Real estate is one of the most preferred methods of investing because not only does it provide good returns but it also cushions the investor from inflation. Despite real estate being a lucrative investment, as the old saying goes, “it takes money to make money”. Whether you are a developer or an end user, here are some ways you can finance your real estate investment:
Equity — private equity funds raise money from various sources. The main advantages of using equity to fund development include having a relatively long investment horizon of 3-7 years and the returns are based on the project success.
However, you may lose some decision-making power over the development and securing it can be lengthy.
Mezzanine — this can be in the form of preferred stock, or as debt, and is meant to bridge the financial gap between senior debt and the investor’s equity. It has an investment horizon of 1-3 years and is considered a favourable option for companies whose cash flows are restrictive. It is also flexible.
However, acquiring can be lengthy, it is unsecured hence associated with a high cost of capital, you may have to relinquish some control over your firm, and you risk double taxation.
Presales — this refers to early sales made before completion of the project. The revenues obtained from buyers reduce the capital required to fund the project. Presales are easily accessible for products with good sales and have no cost of capital. However, sales are unpredictable thus unreliable,
Senior debt — this is borrowed money that a company must prioritise during payment in the case of liquidation. Here, assets are used as collateral for the loan that has a specified period of within which it must be paid back. Given that it requires collateral, senior debt is less risky. It also attracts relatively low-interest rates of between 10 per cent and 16 per cent but is prone to the volatility of financial policies from the lending institutions.
Savings — this is putting money aside to invest in a real estate project. Savings leverage the power of compounding and thus a potential investor can count on previously saved money for funding
Structured investment products — these are solutions that are packaged by investment professionals to enable an investor access a return supported by the performance of real estate in a form that meets an investor’s needs that would not be met from the standardised real estate products in the market. The main advantage of these funding methods is that they are easily accessible compared to debt financing. However, conflicts that may arise from the partnerships, fewer profits and a need for expertise to structure the product are demerits of this approach.
For end users
Mortgages — a mortgage is a loan specifically used for the purchase of buildings, often residential property. Mortgages are attractive because repayments are monthly, hence easy to budget for.
Additionally, interest tends to be lower than most other forms of borrowing because the loan is secured against your property. On the other hand, you must pay a large deposit, usually 20-30 per cent of the value of the property and in the event, you fail to honour the payments you could lose your property.
Loans — loans can be obtained from banks, saccos and microfinanciers. They help you to obtain a large amount of money quickly and repay in instalments.
However, on the downside you must have collateral, default in payment could attract a lawsuit, and getting them is time-consuming and expensive,
Buying off plan — potential homeowners can also opt to buy a property before it is actually developed. With this arrangement, the buyer can pay for the property in instalments or in full. The advantage is that buyers can obtain property at a discount, and can benefit from potential capital gains.
Crowdfunding — this refers to several individuals coming together to pool financial resources, after which they are able to purchase the property. This is mainly through chamas (business clubs) or local social groups, and the property is thus owned by the team. It is an alternative for those who cannot access loans.
On the other hand, you would have to return money to potential investors if the target amount is not reached, failed projects risk damage to the reputation of the business and people who have pledged money to them, and the public display of an idea risks others copying it.
By Beatrice Mwangi, Assistant Research Analyst Cytonn Investments. Source; businessdailyafrica.com