How to Finance Your 1st Rental Property

The Transcript
Hi, I’m Joe White. 
Welcome to the Grow Real Estate Investing Podcast

Today, I’m going to try to answer a question, that I hear a lot:

“How do I finance purchasing rental properties?”

It's a fun question to answer; because there is good new…. if the 1st property is purchased with the strategy I discussed in the podcast on Forcing Appreciation, there will be a built in mechanism to automatically finance all your future properties.

I own a property management company here in Philadelphia and I do it all the time with our property management clients.

I build them large rental portfolios, recycling the same money again and again.

Buying property, after you get over the hurdle of getting the 1st property, can be easy.

So I’m not going to go in depth talking about how to finance yourself a large portfolio of rental properties, since that is well covered in that podcast, so check that out to secure your ability to continue buying rental properties.

And I also have podcasts on what property to buy and where you should buy your property.

So you might want to check those out also, to get yourself well on a successful track.

What I am going to talk about are the basics of rental property financing; because many people are trying to buy their 1st rental property and that 1st step often feels the hardest. 

Now if you have savings, it will certainly be easier. The more savings you have, the easier it will be. I certainly advocate allocating a percentage of your income towards your rental property investment goals.

In the podcast on Forcing Appreciation, I talked about a well exercised, technique, often called BRRRR, an acronym created by Brendon Turner, of Biggerpockets fame, that will self-sustain your initial investment, so that original seed money can be used over and over again, taking it from one rental property, to put it into the next, then the next, as you get cash flow from each rental that you acquire. 

And that’s what my wife/partner and I do; but we still take a percentage of our income, and we save it to add to our original, working investment monies, which increases our returns.

If we add $5,000 to our investing amounts, we can buy a $5,000 better property or improve it $5,000 more  or borrow $5,000 less and save having to pay that interest - all of which, if done strategically will increase our investment returns.

So I highly recommend you do the same.

If all you can save is $10 a month, do it. Creating a habit and refining a system will be 90% of your success, so do that. 

Now when buying a rental property, ideally we want to avoid double closings.

Each time you take out a loan, you will pay closing costs.

Closing costs are the most expensive thing that I pay as a real estate investor.

Buying a property isn’t expensive.

It doesn’t cost me anything as long as I bought it right.

No matter how much I spend to acquire that property, I will get that money back when I refinance it.

The same with renovations.

When I spend money to renovate a property, I do so strategically so each renovation will make money. If I spend $750, I would like that improvement to be worth, at least, $1,000 in equity.

If I buy a property for $50,000, and I put another $50,000 to renovate it, I now have spent $100,000.

But if the property is now worth $200,000. Neither the purchase, nor the renovation cost me anything, rather they made me a $100,000 in this example.

Obviously, there are techniques and strategies you must follow to make this true and I outline those in other podcasts like the one on Forcing Appreciation.

But closing costs are different. When the lender requires you to pay for an appraisal, you don’t get that money back.

You may value the appraiser's opinion; but that is now money spent. It is an unrecoverable cost. The same with title costs, and points the lender will charge you, and so on.

So, we are investors. Our goals are financial. So ideally our goal is to avoid double closings to avoid those closing costs.

But real estate investing is about acquiring tools for your toolbox and at 1st you won’t have every tool.

If you have to use a hard money lender, pay interest on a private loan, do double closing or share the deal with a financial partner to do a deal, and the numbers still make sense; then you do that deal.

Do I pay interest on private lending from others?

Yes, I leverage other people’s money to do deals.

They make money, and so do I. Will I ever use a hard money lender? Certainly, if that’s how the deal goes.

But I also have my own money that I intentionally grow; because using it with no cost so it increases my investment and using saving is way less cumbersome.

Savings is a tool my wife and I have in our tool box, but so is private lending.

Here is a quick list of sources of rental property financing

  1. Savings:
    Savings is nice as it will be the least expensive money you use. It's free - you can’t get less expensive than cash and it is also the least cumbersome to use. You don’t have to answer to anyone, do endless lender paperwork and clear their hurdles. Cash can also open up deals as sellers know you can close on their property. Deals involving lenders often fall through and take longer. 
  2. Home Equity Line of Credit  or a “HELOC”
    A downside to savings is that when it's not being used it just sits around devaluing itself due to inflation. As you are waiting to find a deal, or saving till it you build up enough money to purchase a rental that money isn’t currently working for you, in fact if its devaluing and is actually working against you.

