If you’re unfamiliar with gap funding for real estate then think of the phrase, “bridging the gap.” Gap funding lenders basically loan you bridges of money to get from the small loan that you have to the larger amount of money that you need. It is sometimes called gap financing and is considered second position financing. It’s most typically used for fix and flip style investors and as a home construction loans for builders.
How Does It Work?
For example, you want to purchase a property that’s $100,000 but it also needs about $40,000 in renovations before you can flip it. You’ve only been approved for $100,000. You’re so close and you just know this property will turn out profitable for you. This is where you go to a gap funding lender to get you that extra $40,000.
Gap funding for real estate can be a powerful tool to help achieve your goals. It’s considered a Second Position Loan, basically meaning that you already have an unpaid debt, and are adding additional on. That may sound scary, but it doesn’t have to be.
What Are the Benefits?
What do you gain from using a gap funding lender? For starters it enables you to take less cash to a deal. There’s a possibility you can come to a deal with no cash and still walk away with revenue. You could increase your cash-on-cash Return of Investment. It can bring relief from interest payments but utilizing the gap loan to cover for the first position loan. And for the go getters out there, it allows you to increase the amount of deals and projects you can have going at one time.
Who Is It Made for?
The typical people who use gap funding are real estate investors and builders. These people are often working with high end real estate promising a good amount of profit. An investor should be confident they could repay a gap loan in a short timeframe. Gap funding is not recommended for novices. These are people who know what they’re doing, but due to certain circumstance need a little extra help. What circumstances you ask?
Here are circumstances where gap funding for real estate makes the most sense:
- The project is finished, but took longer than expected. The investor has it on the market but needs reprieve with monthly interest payments.
- The investor wants to be ready for another potential deal or opportunity. They have the money in the bank but prefer to keep it liquid.
- The renovation money from the hard money lender has been used up, but the property is almost ready. They investor wants to get it done and on the market as soon as possible but needs a little extra cash.
- The investor anticipates a quick deal and wants to reduce out of pocket expense in order to fully realize their cash on cash yield.
There are risks to gap funding lenders; these are often higher risk than hard money lenders. Thus, the interest rates for gap funding are higher. Occasionally the funder may also request additional benefits. It’s important to work with someone who’s trustworthy and experienced on both ends. You should only use gap funding for real estate when you are confident you can repay the loan and make a profit.
How Do You Get Gap Funding?
This may go without saying, but, you should already have a property and project in mind. You don’t look for a gap loan first. You look for a gap loan to help you complete a project you’ve already found. You definitely want to do your research and evaluate all the relative factors, like cost and value. This includes but is not limited to:
- Current property value
- Purchasing price
- Property/home value after renovations
- Hard money loan
- Any additional costs
You also want to do your research when deciding who you want to get a gap fund from. You can get them from small investment groups, individuals, etc. Expect to give detailed information when making your request. A lender will want your business history and health, your credit store, the details for the project and all the typical cost information.
When you find someone you can trust who understands your vision and believes in your project you will have found your gap funding lender! All places will have an application process but if you’ve done all the homework mentioned above you should have all the information you need handy already.
What Happens Next?
You will come to a deal with your gap funding lender. There will be terms that involve paying back the lender and/or giving them a portion of sale profits. You’ll have a time frame to complete that which will likely be a bit shorter than that of a hard money loan.
Once you have the money you need get the material and resources required to finish your project. Once it’s complete you can list your property on the market. As an experienced investor you should have a go-to market strategy figured out ahead of time. You should also have reasonable expectations of how long it should be on the market.
After you’ve made your sale, your profit, and the payments expected of you then you can just sit back and enjoy the fruits of your labor!