Investing
What Is House Swapping in Real Estate Investing?
While house swapping is not very common in real estate investing, it is an available tool for some investors and homeowners. There are actually two types of swapping methods available for sellers and buyers of properties.
The most common type of property swap is called a 1031 Exchange. In a 1031 exchange, two property owners come together with at least one party having a substantial capital gain or profit in the property. These exchanges are carefully controlled by IRS (Internal Revenue Service) guidelines. These exchanges have so many time and other parameter restrictions, that an investor should not try these on their own. Have a company that specializes in these property transfers handle all the paperwork and compliance issues that are involved.
The purpose of a 1031 exchange is to effective lock in a substantial profit on a property by trading for an asset of equivalent value or even more equity in some cases. The key to doing this transaction is to find a seller of a “like kind” of property at the exact time the first seller needs to trade for the second property. There are specialty real estate brokers who specialize in these transactions and work closely with 1031 exchange firms that facilitate these complicated transactions most in the commercial property arena.
There will be two complete closing with both the buyer and seller becoming a seller and buyer of each other’s property. For example, seller A will sell his property to buyer B and theoretically at the same time, buyer B will become seller b and seller A will become buyer A. In the end, each party will own the other’s property with no tax consequences of these sales (transfers). The closings are required so that both buyers get clear and marketable title on the purchase of their respective properties.
The more common type of house swap is between two homeowners that have for different reasons have decided to move into the other’s neighborhood. This time the same double closings occur, but there are tax consequences on these transactions in the form of capital gains. If one or both parties take a loss on their property, this loss is not deductible from either seller’s income tax.
This may be important to know in case on seller has a large gain while the other may be taking a loss. If these properties are the homesteaded properties of the sellers, there are currently capital gains exemptions for a specific amount for single or married homeowners if they have lived in the property for a certain time period in the last five years.
Always consult with a tax professional before you commit to a 1031 exchange or a simple house swap because of the longer term ramifications of these transactions.
What Are Hard Money Loans?
To get a hard money loan, you just need to have a good collateral or property, which is completely opposite to a traditional loan, where the lender is only interested in your particulars. That’s why; you are eligible of getting these loans even if you have a bad credit history or no job history.
This is the reason behind the success of hard money and fix and flip investing.
There are investors who get confused while looking for hard money loans because of the usage of terms like “hard money lender” and “private money lender” in the real estate investment business.
What I have learnt from my experiences is that a hard money lender is basically a professional lender, who is doing it for a living. They usually have higher interest rates and they also charge points, which is 1% of the total loan you are getting and you will have to pay that right after your loan is funded.
For example, a hard money lender can also charge you up to 20% interest and 4 points. Most of the lenders I have used, are the people referred to me by my friends or I have found them via internet.
On the other hand, most of the private money lenders are my friends or colleagues i.e. people who are within my social circle. They charge you less interest rates like 8 to 10% with no points.
If you are looking for good amount of money, hard money lenders could be the best choice. That’s why; they are the best options in case of mortgage as these lenders feel more secure that they will recover their money soon.
While doing my first deal in real estate, I used the services of a lender who charged me 15% interest rate and 3 points for 80% of the purchase price of the property including repairs. The rest of the funding was done by private money as I use them on second or third place.
So, basically I am using private money for 25% of my fix and flip needs.
This is basically what I know about private money versus hard money. There are some major differences but the main purpose is to have good connections and building up good relationships amongst each other to get complete funding for your deal.
I don’t use my own money for funding a deal, even though I can afford it because when there are two parties involved, the profit margin also increased and in that way, both of them can make money. It helps you in spreading wealth.
Real Estate: Interest Rates and Fees
This is where things get interesting but don’t let this become your biggest concern. Relationships are EVERYTHING when borrowers and lenders get together. Working with a lender who truly understands your needs but who also can manage any obstacles that crop up throughout a project life cycle is critical.
Yes, your profit will be a product of your debt servicing and acquisition costs so seeking the best rate you can get is important. I would suggest, however, working with a lender who understands you and your project is just as critical.
By no means can I quote on behalf of all private or syndicated lenders but I can provide a range of interest rates and fees you will pay. In most cases, you will be paying simple interest as well as fees. Interest rates range from 8 per cent to 14 per cent in good cases for a first position mortgage and can vary from 12 per cent – 18 per cent on most second position mortgages.
Fees vary widely depending on the lender. They are often calculated as a percentage of dollars being loaned to you and have been called by various labels. There are lender fees, commitment fees, advance fees, broker fees and various other types of fees. The rates can fluctuate depending on your project but expect 2 percent per term in best case scenarios to double digits depending on the project type, term and risk of project. Be sure to familiarize yourself with the fees you are expected to pay.
Sounds high? Not for those who value the flexibility and simplicity of this form of lending. These are short-term loans designed for your specific needs. The return and profits must be captured by the lender in this short time and therefore first appear onerous to those unfamiliar with this type of mortgage facility.
