Asset-based real estate financing
For real estate investors focused on purchasing, rehabilitating, and reselling homes, asset-backed lending can help them move quickly when buying properties that may not qualify for more traditional financing.
What does asset-based financing actually mean?
In short, it’s a loan that is secured by real estate and underwritten with a focus on the asset’s current state, value after repairs are completed, and marketability rather than a long-term repayment plan based on the borrower’s income, other debts, and credit.
As a result, asset-backed financing (there’s a decent explainer at www.investopedia.com/terms/a/assetbasedlending.asp) is most commonly used by real estate investors looking to purchase distressed or fixer-upper properties and doesn’t work for all buyers or all homes. Before making an offer on a home using asset-backed financing, it’s important to have a plan, including a realistic budget for completing necessary repairs and renovations, as well as an exit strategy.
Where does it differ from a traditional home loan?
Short-term, asset-backed financing can be useful for real estate investors in certain situations, such as:
- When a promising investment property could slip through the cracks without quick financing
- When a home needs extensive repairs, like an outdated kitchen or addressing water damage, that could disqualify it from financing
- When renovations on a property are unfinished
The property matters more than the borrower
Since asset-backed financing is focused on real estate investment rather than a long-term home loan for a primary residence, second home, or even long-term investment property, these loans may come with less-than-ideal terms, including higher interest rates and fees and shorter repayment terms than you may find with traditional home financing. Learn more here. Asset-backed financing can be an option for real estate investors when they need to move quickly or are interested in homes that would not qualify for financing, but borrowers should weigh less-favorable financing terms against other costs they could incur without access to this type of financing.
You still have to crunch every number
- Purchase price and closing costs
- Cost of repairs or renovations
- Interest and loan fees
- Holding costs, such as utilities, insurance, maintenance, and property taxes while you own the property
- Timeline to complete renovations, including room in your budget for potential delays
- Cost to refinance or sell the home when you exit the investment
Real estate renovation budget planning
Loan terms affect cash flow from day one
If a loan limits access to funds with a draw system, it’s important to keep this in mind when thinking about your cash flow needs from the get-go. Investors considering a hard money lender in Tennessee should compare the loan structure with the project’s draw schedule and cash-flow needs. Depending on the timing of draws, which may be contingent on factors such as completed work verified through an inspection and supporting documentation, like contractor invoices, you may need to cover costs out of pocket until you’re reimbursed by the lender.
What should you ask before applying?
- What’s the maximum loan amount I can qualify for, and how is this amount determined?
- Can I use loan proceeds for renovations and repairs?
- When will monthly loan payments begin?
- How is interest calculated? Will I pay interest on the entire loan amount I was approved for, or just the amount that’s been funded?
- What are the prepayment terms? Are there extension options?
- Are there requirements for appraisals, insurance, inspections, or construction draws?
- What happens if my project takes longer than expected?
Your exit plan has to hold up
Asset-backed financing also comes with costs, including interest and fees, that could eat into an already slim profit margin. Depending on your investment strategy and goals, the costs of asset-backed financing may outweigh the benefits.
Asset-backed financing may not be worth it if your numbers only pencil out when everything goes perfectly. Ideally, the numbers should still work if contractor costs end up higher than expected, your contractor cancels last minute, or it takes a little longer to resell the property.
That said, asset-backed financing can help real estate investors move quickly to snag a deal when purchasing a fixer-upper, and that may be just enough of an edge to walk away with the investment before another investor swoops in. After all, sellers are more likely to accept an offer when a buyer can show proof they’ll be able to close quickly.
Double down on the exit strategy
Most borrowers who use asset-backed financing to purchase a fixer-upper plan to either sell the property once renovations are complete or refinance into more traditional, long-term financing. Either way, it’s important to have and vet an exit strategy in place from the get-go.
If you plan to sell, make sure you’re not banking on every penny you spend on improvements adding back on in value. While some renovations may be must-haves to make your investment competitive in the market, others may fall flat, particularly if the upgrades are more luxurious than what other homes and buyers in that price point expect.
If you plan to refinance, make sure you understand how your credit, income, home value as determined through an appraisal, and property, including its condition and any projected rental income and related operating costs if you plan to rent it out, could impact your eligibility for and terms on long-term financing down the road.
The bottom line: Vet your exit strategy before finalizing the numbers on your purchase strategy.
Financing won’t rescue a bad investment
The numbers should make sense before you apply for any financing, including asset-backed loans for real estate investors. Make sure you have a solid plan, including a realistic scope of work to complete repairs and renovations, vetted and reliable contractors, wiggle room in your budget for unexpected costs, and a solid exit strategy that will help you pay back your loan.
When you’re eyeing an investment property, double-check the numbers, including your purchase contract, repair budget, after-repair value estimate, and financing terms, before making an offer.
