Category: Education

Private lending for real estate occurs when an investor uses their own capital in order to lend money to individual investors while securing the main property with a mortgage. This capital can also be placed into a managed real estate fund. Private lending is considered to be a viable alternative to large banks and similar financial institutions. In many cases, private lending for real estate is a relatively safe investment since the investment is backed by a mortgage.

If you don’t want to be a landlord or go through the lengthy and time-consuming process of flipping properties yourself, private lending is a great way to invest in real estate. The payments that you receive from the borrower will include interest that can help you obtain consistent returns on your initial investment. If you lend money to a flipper as opposed to flipping a property yourself, you’ll typically have much less work to do, which means that there will be less stress and risk involved during the process.

If you purchase the property yourself, you would have to flip the home on your own. While doing so could net you a high return, it’s a risky process if you’re not completely confident about what you’re doing. If you’re searching for ways to invest in real estate without being required to manage the property, you should consider private lending. This article goes over things you need to know about private lenders for real estate as well as the types of borrowers you could lend money to.

How to Become a Private Lender for Real Estate

planted money in garden

If you want to become a private lender for real estate, the process is relatively straightforward. First, it’s recommended that you start making these investments locally so that you can meet with borrowers face-to-face while also visiting the property in person. This will give you much-needed experience in identifying the right properties and investing in borrowers you can trust. If you start investing on a larger scale where you are unable to meet face-to-face with borrowers or won’t have the opportunity to visit the property that the borrower is purchasing, it’s possible that you could make mistakes during the process that could lead to you losing a significant sum of money before you’ve had a chance to learn the ins and outs of private lending.

Because of how important it is to choose the right borrower and the right property, it’s highly recommended that you perform an extensive amount of research into these aspects. Even before you conduct a face-to-face meeting or visit the home, you should research these components to better identify ones that would make wise investments. Doing research is also going to be essential once you start lending to borrowers in other states, which is why you should get started as soon as you’ve confirmed your interest in private lending. The different types of private lenders that partake in these investments include:

  • Investors with surplus capital
  • Investors who are looking to diversify their portfolios
  • Investors who have a large retirement savings account
  • Retirees who want to make passive investments in real estate

Questions Private Lenders for Real Estate Should Consider

Before you engage in private lending, there are some questions that you should consider. First of all, it’s important that you do your due diligence. Before you provide money to a borrower, you should check with a lawyer to make sure that all of the documentation is legitimate and without error. You should do research to find out if the borrower has had success in the past with other investments. If you’re thinking about providing a loan to someone who flips houses, you likely don’t want to lend to an individual who has been relatively unsuccessful in flipping homes. You may be able to check the credibility of the buyer through your own network.

It’s also important that you understand exactly what the borrower is going to be doing with the money. If you make a loan without being certain about what the borrower is going to do once they purchase the property, you may find that a relatively safe investment has quickly become much riskier. Without asking for this information before providing the investment, you might believe that the borrower is intending to rent out the property when instead they are going to be flipping the home, the latter of which is typically riskier. Once you identify what the borrower is going to be doing with your loan, make sure that they have experience with that kind of investment.

Private Lenders for Real Estate Should be Cautious

stacked coins with clock in the background

You should also ask yourself if the numbers are realistic. If the borrower is asking for a certain amount of money, make sure that this amount will be used for the intended purpose of the investment. All applicants for private loans will be required to provide their own research on the property that they are looking to flip. This research will include the value of the home as well as the budget for the renovations, which can help you determine if providing them with a loan is the right decision.

However, it’s important to understand that nearly every applicant will overestimate the value of the home while underestimating the budget for renovations at the same time, which can make your loan seem much less risky. As such, you should check out the value of the home on your own to make sure that it matches the estimate provided by the borrower.

