Investors looking to purchase investment properties have several financing options. The type of financing you choose will significantly impact your bottom line. Understanding what each option entails ensures you leverage the best financing for your investment goals.
The most popular real estate finance is conventional bank loans. It is structured such that the income from the property services the loan. Lenders evaluate your assets, income, credit score, and credit history to determine your ability to repay your debt. Your financial history and status will also dictate your interest rate. Next, you put down a percentage of the property’s sale price. The main advantage of conventional loans is that they typically have relatively lower interest rates. What’s more, you get a 15 to 30-year repayment period. Traditional loans are, however, hard to qualify for. Strict pre-approval requirements like lower debt-to-income ratio and higher credit score, not to mention considerable paperwork, can be off-putting. Then there’s hard money loans. They’re short-term loans by individuals or private companies. Unlike traditional loans, where you pay back over years, repayment for a hard money loan is prompt and in full. Hard money financing is ideal for house flipping - purchasing a house for resale, not renting. It’s also ideal if your credit score or credit isn’t all that impressive, as hard money lenders focus on the property’s value and whether the estimated after-repair value can offset the loan. They, however, come with interest rates of up to 18 percent or more depending on the lender and repayment period. The third real estate finance option is to tap into your home equity. Home equity is the portion of your property that you own outright – equity you get as soon you make a down payment. The main advantage of home equity is access to lump sum cash. You can borrow up to 80 percent of your home’s equity to acquire or renovate an investment property. Also, home equity interest rates are relatively low because your primary residence serves as security. Even so, home equity interest rates tend to be variable, which may complicate financial planning. Another major drawback is that you can only access loans up to the value of the available equity. Another option is commercial loans. They are popular among investors looking to invest in commercial real estate, such as mixed-use, industrial, and multi-family residential properties. Commercial loans have shorter repayment periods than residential loans, ranging from five to 20 years. Commercial loans are ideal for financing huge projects due to their higher borrowing limits. Also, interest rates on such loans tend to be competitive, especially for investors with solid credit history and a viable business plan. Unfortunately, commercial loans are hard to qualify for due to extensive documentation and large down payment requirements that only wealthy investors can meet. Another option is to get a loan from friends or family, also known as a private money loan. You can also look for potential financiers at local real estate events. How favorable the terms are will depend on the type of relationship you have with the lender. Private money loans are devoid of the documentation requirements associated with typical loans. As such, they are ideal for taking advantage of short-term investment opportunities. Also, private money loan terms are less rigid. However, they may come with high interest. Moreover, such arrangements are not regulated, meaning little to no protection. You may take two different loans simultaneously. For example, you acquire a property using a hard money loan and then pay it off with a conventional loan, home equity loan, or private money loan. Real estate financing allows investors to acquire property without paying in full. The trick is to find an option that benefits you, not one that makes you work for your lender. Even so, owning property isn’t the only way to invest in real estate. For example, with private equity real estate, you invest via a fund. Many other investment options allow for such an arrangement.
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The Federal Reserve functions as the central bank of the United States. Headquartered in Washington, DC, the Federal Reserve is a complex federal agency led by a Board of Governors and consisting of 12 Federal Reserve Banks throughout the US. The agency was established via the passage of the Federal Reserve Act of 1913, which outlined a more reliable and resilient national monetary system. The Federal Reserve Act was authored and authorized in response to several economic challenges facing the nation.
Many of the issues that led to the creation of the Federal Reserve had existed since America's founding. Numerous pundits and policymakers had raised the issue before 1913. However, reforming the national banking system was a daunting task, complicated by the competing interests of political parties, government agencies, and private interest groups. America's banking system was decentralized prior to the Civil War, with most banks operating under state charters. Around this time, only two of the country's banks had federal government charters. These banks were viewed as controversial government installations by proponents of states' rights and limited federal influence, including Thomas Jefferson. As a result, these banks, both carrying the name Bank of the United States, were shut down. Over the next several decades, public opinion of the national banking system remained largely negative. The Civil War and the Reconstruction period provided opportunities to reassess banking operations in the United States. In response, the government enacted a series of National Banking Acts, which established federal charters for banks, although these charters differed from those used before the Civil War. A key difference was that the newly chartered federal banks were entirely privately owned and operated. Both the public and the US government initially espoused nothing but antipathy towards the new federally chartered banks. This mistrust manifested additional prohibitions, making it difficult for federal banks to remain competitive with banks operating with state charters. However, the rise of thousands of single-office banks, called unit banks, resulted in widespread instability, as most offices struggled to grow to a size that allowed for efficient banking operations. When paired with the relative inelasticity of the US currency of the day, unit banking resulted in a national system of banks that were vulnerable to many financial crises. Once again, political leaders found themselves trying to overhaul a banking system while balancing the competing needs of large metropolitan banks and smaller offices in rural areas, as well as the longstanding conflict between states' rights advocates and those promoting the benefits of federal banking regulations. A political solution was eventually found after the Panic of 1907, when in December 1913, Congress passed, and President Woodrow Wilson signed the Federal Reserve Act. Opponents finally reached an agreement, the Federal Reserve Act of 1913, following the Panic of 1907. The panic occurred during a three-week period when the New York Stock Exchange plunged 50 percent below its 1906 peak. A wave of bankruptcies hit state banks throughout the nation. A series of lesser financial crises followed, prompting Senator Nelson W. Aldrich to lead an investigation into the national banking system. His efforts led directly to the creation of the Federal Reserve System. Selling a property that has increased in value considerably can be a cash cow for investors if you can avoid capital gains taxes. These taxes are the bane of existence for investors, taking as much as 37 percent if the asset (property) was held onto for only a year. According to a February 2025 Kiplinger article, the installment sale strategy can help sellers reduce capital gains taxes while allowing buyers to finance the purchase.