Remember how much money the banks make from your residential mortgage? If you take 25 years to pay off your amortized home mortgage of $400,000.00 and average 5% interest over the life of the mortgage, you will have paid upwards of $300,000.00 in interest only, for the privilege of using the bank’s money. Put another way, that’s just about a 75% return to the banks. This is assuming a few issues:
1. You don’t move your mortgage to another lender and start another 25 year
term.
2. You maintain that 5% interest rate for the life of the mortgage.
3. You haven’t made additional payments along the way.
Keep in mind that the risk/reward ratio is always at work here. Investors – those who supply the investment dollars to the brokerage or administrator (usually the private lender) – are taking a risk in lending you their hard-earned funds. And to this end, their reward must match their investment comfort level.
This is not advice to simply accept any interest rate thrown at you, but it is prudent to consider many aspects of the relationship moving forward. As an example, you may want to seek a lender who:
1. Provides knowledge and counsel to your team. Many of the underwriters and
various principles of a private lender have been part of many deals and probably a few like yours. They have seen what has succeeded and what has not. The willingness to provide this advice and counsel is worth more than any fee or interest rate you will pay.
2. Is flexible on fee payment options. Granted, the amount of fees required to be
paid won’t be very negotiable in most cases, but how these fees are paid can often be structured to meet your specific needs.
3. Will display character should your deal go sideways. You will need a lender who has experience and the character to work with you in the ups and downs many real estate development and improvement projects can take. No doubt, most lenders have experienced a hiccup and had to formulate a plan to resolve the problem. The question is, how did they do this? I invite you to ask a prospective lender the following: “In the past, what steps did you take to assist a borrower when a project was in distress?” The answer must involve both the project and you. Securing the best interest and fee rate with a lender who is difficult or frustrating to deal with when things aren’t all roses will come back to haunt you!
3 Helpful Tools for Real Estate Investing
Who Supplies The Capital?
The capital is literally infused by investors who want to participate in real estate and earn a return on their investment. Investing in the Canadian mortgage market is a solid option for those who want to get into real estate yet not necessarily own the property.
There are a number of methods by which investors can supply you the funds for your project mortgage. A common investment vehicle is a MIC.
1.) Mortgage pools: Many investors prefer this type of investment as it allows an investor to participate with other investors in a pool or diversified gathering of mortgages.
The attractiveness of this structure is the diversification of risk for investors as their funds participate with other investors’ funds and are spread or pooled among many projects. There are a number of Mortgage Investment Corporations (MICs) in Canada and many often participate in the same deals. It is conceptually similar to
a mutual fund in design but different in that your funds are secured by the real estate underlying the investment. (If you are considering investing in a MIC, consult your financial advisor and legal counsel before doing so.)
Keep in mind, a MIC doesn’t necessarily structure the mortgage; it simply accesses its pool of funds to participate in the lending on a deal.
2.) Syndicated mortgage: A syndicated mortgage is ideal for investors seeking a specific rate of return for a specific period of time. Where a MIC invests in a portfolio of mortgages, a syndicated mortgage is a group of investors investing in one mortgage at a time. The risk is slightly higher and the corresponding return is slightly higher on these funds.
Types of Real Estate
The essence of private lending stems from individual investors willing to lend their money on deals that typically fall out of bank lending parameters. In other words, there is a supply of funds in the capital markets with an appetite for this investment type.
While there are a multitude of reasons and parameters by which banks will not lend on certain real estate deals, there exists a few common denominators which exclude the chances that a bank will lend their funds.
Having said that, these deals also are inherently riskier and thus the reason the interest rates on these deals are higher. In order to accept this risk, private lenders and individuals (capital suppliers) expect a higher rate of return than what a bank would provide.
The most common characteristics of a deal:
*Short term funding requirements; to bridge the project until alternative financing is warranted. Very often, many real estate projects require short term funding as short as six months to as long as 24 months simply because of the design and nature of it.
These types of deals are often development in nature or a form of project in which the real estate is forcing equity growth and value towards what is known as “highest and best use.” This essentially means the real estate will be improved, changed or in some cases even destroyed in order to create the best value at a future point in time.
*The borrowing entity (person or group of persons) applying for the funds is limited in collateral, capital, experience, credit worthiness, or in some other way. Consequently, these perceived weaknesses may result in borrower falling out of grace with institutional lenders. Assessing the entire package and considering alternatives and options is what a private lender does.
As an example: A borrower who possesses land and wants to build on it may find that banks are unwilling to fund any or all of that deal because the asset is deemed incomplete. Private lenders specialize in construction financing and understand your intentions and goals.
Randy Bett is an Author, Investment Realtor and a Professional Real Estate Investor (along with his Wife and Family) with a Passion for Showing and Teaching Others How to Get Involved in the Real Estate Investing. He has a Special FREE Offer for Newbie and Veteran Investors Alike- 57 Real Estate Investing Video Tips, including What Your Financial Planner is Not Telling You about Investing in Real Estate, Why Most Real Estate Investors Fail, and When to Invest in Real Estate and The Strategies to Use, among many others.