One of the last things to do is to look at the interest payments that the borrower is offering when asking for the loan. Borrowers want the lowest interest rates imaginable. If they happen to offer 20 percent interest payments, there’s a good chance that there’s something wrong with the deal that you might have overlooked. If the loan terms appear to be much more beneficial to you than they are to the borrower, you may want to avoid making this deal. It’s possible that there’s a much higher risk of making such an investment than you initially realized.

Types of Borrowers

two people shaking hands

There are several different types of borrowers that you can provide a private loan to, which include rehab/sell borrowers, rehab/rent borrowers, and commercial investors.

Rehab/Sell: This type of borrower usually purchases residential properties with the intent of completing renovations and improving the value of the property. Once the renovations have been made, they will quickly resell the property. The main reason that private lenders are considered to be more willing to lend money to individuals who want to flip homes is that banks are wary of lending money when it involves properties that are currently in poor condition.

Rehab/Rent: This borrower will typically buy residential properties in order to make necessary renovations that will improve the quality and value of the property in question. When the renovations have been completed, the property will be rented out in order to obtain a consistent cash flow.

Commercial Investors: These are investors who are seeking private money for what’s known as a bridge loan. This type of loan is used to purchase a commercial property when a standard bank will not lend on an unstable asset. Keep in mind that a bridge loan is usually a short-term loan that can last for anywhere from two months to three years. As such, this specific type of loan can come with some risk.

Private Lenders and Commercial Real Estate

person signing document

Are you looking for ways to diversify your portfolio while minimizing risk? If so, becoming a private lender for commercial real estate is a great way to minimize the amount of risk that comes with investing in a property. Since you won’t be flipping the home yourself or renting out the property to tenants, you will be able to receive consistent returns without the time that comes with managing the property. Before you get started with investing in commercial real estate, it’s important that you understand what these investments entail. While you won’t be required to manage a property, you will be tasked with completing comprehensive research to make sure that the borrower is legitimate and that the property is a good investment.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

Mezzanine capital is a type of financing that’s comprised of part equity and part debt, which typically allows investors to seek higher than average returns . If you invest in mezzanine capital, you will be able to enjoy the best aspects of senior debt and equity. When looking specifically at the basic capital structure of a building or property, the top of the stack consists of equity holders, which include common equity and preferred equity holders. Below these two levels are mezzanine debt and senior debt.

If you make an investment into a property with senior debt, you take priority over anyone else within the capital stack. When the property performs well, you will be paid before anyone else with the interest payments that are received from the property. If the property doesn’t perform well, senior debt holders can start the foreclosure process or obtain ownership of the property in question. Holders of common equity often take on the most risk since they are paid last, which means that they may not be able to recoup their initial investment if the property fails. However, holders of equity and preferred equity are able to receive higher returns than anyone else in the capital stack. If the property performs well, common equity investors will receive regular payments from the cash flows of the property.

piggie bank with coins

Both mezzanine debt and preferred equity are forms of hybrid capital. While mezzanine debt isn’t secured by the property, it is secured by ownership interest. Holders of mezzanine debt do have some limited foreclosure rights as well. When you’re looking to invest your money into different properties, mezzanine debt often allows you to seek higher interest rates than senior debt holders. This form of debt usually comes with a shorter term of 6-24 months. Since you will also hold some of the borrower’s equity interest, you can foreclose on this portion of the property in the event that the borrower defaults. If you want to get started with real estate investing and are interested in taking on some mezzanine debt, the following article offers up a look at the basics of mezzanine capital.

What is Mezzanine Capital?

debt coins increasing

Mezzanine capital is a type of financing that’s made up of part equity and part debt. While senior debt holders use the property as collateral, the mezzanine capital investment is made against the property cash flow. Once you invest in mezzanine debt for a specific property, your returns will be largely dependent on the cash flow from the property in order to receive repayment for the principal of the loan.

