Throughout my real estate investing career, I’ve spent many dozens of hours speaking with lenders and potential financiers of my deals. With all the different types of loans and equity financing products available to investors these days, it’s important to have a good understanding of the benefits and the drawbacks of each, so you can choose the most appropriate financing option for your particular need(s).

Of course, given today’s credit situation, options are not only more limited than they were a couple years ago, but the definition of a “good deal” from a lender has changed as well. When I first started looking at financing for single family houses, I passed on a couple potential options that in hindsight were pretty good given today’s tight credit market; so it’s important to not only understand the types of financing that’s out there, but also which types are most prevalent and most easy to come by.

The point of this article is to define the four most common types of financing available to real estate investors; while there are, of course, more than four ways of financing real estate investments, most are a derivative — or combination — of the four we will discuss here.

1. Traditional Financing

This type of loan is generally done through a mortgage broker or bank, and the lender may be a large banking institution or a quasi-government institution (Freddie Mac, Fannie Mae, etc). The requirements to qualify for a loan are based strictly on the borrower’s current financial situation — credit score, income, assets, and debt. If you don’t have good credit, reasonable income, and a low debt-to-income ratio (i.e., you earn a lot compared to your monthly obligations), you likely won’t qualify for traditional financing.

Benefits: The benefits of traditional financing are low-interest rates (generally), low loan costs (or points), and long loan durations (generally at least 30 years). If you can qualify for traditional financing, it’s a great choice.

Drawbacks: There are a few drawbacks to traditional financing for investors, some major:

The biggest drawback to tradition financing is what I stated above — it’s difficult to qualify these days. Just a year or two ago, you could have qualified under a “sub-prime” variation of traditional lending, where income and credit were less of an issue; but given the sub-prime meltdown (many of these borrowers defaulting on their loans), these sub-prime options have gone away. So, unless you have good credit, income, and small debt, you’re better off not even bothering with trying to get traditional financing these days.
Traditional lenders generally require that at least 20% be put down as a down payment. While this isn’t always true, investor loans with less than 20% down can be tough to find via traditional lending these days.
As an investor, it can be difficult to deal with traditional lenders who don’t necessarily understand your business. For example, a house I closed on last week with traditional financing almost fell-through because the lender wouldn’t provide the funds until the hot water heater in the investment property was working. As an investor, it’s common that I’ll buy houses with broken hot water heaters (among other things), and I can’t generally expect the seller to fix this for me, especially when my seller’s are usually banks. In this case, I had to fix the hot water heater before I even owned the house, which is not something I want to do on a regular basis.
Traditional lenders take their time when it comes to appraisals and pushing loans through their process. It’s best to allow for at least 21 days between contract acceptance and close. As an investor, you often want to incent the seller to accept your offer by offering to close quickly; with traditional lending, that can often be impossible.
If the lender will be financing through Freddie Mac or Fannie Mae (and most will), there will be a limit to the number of loans you can have at one time. Currently, that limit is either 4 or 10 loans (depending on whether it’s Freddie or Fannie), so if you plan to be an active investor going after more than 5 or 10 properties simultaneously, you’ll run into this problem with traditional lending at some point.
There are no traditional loans that will cover the cost of rehab in the loan. If you plan to buy a $100K property and spend $30K in rehab costs, that $30K will have to come out of your pocket; the lender won’t put that money into the loan.
2. Portfolio/Investor Lending
Some smaller banks will lend their own money (as opposed to getting the money from Freddie, Fannie, or some other large institution). These banks generally have the ability to make their own lending criteria, and don’t necessarily have to go just on the borrower’s financial situation. For example, a couple of the portfolio lenders I’ve spoken with will use a combination of the borrower’s financial situation and the actual investment being pursued.

Because some portfolio lenders (also called “investment lenders”) have the expertise to actually evaluate investment deals, if they are confident that the investment is solid, they will be a bit less concerned about the borrower defaulting on the loan, because they have already verified that the property value will cover the balance of the loan. That said, portfolio lenders aren’t in the business of investing in real estate, so they aren’t hoping for the borrower to default; given that, they do care that the borrower has at least decent credit, good income and/or cash reserves. While I haven’t been able to qualify for traditional financing on my own due to my lack of income, portfolio lenders tend to be very excited about working with me because of my good credit and cash reserves.

