What’s the best way to buy an investment property? Just as there are many investment strategies, various financing options are at your disposal, each with drawbacks and benefits. While we certainly have avenues we recommend more than others, every investor should be well-informed about every option.
With that said, here’s the rundown on financing options for turnkey investors, how they work, plus the pros and cons!
How it works: Investors use cash to buy the property outright. No loans, no interest rates. Just the total price all at once. All-cash offers may be attractive to sellers and popular among certain investors, but it’s not always the prudent choice.
Pros: The good news about paying in all cash is there are no mortgage or interest payments. The closing process is quicker without the time to underwrite loans, sellers like it, and you have immediate full ownership of the property.
Cons: The problem with buying in cash comes down to a lack of leverage. Say you pay $200,000 for a property. If you financed it using a traditional 20% down, that’s $40,000 to secure the property. You could then acquire five properties with financing for the cost of one in all cash. This strategy hinders the speed of diversification, even if the individual buying process is straightforward.
How it works: If you’ve ever bought a house, you’re familiar with this one. Investors obtain a mortgage loan from a bank or lender, typically requiring a down payment of 20% or more (and sometimes less.)
Pros: The leverage from financing means a lower financial barrier to entry. You can diversify your portfolio more quickly and use less of your own money to generate equity and cash flow.
Cons: Traditional mortgages require an excellent credit score and financial history to secure the best rate. Even then, a high interest rate can diminish profit margins. There may be limits on how many loans you can utilize at once. Monthly mortgage payments will take up initial cash flow; missed payments could result in foreclosure.
How it works: Investors use funds from their self-directed IRA to purchase real estate, with rental income and gains flowing back into the IRA. A traditional IRA has limited available investment assets, but an SDIRA allows real estate.
Pros: SDIRAs, separate from your personal finances, are tax-advantaged and tax-deferred. This means you can invest and reinvest in real estate through the SDIRA without incurring capital gains taxes.
Cons: SDIRAs come saddled with complex rules and regulations, penalties for non-compliance, and limited access to funds until retirement age. It is best utilized for a long-term buy-and-hold strategy.
Further Reading: The Definitive Guide to Self-Directed IRAs and Real Estate Investing
How it works: These short-term loans come from private lenders or investor groups. The interest rates are higher, and the repayment periods are shorter. With the right contact, funding can be quickly secured compared to traditional lending.
Pros: Investors enjoy quick access to funds and less stringent approval requirements than traditional mortgages. The right contacts can provide a reliable, mutually beneficial arrangement.
Cons: Unfortunately, investors will face higher interest rates and fees, shorter repayment periods, and potentially substantial down payments.
How it works: Investors use the equity in their primary residence to secure a line of credit, which can be used to purchase investment properties.
Pros: Investors leverage existing equity in other assets rather than putting cash down. You can access funds without selling assets. Typically, a HELOC has more flexible repayment terms and can even have lower interest rates than other loans.
Cons: A HELOC ties your investment to primary residence equity. If things go south, both the investment property and the primary residence are at risk. Additionally, variable interest rates can increase over time. As with a traditional mortgage, there are threats of foreclosure.
How it works: Investors sell a property and reinvest the proceeds through a qualified intermediary into a similar property to defer capital gains taxes.
Pros: Investors can enjoy tax-deferred growth and upgrade properties without immediate tax consequences.
Cons: A 1031 Exchange can be complex and demands forethought and planning ahead. There are strict IRS rules, tight timelines, and regulations around suitable properties. Conducting an exchange is a wonderful but complex strategy that’s easy to mess up!
Further Reading: Use the 1031 Exchange to Maximize Money You’ve Already Invested
At the end of the day, every individual investor must decide for themselves the best financing option for their goals. Arm yourself with knowledge, weigh your options, and take the path that best serves your strategy!
Not sure? Your turnkey advisor is here to answer your questions!