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Real estate

Real Estate Financing: A Detailed Guide to Options Developers Have in 2022

Written By Valerie Mhere Community Manager
Last Updated: 2022-05-03 •

When it comes to real estate financing, every developer needs to know what options are available. Wondering how to become a property developer with no money? The simple answer is: you can’t. 

Real estate requires capital, and this article will give you all you need to secure real estate financing for any development project. 

The Capital Stack and How it Works?

A capital stack is the layers of financing required for a development project. This stack has four elements and outlines debt and equity. The four main elements of a capital stack are:

  1. Senior debt
  2. Mezzanine debt
  3. Preferred equity
  4. Common equity

 

The capital stack also highlights the priority of debt repayments for all financial parties. Let’s look at the image below (insert image):

Common equity is the lowest priority because you only get common equity once you've repaid all financial parties. This layer of the capital stack also has the highest risk and return. At the bottom, senior debt is the first priority with the lowest risk and lowest return. The mezzanine debt would typically be a second mortgage. 

 

Real Estate Development Stages and the Funding for Each Stage

You’re going to acquire different real estate financing for various milestones of your development project. There are four main stages of a development project. These stages include site selection and land acquisition, pre-development and land entitlement, development and construction, post-construction, and operation. 

Each stage of the project requires its own equity and debt financing based on the milestones risk and how likely it is to succeed.

 

Real Estate Development Stage

Description

Real Estate Financing Required

Site selection & land acquisition

This is a very risky stage of the project as developers need to conduct land evaluations, due diligence, and assess the environmental features of the land. 

Developers need equity and land loan

Pre-development & land entitlement

This stage is when you’ll review zoning regulations, requirements for a permit, and any subdivision requirements. Due to rezoning, this is a stage with high risk. 

Developers need an equity or construction loan

Development & construction

Now you have all the necessary permits and rezoning procedures. You can start executing all construction steps. 

Developers need an equity or construction loan

Post-construction & operation

Once construction is complete, you can develop an exit strategy. Instead of an exit strategy, you can employ a property management team. The latter option is for developers who plan on managing the commercial property and not selling it. 

Developers need equity or permanent operating loan

 

 

5 Types of Real Estate Development Loans

Development Loans

To understand how to make money as a real estate developer, know how to secure capital. You can do this through several loans. Here are the top five real estate development loans available. 

Development loans

would also be considered equity loans. These loans are the money developers acquire to make developments and improvements on the land. These development activities include constructing roads and enhancing the current infrastructure. Developers need to get these loans to turn vacant land into established commercial real estate. 

Acquisition Loans

The point of acquisition loans is to get money to buy land. Usually, developers get acquisition land when they have no intentions of constructing anything. You can’t do anything more than land acquisition with these loans. If you want to do more than acquire land, get subsequent loans. 

Acquisition And Development Loans

If you plan to acquire land and make developments, you can get a hybrid of both loans. This loan is much more flexible and versatile than sole development and acquisition loans. 

Construction Loans

Construction loans are as the name suggests. Developers use these loans to make building renovations and construct real estate. Unlike other loans, you don't get a lump sum of money. Instead, construction loans come in monthly payments. 

Permanent Operating Loans

While these loans aren’t permanent, they have longer repayment terms than typical loans. Developers can apply for permanent operating loans to cover costs for all aspects of their development project. These costs include construction, expenses, and development costs. 

10 Sources to Generate Real Estate Financing

Now that you know what loan options you have, consider the top ten sources for real estate financing. 

1. Traditional Financing
Developers can find traditional loans at an institutionalized lender or registered bank. The interest rates for these loans aren’t too high, and there are flexible repayment terms. Yet your repayment terms will be lengthy, ranging anywhere from 15 to 30 years. 

A few disadvantages of traditional financing are that the application process is slow, and banks usually cap the number of loans you can take. It would also be difficult for entities to apply for traditional financing, and your property must be in good condition. 

2. Venture Capitalists
Venture capitalists are often highly successful networks of people or a corporation. These parties invest in startups they see value in. The advantage of funding from venture capitalists is that the borrowing amount is often much higher than traditional financing. It’s also a lot more personal than other real estate financing options.

The problem most real estate developers face with venture capitalists is winning them over. There is high competition to convince these investors, and they’re highly selective. 

3. Private Lenders
Private lenders aren’t licensed to lend money, but they’re anybody who has the expenditure to invest in your project. A private lender can be your neighbor, a friend, or a close family member. Because these lenders are less regulated, it may be easier to gain their interest in your real estate development project.

Your loan repayment term will also be much shorter with private lenders. But the interest rates are higher. Private lenders may charge three to four times more interest than traditional loans. 

4. Crowdfunding
When it’s not possible to get a single entity or lender to take the risk of financing your project, ask multiple people. Crowdfunding is when a large pool of people invest in a project. This real estate financing option works because you can negotiate interest rates and repayment terms. Crowdfunding is also becoming a popular way to source financing, as, by 2019, the market hit $84 billion

5. Angel Investors
Angel investors are accomplished people who love investing in startups they believe in. In exchange for their investment, angel investors often want equity in your project or convertible debt. A significant advantage of these investors is that they aren’t afraid to invest in projects with high risk.

6. Micro Loans
If your project is small, consider microloans. Microloans lend up to $50,000, and many real estate developers only take a portion of that. While these loans are much easier to get from banks compared to traditional loans, it’s not likely the loan amount will cover everything you need. 

It’s good to know that microloans aren’t such a complicated process as traditional loans. The interest rates are also low. 

7. Funding Partner

Funding partners are people who have the capital to come together and fund a project. Many investors prefer this method as there is less risk for each investor. If you don’t have enough capital to fund your project, network with professionals who may invest some money too.

8. Commercial Loans

Banks offer commercial loans primarily for commercial property. These loans have long repayment durations with low-interest rates. Commercial loans are also quite restrictive, but the borrowing amount is high. It’s not easy to get approved for commercial loans because of the low-interest rates and high loan amounts. 

Like traditional loans, commercial loans offer an extensive application process. So, this is certainly not a quick solution for real estate financing. Over one year, commercial loans saw an increase of $364 billion, proving how many professionals turn to these financing options. 

9. Hard Money Lenders

Hard money lenders aren’t institutionalized like banks, but they are regulated to lend money. A hard money lender is an establishment, not a single individual with capital. The application process is swift, and the requirements are flexible for these loans. 

The downside to hard money lenders is the repayment terms are very short. Your interest rates will be high too, and there is a risk of foreclosure if you can’t repay the loan. 

10. Home Equity Loans

Home equity loans are loans that use the property as collateral. This means you’ll have a second mortgage on your home, which isn’t ideal. Plus, taking equity from your home decreases its value. But many homeowners see this as their only solution. Over ten years, home equity loans increased by $12 trillion. 

It’s not all negatives with home equity loans. These loans have a fixed interest rate, and there is tax-deductible interest too. The repayment terms are also long, giving you enough time to settle your loan.

 

 

The Bottom Line

Financing for real estate is a vital part of any developer's projects. The kind of financing you need varies between stages of your development project. There are tonnes of options available to you. Be strategic about the real estate financing option you choose, and understand all the risks and requirements that come with it. 


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Valerie Mhere Community Manager

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