Benefits: As mentioned, the major benefit of portfolio lending is that (sometimes) the financial requirements on the borrower can be relaxed a bit, allowing borrowers with less than stellar credit or low income to qualify for loans. Here are some other benefits:

Some portfolio lenders will offer “rehab loans” that will roll the rehab costs into the loan, essentially allowing the investor to cover the entire cost of the rehab through the loan (with a down-payment based on the full amount).
Portfolio loans often require less than 20% down payment, and 90% LTV is not uncommon.
Portfolio lenders will verify that the investment the borrower wants to make is a sound one. This provides an extra layer of checks and balances to the investor about whether the deal they are pursuing is a good one. For new investors, this can be a very good thing!
Portfolio lenders are often used to dealing with investors, and can many times close loans in 7-10 days, especially with investors who they are familiar with and trust.
Drawbacks: Of course, there are drawbacks to portfolio loans as well:
Some portfolio loans are short-term — even as low as 6-12 months. If you get short-term financing, you need to either be confident that you can turn around and sell the property in that amount of time, or you need to be confident that you can refinance to get out of the loan prior to its expiration.
Portfolio loans generally have higher interest rates and “points” (loan costs) associated with them. It’s not uncommon for portfolio loans to run from 9-14% interest and 2-5% of the total loan in up-front fees (2-5 points).
Portfolio lenders may seriously scrutinize your deals, and if you are trying to make a deal where the value is obvious to you but not your lender, you may find yourself in a situation where they won’t give you the money.
Because portfolio lenders often care about the deal as much as the borrower, they often want to see that the borrower has real estate experience. If you go to a lender with no experience, you might find yourself paying higher rates, more points, or having to provide additional personal guarantees. That said, once you prove yourself to the lender by selling a couple houses and repaying a couple loans, things will get a lot easier.
3. Hard Money
Hard money is so-called because the loan is provided more against the hard asset (in this case Real Estate) than it is against the borrower. Hard money lenders are often wealthy business people (either investors themselves, or professionals such as doctors and lawyers who are looking for a good return on their saved cash).

Hard money lenders often don’t care about the financial situation of the borrower, as long as they are confident that the loan is being used to finance a great deal. If the deal is great — and the borrower has the experience to execute — hard money lenders will often lend to those with poor credit, no income, and even high debt. That said, the worse the financial situation of the borrower, the better the deal needs to be.

Benefits: The obvious benefit of hard money is that even if you have a very poor financial situation, you may be able to a loan. Again, the loan is more against the deal than it is against the deal-maker. And, hard money lenders can often make quick lending decisions, providing turn-around times of just a couple days on loans when necessary. Also, hard money lenders — because they are lending their own money — have the option to finance up to 100% of the deal, if they think it makes sense.

Drawbacks: As you can imagine, hard money isn’t always the magic bullet for investors with bad finances. Because hard money is often a last resort for borrowers who can’t qualify for other types of loans, hard money lenders will often impose very high costs on their loans. Interest rates upwards of 15% are not uncommon, and the upfront fees can often total 7-10% of the entire loan amount (7-10 points). This makes hard money very expensive, and unless the deal is fantastic, hard money can easily eat much of your profit before the deal is even made.

SRED Financing is your firm’s ability to take immediate cash flow and working capital advantage of our SR&ED tax credit claim. This program, (formal name = Scientific Research and Experimental Development) is bar none the best tax incentive program in Canada. Other than being taxable as income the refund you receive from the government is a non repayable grant. What could be better than that?

The irony in this great program is simply that almost 70% of companies in Canada that are eligible for the program do not even apply, let alone receive their funds! It clearly is a source of untapped cash flow and working capital for your Canadian business that should be maximized to the hilt.

The other 30% of Canadian firms who use the program utilize it around their efforts to develop new products and services, building prototypes, and solving technological challenges.

So your Canadian controlled private company utilizes and files SRED filings. Did you know your claim can be financing immediately after you file it, literally the same day. Specialists that work as ‘SR&ED consultants are experts in preparing your claim and in Canada your SRED claim can be prepared at your cost – and you keep all the proceeds of the government grant, or alternatively, your claim can be done on a contingency basis, at no cost to yourself, and the consultant usually keeps anywhere from 10-30% of the total refund received.