This typically means that you will need to have patience when dealing with the borrower. While you’re taking on more risk than a senior debt holder, your returns will often be higher and can range from 12-18 percent each year. The equity from this investment usually comes in the form of a warrant, which allows you to purchase actual equity in the property at a later date. If the property happens to be highly successful, the equity that you purchase may provide you with high returns.

The best aspects of mezzanine capital include the regular cash returns that you should receive along with the potential for high returns over the length of the loan. Unlike preferred equity or common equity, this type of investment has low volatility and provides you with some protection in the event that the real estate project fails or the borrower files for bankruptcy. Since around 65 percent of the returns from a mezzanine investment are generated from the contractual interest that the borrower pays, the overall risk of the investment is reduced. Even if you don’t receive any return from the equity that you’ve purchased, most of your initial investment can be recouped with mezzanine capital.

Risks of Mezzanine Debt

chess game risk

There are several risks that you should be aware of when you invest in mezzanine debt. It’s important to understand that a mezzanine debt investment is going to be structured as a long-term investment, which means that there’s less liquidity with this investment type. It’s very difficult to liquidate a mezzanine debt loan until it has reached maturity. If the property fails, senior debt holders will have access to any remaining funds and assets before you.

If the borrower defaults on the property, the only protection that you have comes in the form of the guarantees that you initially received from the borrower. In general, this is the ideal investment type if you want to have a mixture of risk and consistent returns. While senior debt investments are safe, they don’t always garner high returns. If you invest in preferred or common equity, you may be taking on more risk than you’re comfortable with.

The primary characteristics of mezzanine capital include:

  • Investment is made against cash flow
  • Regular cash payments
  • Low volatility
  • Extensive downside protection
  • High returns
  • Warrants
  • Potential collaboration with senior debt holders

How Does Mezzanine Capital Work?

interior of restaurant

If you want to make an investment with a local restaurant, you will first need to identify how much operating income that they receive. Let’s say this operating income is $300,000 per year and that you receive a purchase offer from the owners for $1.2 million. If you don’t have this amount of money in your bank account, you could turn to a senior lender to contribute around $800,000 of the $1.2 million price tag. This would leave you with $400,000 in equity that you would need to pay. If you made this investment, you could receive more than 18 percent in yearly returns.

However, you can choose to reduce this equity by focusing on mezzanine debt. Of the remaining $400,000, you could find a lender to add more leverage above the senior debt holder. If they pitch in $200,000 of the remaining $400,000, this would leave you with $200,000 of equity. The mezzanine lender usually provides this financing at a rate of 12-18 percent per year. While the equity holder will earn less each year because of the interest that needs to be paid to the mezzanine lender, their initial investment can be halved, which allows for less risk.

If you want to make a mezzanine investment, you need to find a project or property where the equity holder is searching for a mezzanine lender. Since you are charging an interest rate for your loan, the returns that you obtain can be paid in any way you see fit. The rate of returns will be set in the initial contract with the borrower. You can mandate that the interest payments be made monthly, quarterly, or annually.

What is the Difference Between Senior and Mezzanine Debt?

open house property

The main difference between mezzanine debt and senior debt is that the latter doesn’t include any amount of equity. Senior debt investments usually come with lower returns but also lower risk. While mezzanine debt is lower on the capital stack than preferred equity and common equity, there’s still a considerable amount of risk attached to this form of investment. The main risk difference is in what these loans are backed by. Unlike preferred equity or common equity, there is a kind of collateral available with mezzanine debt and senior debt. However, this type of collateral is very different.

When you make an investment with senior debt, your investment is backed by the actual property you’re investing in, which means that a default on the property would allow you to acquire the property completely as a means of selling it or foreclosing on it. With mezzanine debt, your initial loan is backed solely by the cash flow of the property. Because of the higher risk of this loan type, you will charge the borrower a higher interest rate. With senior debt, the interest rate is close to eight percent. It’s possible for mezzanine debt holders to obtain interest rates of 12-18 percent. The choice that you make depends entirely on what you’re looking for from an investment.

