now, instead of receiving the $10k original investment plus $6k in profit, the equity investor only recovers $9k from the deal – a $1k loss. As equity investors, that’s the risk you take. That is, you have no recourse to force the house flipper into returning all of your initial investment.
The opposite is also true, though. While you risk greater losses as an equity investor, you also stand to earn larger profits if the deal exceeds expectations. For example, say that, rather than a profit of $30k, this house flip results in a $40k profit. Now, the equity investor would collect $8k ($40k profit x 20%).
Bottom line, equity investors assume more risk. This exposes them to greater potential losses while also letting them share in increased profits.
How to Attract Investors for Real Estate
Now that I’ve discussed the different ways to structure an investment, the question remains: how can I attract investors for a real estate deal? Most importantly, I can’t emphasize enough that when you seek investors, you’re not looking for charity. Instead, you’re looking for a mutually beneficial relationship: the investor generates solid returns, and you get the capital necessary to fund a deal.
Having said, here are the sources I recommend for attracting investors:
- Co-workers and business associates: These are people you already have a relationship with, and they may have money they want to invest. But, frequently, people with full-time jobs don’t have the time or experience to personally manage a deal.
- “Love” money: Some of our best potential investors are the people who love us – parents, siblings, other relatives, and close friends. These people already know and trust us, and they’re an outstanding pool of potential investors. And, they may have access to money and not even realize it. For instance, many people can access 1) credit card loans, 2) self-directed 401k or IRA funds, 3) HELOCs, 4) or business lines of credit. As long as you can offer them higher returns than the associated fees for any of these sources, they’re coming out on top.
- Other real estate investors: These are the people who understand real estate investing but may not have the time to focus on an additional deal. As such, if you offer a compelling enough debt or equity arrangement, they may decide to invest with you.
Additional Considerations to Attracting Investors
Build Your Pitch
Now that I’ve explained both how to find potential investors and ways to structure an investment, I want to tie it all together. Of utmost importance, you should be completely transparent when proposing an investment opportunity. If you appear to mislead someone – even accidentally – you’ll undercut your credibility. Accordingly, I recommend sequencing an investment pitch as follows:
- Part 1, Deal Overview: Provide a general overview of the property and the deal’s numbers (acquisition, rehab, and transaction costs; projected ARV). This allows the investor to frame the broader investment opportunity.
- Part 2, Investment Options: Next, create two to three potential investment options and the associated returns. For instance, you may create one debt option, one equity option, and one hybrid option including elements of both debt and equity investment. For each of these, include the investor’s projected returns.
- Part 3, Risks and Concerns: No investment opportunity is 100% guaranteed. And, suggesting that a deal lacks risk is disingenuous at best and downright fraudulent at worst. Part of working with investors is being transparent about any potential risks. Then, they can assess those against their own risk tolerances and decide whether or not to invest in the deal.
Get Out There and Talk to People
It doesn’t matter how good your proposed investment is if you don’t actually talk with potential investors. At some point in time, you have to move from the drawing board and out into the world, pitching your deal to people. Don’t get dejected. Plenty of people will say no. But, all that matters is that at least one person says yes.
Final Thoughts
At the end of the day, hard money loans represent the best ways to finance a real estate deal. But, if you have a gap between these loans and a deal budget, attracting investors can be a good option.
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