Finding a way to fund commercial real estate investments is one of the most challenging components of investing in commercial real estate.
Luckily, using other people’s money to purchase property is common and one of the most appealing aspects of investing in commercial real estate.
There are various ways you can use other people’s money to acquire a commercial property. Here are five ways to fund commercial real estate deals:
1) Bank Loans for Commercial Real Estate
Banks like investing in commercial real estate properties because commercial real estate provides steady and secure income. Because of this, you can secure a commercial real estate loan from a bank on almost any type of property you want.
What’s nice about securing bank loans for commercial property vs. residential property is that
the Federal National Mortgage Association (FNMA), or Fannie Mae, only allows an individual to take out ten loans for conventionally financed residential properties. Furthermore, after you have four conventionally financed residential properties, the underwriting guidelines can become significantly more strict when you want more than four mortgages.
On the other hand, commercial real estate loans do not have a limit, and you’re not evaluated solely on your personal financial situation or how many loans you have. If the numbers make sense and the opportunity is sound, the bank will often finance it based on the merits of the property itself.
Commercial bank loans often cover 60% to 80% of the total cost of the property, depending on the kind of asset and the strength of the guarantors. They may lend you up to 100% of the purchase price in some cases. However, this relies on the property’s quality and resale value, the history and relationship between the bank and the investor, and other factors.
2) Private Equity for Commercial Real Estate
If banks aren’t a good option for a particular deal, you can consider equity investors to step in and fill the bank’s role. To use private equity simply means you use the liquid funds of individuals or smaller, private funds to acquire a property.
Private equity is used to purchase the property. Then, the owners of that private equity (investors) receive an agreed-upon portion of the returns for the duration of the property. Private equity for commercial real estate can be deployed through legal structures for maximum protection and tax advantages, such as an LLC, General Partnership, or Limited Partnership.
One primary difference between private equity and a commercial loan from a bank is the length of coverage. Commercial bank loans are often terminated after the amortization is paid, whereas private equity agreements will usually remain in place for the holding period.
It’s also worth noting that you can combine private equity with a commercial bank loan. In these instances, investors will often use private equity as the down payment of a property and then use a commercial bank loan to cover the remaining cost of the property. By doing this, you may be able to acquire commercial real estate with zero dollars out of your pocket, but we’ll get into that more below.
3) Real Estate Syndication
Real estate syndication is very similar to private equity because you are typically raising funds from individuals and smaller, private funds or companies. However, real estate syndication comes with more red tape and requirements because it is overseen by the Securities and Exchange Commission (SEC).
In syndication, the person known as the “deal sponsor” will find an appealing property for the group to acquire. They conduct a foundational round of due diligence to determine how much capital they need to acquire and update the property, how much they can increase rents due to the renovations, what the estimated returns for investors will be, and how long to hold the property. With this information, two types of investors can invest in the syndication (accredited and sophisticated investors) and pool their money together to purchase the property.
You can learn more about real estate syndication here.
4) Seller Finance for Commercial Real Estate
Seller financing is a great, creative way to fund commercial real estate investments. A seller-financed deal occurs when the property seller agrees to act as the bank or lender for the buyer.
In this case, the seller likely owns the building fully and does not have a loan to pay off, which allows them to accept monthly payments plus interest from the buyer just as the bank would.
Often, the buyer is expected to make a down payment of some sort, although there have been instances where a seller will accept 0% down. Since the seller is the building owner, it is really up to them and their unique situation and goals that determine what they want to do. Because of this variability, and the fact that you’re not going through regulated third parties such as an agent or lender, it’s critical that both parties have a specialist draft a contract and a promissory note, and then review it each step of the way by a trusted real estate lawyer. The contract for a seller-financed deal should include everything from the down payment amount to the interest rate, payment schedules, loan length, late fees, inclusions, exclusions, and implications of all other scenarios such as a breach of contract.
5) Little To No Money Out of Pocket Options for Commercial Real Estate
Buying a commercial real estate property with no money out of pocket is challenging, and it’s frequently complex—especially when you’re first getting started and don’t have a track record or connections. However, there are investors out there who manage to fund commercial real estate deals with zero dollars out of pocket and secure an infinite return.
No money out of pocket deals often come in one—or a combination—of the four financing methods mentioned above: bank loan, private equity, syndication, or seller-financing.
Here are some examples of how you can leverage the different financing methods to acquire properties for little to no money out of pocket:
- Raise private equity for the down payment and closing costs of a property and secure a bank loan for the remainder of the property balance.
- Use private equity for the down payment of a seller finance deal
- Negotiate a 0% down payment in a seller finance deal
- Raise funds for all costs—including the down payment and closing costs—for a property with a syndication
As you can see, there are multiple ways to finance a deal without any money out of pocket. However, to do this, you must be the person who can bring the deal together. In other words, you must have a property “in hand” and be able to line up the appropriate players to make the deal happen. You effectively identify all the puzzle pieces and then put the puzzle together. In return for identifying all the pieces and putting the puzzle together successfully, you earn a property with no money out of pocket. It’s hard work, but it’s possible.
Commercial Real Estate Funding Summary
- There are four primary methods for funding commercial real estate deals:
- Bank Loans
- Private Equity
- Seller Finance
- All four methods have different pros and cons, but understanding all four gives you more tools in your toolbelt to close a deal.
- It’s possible to acquire a property with little or no money out of pocket
- To do this, you must be the person who identifies all the pieces of the puzzle and then put the puzzle together. It’s hard work, but it’s possible.
- Funding is crucial in evaluating a deal—conduct thorough due diligence on every property. Just because you can acquire property with no money out of pocket doesn’t automatically make it a good deal. Stick to sound investing principles.