Characteristics of Senior Debt

The main characteristics of senior debt include:

  • Prioritized for repayment in the event of bankruptcy
  • Lower returns
  • Secured by property
  • Lowest risk in capital stack
  • Regular interest payments

Characteristics of Mezzanine Debt

The main characteristics of mezzanine debt include:

  • Potential for high returns
  • Backed by property cash flow
  • Relatively low volatility
  • High-interest rates
  • Regular interest payments
  • Small amount of downside protection
  • Warrants that allow you to purchase equity in the property

How Do I Invest in Mezzanine Debt

dollar bills

When you want to invest in mezzanine debt, there are two primary methods for doing so. You can either negotiate mezzanine debt transaction with a company or invest in a private fund structure that pools investments together for the sole purpose of investing in mezzanine debt. If you’re an individual investor, you should consider the second option. By joining a private-fund structure with many other investors, your risk may be significantly reduced. You may also be able to join the private fund without needing to make a large initial investment.

Mezzanine debt investments that are made directly with the company or company owners typically require that the investors provide a large amount of capital. These direct investments are commonly made via private equity firms, investment banks, or family owners. If you’re a smaller investor, you will likely need to have a relationship with the borrower if you want to be able to invest in mezzanine debt. Otherwise, this type of direct investment is usually reserved for large institutions.

When you want to engage in this type of investment, keep in mind that the negotiation and closing process can take anywhere from a few weeks to a few months. The easiest way to enter the mezzanine debt market is via a private limited partnership, which is usually organized by an asset management firm. They will gather the funds and handle negotiations for obtaining high returns with comparatively lower risk.

Why Your Company Might Choose Mezzanine Financing

blocks of gold

If you or your company is considering investing in mezzanine financing, there are numerous reasons why you might want to do so when compared to the other types of financing in a capital stack. The potential returns are high and may provide you with fantastic dividends. Because of the contractual interest return that you will have made with the borrower, the volatility of this type of investment is typically lower. In most cases, the interest rate that’s negotiated when making a mezzanine debt investment is around 15 percent. You should receive interest payments in cash around once per quarter. If you are looking to take on some risk with your investment portfolio but want some amount of protection with your investment, choosing mezzanine financing as your primary form of investment is a good option for your portfolio.

When you want to get started with a mezzanine debt investment, you should first determine how much capital you’re willing to invest. If you’re investing hundreds of thousands of dollars, you could consider directly negotiating with the owners of the property. In the event that your investment is closer to $5,000-$20,000, it may be better to join a private investment management firm that focuses on mezzanine debt. With this approach, your investment will be pooled with other investments and will be managed directly by the private firm.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

A commercial mortgage involves any kind of real estate loan for an income-producing property that’s meant to be used for business purposes. Commercial mortgages can be used to purchase such buildings as hotels, office buildings, and shopping centers. If you require a commercial mortgage for a building that you wish to purchase or invest in, you should think about obtaining assistance from a commercial mortgage broker. These brokers are financial specialists who have the experience and training needed to provide investors and businesses with assistance in securing a standard commercial mortgage loan. Commercial mortgage brokers also provide investors and businesses with advice on which options are right for them, which allows them to make the right decision for their company or investment portfolio.

Mortgage brokers have comprehensive knowledge of the mortgage process, which means that they can help you find the best interest rates and loan terms. Their expertise gives them the ability to understand all of the financial options available to investors and businesses that are looking for a commercial property. The connections that mortgage brokers build should allow for a smooth loan application process. The following provides an in-depth look at why it’s important for investors and businesses to retain the services of a commercial mortgage broker.

Benefits of a Commercial Mortgage for Your Business

When you’re getting ready to expand your business, there are many benefits that can be derived from obtaining a commercial mortgage as opposed to renting office space. For one, purchasing a building outright with the assistance of a commercial mortgage can often times be cheaper than renting. While the upfront spending for the building can be very high with a possible down payment of 10-40 percent, you should be able to save a significant amount of money over the duration of the loan.

