A Real Estate Investor’s Guide To Financing Investments
Getting a short-term loan quickly can be difficult for real estate investors and wholesalers, especially if a great potential deal is coming up soon. However, you don’t necessarily need to go with a sketchy loan or a high interest offer. Instead, you might be able to rely on transactional funding to finance real estate deals and other investment opportunities. But before you put all your eggs in one basket, let’s take a closer look at this process and break down whether it’ll be a good choice for your investment goals.
What is Transactional Funding?
Also called same-day funding or flash funding, transactional funding is a unique financial strategy in which investors take out very short-term loans to make purchases, then pay back those loans much more quickly than normal, oftentimes within the same day or week. They pay the loans back with profits made on the purchase. Through this alternative form of financing, investors, especially real estate wholesalers, can buy and sell target properties quickly without risking their capital. Because of their extremely short-term nature, these agreements are best used for real estate deals where a buyer will close on a deal and resell the same property (in a separate deal) for a profit within a few days at most.
How Does Transactional Funding Work?
There are several key agents in a transactional funding process:
- A lender that provides the money for the transactional funding
- An intermediate agent, like a real estate investor or real estate wholesaler
- An initial seller, who sells the target property to the real estate investor
- An end buyer, who buys the target property from the real estate investor once the investor gets the cash they need from the lender
In most cases, capital is available from hard money or private money lenders. Additionally, transactional funding is usually only possible when the intermediate agent (such as the real estate wholesaler) has a well-documented and established end buyer in place for the second deal. That’s because the second or end buyer needs to be ready to buy a real estate wholesaler’s property immediately after the investor buys their target property from the initial seller. In other words, this type of financing only works when all the players in such a transaction are ready to go and trustworthy.
You can use transactional funding for any real estate purchase and sale so long as the closing agent is willing to facilitate all the transactions and the lender agrees to the terms. In many cases, the lender will need important details made available to them to trust in the transaction. Note that transaction funding was available on a “pass-through” basis before the 2008 recession. This allowed an investor to sign a contract to buy an excellent deal for real estate at a low price, then sign a secondary contract promising to sell the property at a higher price for a profit. Then the investor could use the end buyer’s money to fund the initial transaction to kick off the entire process. However, new regulations now require the purchase of the target property and the selling of the property to be two separate transactions.
How Much Does Transactional Funding Cost?
It depends on the comfort levels of different lenders. Some lenders may be more comfortable with certain deals than others. Even with this variability, real estate investors should assume that lenders will charge between 2% and 12% of the total loan amount. For example, if you need a $100,000 loan, you may need to pay between $2000 and $12,000 to facilitate the transactional funding process.
Transactional Funding in Wholesaling
Transactional funding is often useful when trading wholesale properties. Investors can get the cash they need to get a deal from a seller and quickly resell the property they purchased for a profit in a separate, transaction. This funding method gives investors more versatility and can replace the assigning contracts method of real estate trading, which is sometimes not permitted depending on your area. Because of its benefits and speed, transactional funding is of great use to real estate wholesalers.
What Do You Need To Be Eligible?
Although eligibility requirements may vary from lender to lender, there are generally 3 things you need to be considered eligible:
- A motivated seller
- Proof that you represent a business entity, such as an LLC
- An end-buyer who is ready to close the deal immediately.
Note that the title company must be able to send a written confirmation stating that the money is in their escrow account.
Is A Proof Of Funds (POF) Letter Provided By The Lender?
Yes, the lender will provide a proof of funds (POF) letter. This letter proves to your seller that you have the funds available to purchase the property. Your deal is more likely to move forward once you have a POF, representing official backing from a legitimate financial institution.
Are There Any Upfront Fees?
Borrowers are expected to pay an origination fee, which is the equivalent of a few percentage points of the loan amount. When it comes to wholesaling, borrowers don’t have to pay a down payment on top of an origination fee. Wholesaling is an investing modality that allows you to access capital with minimal costs.
Is There A Processing Fee?
Yes. Borrowers must pay a processing fee that is separate from the origination fee. The fee pays for an attorney who will review the documents and certify that the property and title meet any legal criteria required for it to close. The closing fee varies from lender to lender but expect to pay at least $1,000.
Transactional Funding in House Flipping
Not surprisingly, transactional funding is an important tool used by house flippers and rehabbers. Most notably, it increases optionality and the ability to secure more deals. Thanks largely to the speed at which transactional funding may be deployed, investors may gain access to deals they would have otherwise lost out on to the competition. In securing and deploying money faster than others, investors can make offers sooner than those seeking traditional financing. Through this transactional method, house flippers can get the funds they need to rapidly purchase a wholesale deal, then flip the house and sell it to an end buyer without rehabbing it or spending lots of money fixing it up.