    Which makes HELOC’s so attractive. A HELOC is essentially borrowing from yourself, through a lender.

    You are borrowing your own equity from your property; so this tends to be an extremely low interest loan.

    It's extremely likely to be the lowest interest loan that you can get. And also there aren’t typically closing costs. So you avoid those losses altogether.

    And the nice thing about helocs is that they don’t cost you anything, unless you use it, and they only cost you for the amount you use.

    If you have a $100,000 home equity line of credit and you buy a property for $50,000, you will only pay against that $50,000.

    If you renovate it, for another $40,000, you are only paying as you spend it.

    So if appliances are your final improvement for your rental, you would wait till right before you enter the market to buy them, so you are only paying that debt for a short while before a tenant takes over paying for it by paying you rent.

    The one consideration is that most lenders will only do a heloc on a primary residence. Meaning it will need to be your home. So you likely won’t be able to do helocs on each rental property you acquire.

    How this works is that you speak with a lender, get the heloc, use it strategically, refinance the property when it's time and pay off that line of credit, so you can use it again for the next property, then the next. 
  3. Private Lending:
    Private lending can be another very important tool in your toolbox.

    It is when you borrow money from an individual.

    It might be a friend, a family member, an old classmate, someone you meet at a real estate investing meetup, or maybe someone you met at a party.

    A private lender is someone willing to invest in you. Finding a private lender is both difficult and easy. Difficult as they might be tough to find; but easy because you might only need to find one. And once you make a profit for a private lender, they might be far more likely to continue investing in your future projects.

    As you start building your rental property portfolio you might be using a combination of savings, a heloc and a short term bridge loan of private lending.

    Even if you have the savings, it might be tied up in another investment. Again, we want to keep our money working for us as much as possible.

    Often the way to really help get private lending is to first have the deal.

    If you have a property lined up, and you have very clear, realistic numbers on the cost of the renovation, plus if you can show an exit plan on what you will do to get them their money, if things go south, all this will go a very long way to lining up a lender.

    Better might be if you can buy the property with your savings and/or your heloc and to borrow the money to renovate it. Having an asset that protects the lender certainly helps. I have a podcast on private lending so check that out. 
  4. Hard Money:
    Hard money is a form of private lending.

    It can be more expensive since a hard money lender is in the business of providing private lending. And the hurdles and paywork will typically go up.

    As a professional private lender, they tend to also have fees and much higher interest rates.

    They know what they can get away with charging, and they also tend to have far stricter criteria. Which can be a safeguard for both of you.

    Being a professional, a hard money lender will very likely want you to have a deal already and they will likely want you to “have skin in the game”.  This proves you are invested and it also offsets their risks.

    They will want the full details and they will want to analyze the deal themselves. This can be helpful getting a second set of eyes.

    Especially eyes that might have experience.

    If a hard money lender turns you down, you should re-analyse the deal, to make sure it truly makes sense.

    Hard money can be a very expensive way to fund a deal; but it is a short-term, bridge loan and can sometimes be necessary to make a deal happen. If the numbers make sense, use hard money. Remember, hard money might not be your favorite tool; but until you get a better tool, it might be your best tool at the moment. 
  5. Self-Directed IRA:
    Few people realize that they can invest their own IRA monies, and this includes investing in real estate. This literally can open the doors to rental property investing and can give you a way to super-size your retirement. Look for that podcast if you have an IRA. 
  6. Creative Financing:
    There many ways to make deals happen - again, tools in your toolbox. The seller might act as your short term lender, giving you the window to renovate the property so it can be refinanced, then you pay the seller in full.

    Waiting a short time to get paid might make the most sense for a seller who gets to finally sell their property and at a price that satisfies them.

    Funding can come from a partnership where you share the expenses, or you can do a lease option where you lease the property from the seller with the option to buy it once it has been renovated and can be refinanced.

    You can assume someone’s mortgage….there are countless ways to make a deal happen.

    But each way should be considered a tool that you should master. Work on saving as a tool, consider if you can utilize a heloc or if using your IRA is the right tool for you, work on lining up private lending and most importantly, find deals.

    Happy investing everyone!


Joe White

Joe White is a Philadelphia Property Manager and Real Estate Broker. He is the owner of Grow Property Management and has been involved in the management, sales and purchases of Philadelphia area rental investment properties since 2008. He is an author and works as a real estate investment consultant and construction manager.

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