However most Canadian business owners and their SRED consultants do not know that your claim can be financing, either during the preparation of your claim, (yes, before your file, if you qualify!) or immediately on filing of your claim.

Generally with this type of financing you receive immediately approximately 70% of the value of your claim. The other 30% still comes back you of course, but its simply a bit of a buffer to cover financing costs and any risk that a portion of the claim will be disallowed or clawed back.

When we think in terms of specialty financing we can categorically state that SRED financing is specialty financing in Canada. We urge clients to locate a business financing advisor who has credibility, experience and background in this area.

The SRED financing process is not as complicated as you seem if you are well prepared and have access to good assistance. Its as simply as completing a basic business financing application, ensuring proper back up is in place and valid. That includes info on your company, the SRED claim itself, your previous SRED claims if you have filed previously etc.

The reality is that SRED financing can be completed within 2-3 weeks of starting the process. The beauty of this type of financing is that no payments are made on the SRED loan. In effect you can say that you have factored or discounted the SRED claim. You are simply waiting for your cheque from Ottawa, and are making use of the working capital and cash flow now. That’s a solid interim financing strategy for many firms, and that cash can be used for reduction of payables, investments in new equipment, additional staff, etc. The bottom line = any general worthwhile corporate purpose.

In summary, of course ensure you are taking advantage of Canada’s Sr&Ed program. Once that is the case you have the option of financing your claim, allowing you to maximize the true benefits of the program, i.e. the recovery of your R&D expenses in the most time efficient manner possible. That’s a solid financial strategy.

Supply Chain Finance can also be known as Supplier Finance or Reverse Factoring. The term “supply chain” in this context is used to refer to the network of organisations and activities involved with producing, distributing and paying for goods and services provided by one or more suppliers to a single customer. For example a large company being supplied by numerous smaller businesses. “Supply Chain Finance” refers to the provision of finance to a number of supplier businesses, within a single supply chain, under one umbrella arrangement that has been initially set up by the customer at the top of the supply chain.

An example of Supply Chain Finance would be where a supermarket is purchasing products from a wide range of smaller suppliers. The supermarket will arrange a Supply Chain Financing agreement with a financier such that all of their suppliers have the option of accessing finance under the umbrella arrangement. This is often provided at competitive rates that reflect the size of the supermarkets business rather than the size of the individual supplier businesses. In this way, the suppliers benefit from the arrangement as they are able to access finance at much lower rates than they would typically be able to achieve in their own right.

Some arrangements may be as simple as funding the outstanding sales invoice to the supermarket or similar large business, but in some cases there may be other services bolted onto the arrangement to help improve the management of the entire supply process.

The Benefits of Supply Chain Finance
The benefits of Supply Chain Finance to the large business arranging it in respect of their suppliers is that they are able to enjoy credit periods from their suppliers. These are being funded at competitive rates that their individual suppliers may not have been able to achieve in their own right. This will encourage their suppliers to continue to provide that level of credit when they may not otherwise have been able to afford it.

The key benefit from the perspective of the suppliers within the arrangement is that they are able to access finance at rates that would normally be reserved for businesses that are much larger, for example, national or global supermarket chains.

In recent times we have seen a few examples of this type of arrangement being established by some major companies and these types of arrangements can be provided by a number of funders that also provide more traditional invoice finance and factoring facilities.

Alternative to Supply Chain Factoring & Reverse Factoring
However, a Supply Chain Finance or Reverse Factoring arrangement may not always be the right answer for a particular supplier as there can often be other issues that cause a supplier to seek a facility that is independent of their customer. An example might be not wishing their financing to be connected to their customer. The take up of a Supply Chain Finance arrangement may not be unanimous amongst the suppliers to a particular business and each situation needs to be reviewed on its own merits and compared with other options available independently within the market.

The Future
Although Supply Chain Finance appears to have taken off relatively slowly within the UK so far there are examples of new arrangements emerging and the product is likely to feature increasingly within the Invoice Finance market.