Example Of Transactional Funding
Let’s walk through an example of transactional funding to help solidify the concept. Let’s say that you’re a wholesaler working with a buyer who wants to move to Arizona from Illinois. You identify a property that needs minor upgrades and negotiate a selling price of $300,000.
You put the property under contract such that the property will be sold from your seller to your buyer for $350,000. You then secure a transactional loan and coordinate closing dates. You also arrange for a contractor and their workers to make the necessary upgrades within the next two days.
You put $10,000 of your potential profit into contractor and lender fees. After closing, you walk away with a profit of $40,000, all without having to put in a dime of your own funds.
Pros & Cons Of Transactional Funding
Transactional funding is a proven strategy that has found its way into investors’ playbooks. The optionality and speed of implementation transactional funding awards investors are invaluable. That said, the method in which transactional funding grants those who use it access to capital isn’t without downsides. Taking on debt to secure an investment does come with inherent risk. As a result, investors need to weigh the pros and cons associated with transactional funding and decide for themselves if it’s worth pursuing.
Pros of Transactional Funding
The pros of using transactional funding include, but are not limited to:
- Loans Cover The Entire Cost Of The Property: There’s minimal risk for real estate investors and wholesalers, as the loans provide 100% of the loan amount to purchase a property.
- Straightforward Processing: The paperwork is straightforward, and most deals don’t require your credit score or income to be reported for approval.
- Relatively Easy Qualifications: All you need is a proof of funds letter from the end buyer for your target real estate property.
- Speed Of Implementation: Funds can be acquired extremely quickly, sometimes in a matter of hours.
- Optionality: Transactional funding allows you to take advantage of “flash in the pan” real estate deals that don’t come around very often.
- Accelerated Process: Most transactional lenders don’t require insurance, appraisals, or full title reports, which accelerates the process and may increase your profit margins.
Cons of Transactional Funding
The cons of using transactional funding include, but are not limited to:
- Closing Costs: The funds from a transactional funding deal come with closing costs. Fees will usually be taken out of your profits at both deals’ closes.
- Short-Term Loan Duration: Transactional funders usually offer short-term loans, so you must be prepared to settle with your end buyer very quickly after taking out your loan.
- Payments Due Within Weeks: Transactional loans are often due within two weeks of being taken out or may even be due within 48 hours.
- Deal Dependent On End Buyers: Any end buyers must qualify for financing for the deal to go through.
How to Qualify for Transactional Funding
While transactional funding can be effective, you’ll need to qualify for these deals to take advantage of them. Generally, you’ll need:
- An end buyer contract that proves the end buyer’s funds are present to convince the transactional lenders that the deal can go through ASAP
- Possibly a credit report and background checks for the borrower
- Some due diligence for the property, like a desktop valuation or examining pictures from the interior and exterior of the property
- Many lenders may also require a letter, which evaluates the borrower based on the “5 Cs of Credit”
Alternatives to Transactional Funding
Given the risk inherent with transactional funding, some real estate investors may wish to consider alternatives, including:
- Hard Money Loans: Offered by private lenders, hard money loans offer short-term capital, which is backed by the subject property. Hard money loans typically come with lower interest rates than their private money counterparts, but approvals can be harder to come by for some investors.
- Private Money Loans: Private money loans are not associated with an institution but rather private investors with access to capital of their own. Without an attachment to an institution, private money lenders are easier to qualify for and faster to act. However, private money lenders will ask for higher interest rates, upwards of 12% to 15%.
- HELOCs: Otherwise known as home equity lines of credit, HELOCs allow investors to borrow against the equity in their own homes to finance subsequent real estate purchases.
- Joint-Venture Capital: A joint venture, as its name suggests, is a convergence of two or more parties that seek to invest in a single property for profit. In addition to sharing risks, joint ventures will also usually share the acquisition costs.
All in all, transactional funding can be an excellent tool in your real estate investing repertoire, particularly if you stumble upon a great deal you want to jump on ASAP. But keep in mind that you will need a guarantee of an end buyer’s funds, plus their willingness to pay, to secure transactional funds from a suitable lender. Furthermore, you may be on the hook for paying back the loan faster than you anticipate, so make sure to close both transactions in a deal quickly.
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About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.