Capital gains taxes apply to profits from selling stocks, bonds, real estate, and other investments. Short-term capital gains (assets held for less than a year) are taxed as ordinary income at rates between 10 percent and 37 percent. Long-term capital gains (assets held for more than a year) have lower tax rates of 0 percent, 15 percent, or 20 percent. One strategy for mitigating losses from capital gains taxes is to get buyers to pay for your property through an installment sale instead of being paid one lump sum. By strict definition, an installment sale involves a buyer who makes at least one payment after the year of the sale. However, an installment sale typically consists of a seller receiving a smaller payment (down payment). Then, the seller pays the rest of the payments over multiple years. For example, a seller who bought a property for $600,000 and sells it for $1 million has a capital gain of $400,000. Instead of receiving the full amount at once, the seller could arrange for the buyer to pay $200,000 upfront and the rest over five years. With a 15% capital gains tax rate, this reduces the tax owed in the first year to $30,000, compared to $60,000 for a lump sum payment. By spreading payments over several years, sellers can defer their tax liability and potentially benefit from future savings if they fall into a lower tax bracket. This strategy also aligns tax payments with income received, helping sellers avoid a large tax bill all at once. Who would benefit from this approach to selling property? Usually, sellers who purchase the property for business purposes benefit from this strategy. Personal property, business assets, and anything that qualifies as real estate are eligible for the installment sale. Assets not qualifying for installment sale are inventory, publicly traded securities, or properties that depreciate and are sold to relatives. While installment sales can save sellers money, this approach comes with some considerations, including properties with an existing mortgage. Sellers must pay off the mortgage during the sale, which cuts into profit. Even so, sellers have options, such as rolling the mortgage loan into a new loan. Also, installment payments tie up the seller's funds because they do not receive payment for some time. Additionally, the buyer might consider paying off the loan early, which might trigger capital gains taxes on the remaining portion of the money earned on the real estate sale. Finally, the seller must consider that tax laws are bound to change, decrease, or increase. In general, the installment sale approach to avoiding capital gains taxes is one way to help a buyer finance a property while reducing tax liability. However, each investor's situation is unique, and this might not be the best approach to reducing tax liability on a sale. Ideally, investors could project future income by analyzing current and historical multifamily market performance. However, most markets are competitive, making accurate projections challenging. Supply and demand dynamics constrain income components, such as occupancy rates and rent. Multifamily real estate investors should thus be aware of the dynamics below and learn how to navigate them.
Economic conditions directly correlate to housing supply and demand. Strong job markets in industrial areas attract individuals and families, increasing housing demand. Conversely, areas with weaker job markets see the opposite. In strong job markets with high incomes, developers may increase premium multifamily housing, while in lower-income areas, they may add more affordable units to meet rising demand. On the other hand, job insecurity and reduced income as a result of economic recessions may lead to decreased consumer confidence, causing developers to scale back on new projects. Public health crises are also significant drivers of multifamily property supply-demand, as seen during the pandemic. As people switched to remote work, there was a heightened demand for spacious living arrangements in less densely populated areas, leading developers to focus on building apartments over single-family units. Economic uncertainty during this time also made renting more appealing than purchasing a home. However, this construction surge in multifamily properties during the pandemic led to an increase in supply. The influx of new units raised oversupply concerns in several US regions. High vacancy rates followed this supply-demand imbalance. Multifamily property owners and managers also struggled to raise rents due to the surplus. Demographic trends are another factor affecting supply and demand. Besides population increase and urbanization, which increase demand for multifamily housing and rental rates, generational factors are also key. Developers in urban areas target younger generations like millennials due to their preference for flexibility, convenience, and amenities such as high-speed Internet. Developers know these additions increase demand. For older generations, like baby boomers seeking to downsize, demand results from developing properties catering to their needs, such as low-maintenance living, accessibility features, and proximity to healthcare. Environmental factors and shifting tenant preferences are other integral supply-demand drivers. Climate change and natural disaster concerns may lead people to seek resilient housing in less vulnerable areas. Natural disasters also lead to significant demand fluctuations in affected regions, affecting property values and desirability. Regarding tenant preferences, environmental sustainability is worth an investor’s consideration. Multifamily apartments with smart technology and eco-friendly materials are in high demand compared to other market offers. Lifestyle amenities like fitness centers and co-working spaces also influence demand. Financial factors impact multifamily property investment. When interest rates are high, few investors borrow money to acquire or develop multifamily units, resulting in decreased construction activity. This reduction can create a supply-demand imbalance and potentially increase rental rates. The reverse is also true. There are more construction activities due to low interest rates and readily available debt and equity financing, which gives more investors greater capital access. Investors also have multiple financing options, including crowdsourcing or real estate investment trusts. Government regulations and policies affect multifamily housing supply and demand. Zoning regulations—by restricting new development and dictating where and how densely housing can be built—can create housing shortages in a given area. Additionally, rent control measures, even though seeking to maintain housing affordability, discourage investment in new multifamily units by making them less profitable. However, governments can stimulate development and address housing shortages—particularly for households with low incomes—by offering tax incentives and housing subsidies. |
AuthorKC Kronbach – Dallas’s Caliza Capital Co-Founder ArchivesCategories |