When you purchase a property for your business, it’s also possible for you to make money depending on how much of the space you’re using. If you’re only expecting to use around 60 percent of the space in the building, you could rent out the other space to smaller businesses that need office space for their operations. This option isn’t available when you rent a building for your business. Your monthly rent payments would also likely be significantly higher than the monthly payments on your mortgage, which is why renting the property would be more expensive than purchasing it. Along with the standard rental payments, you would likely be tasked with paying for utilities, maintenance costs, insurance, and property taxes.

Another key benefit of obtaining a commercial mortgage is that this type of mortgage assists with the future financing of your company. In the event that the property goes up in price, your business capital will increase as well. As the equity of the building increases, you will be able to use the equity to provide further funding for any growth or expansion that you believe your company is ready for. Keep in mind that the rate of appreciation will vary depending on such factors like interest rates, local supply, inflation rates, and demand conditions. Purchasing a property also comes with substantial tax breaks in the form of deductions for depreciation, expenses that aren’t related to the mortgage, and interest.

More Reasons to Take Out a Commercial Mortgage

Two women sitting at table with documents

There are additional reasons that you might want to take out a commercial mortgage, the primary of which is that it will provide you with the ability to secure land-development ventures as an investor. If you believe that you’ve found a location that would be ideal for land development and would provide high returns, you might want to take out a commercial mortgage to help you pay for the purchase of the land and eventual development of property on that land.

This type of mortgage will also provide you with the ability to add to your buy-to-let portfolio. When you invest in a buy-to-let mortgage, you will be purchasing the property as a building that you will rent out in order to obtain returns on your investment. If you’re not purchasing the property with the intent to live in it, you won’t be able to use a standard mortgage to purchase the property. Keep in mind that most lenders of these mortgages will require a down payment of 20-40 percent, which should help you get a low-interest rate of 2-5 percent.

There are many benefits that come with adding a buy-to-let property to your portfolio. For instance, this type of investment is designed to be used as a long-term investment that will have consistent growth. While real estate prices can fluctuate somewhat, they have been stable over the past decade, which means that the value of your property should continue to grow as you own it. When you rent out a property, you will be able to generate income from your tenants, which should help you make your mortgage payments while also increasing the returns on your investment. Profits can be increased further if you can obtain a low-interest rate on the mortgage. While investing in a buy-to-let property isn’t automatically a perfect investment that will net you a high return, it’s a relatively low-risk investment that will allow you to diversify your portfolio without increasing the risk by a substantial amount.

What Makes a Good Commercial Mortgage Broker?

Once you’ve made the decision to obtain a commercial mortgage for your business or as an investment opportunity, it’s highly recommended that you find a good commercial mortgage broker who will be able to guide you through the process and help you find the ideal mortgage. A good mortgage broker will have great connections and a vast network that they can tap into when helping a client. It’s important to understand that a mortgage broker represents your interests rather than the interests of a lending institution, which means that they will do everything they can to find the best deals for you in a commercial mortgage.

Because of the connections that a good mortgage broker has, the one you choose should be able to provide you with the greatest value in terms of interest rate, repayment amounts, and loan products. In order to maximize your investment or make low monthly payments on the mortgage, it’s important that you find the lowest interest rates that are available. Since mortgage brokers aren’t loyal to a single lending institution, they can look across the entire industry and numerous lenders in order to find the lowest rates.

When you go to meet a mortgage broker who you feel will provide you with exemplary service, it’s recommended that you attend this meeting with a high credit score, which will also help you obtain a low-interest rate when it comes to the commercial mortgage. If your credit score is hovering in the low 600’s or even lower, you will likely need to increase it if you want your application for a commercial mortgage to be improved.

There are several ways that you can effectively improve your credit score. For one, make sure that you start paying all of your bills on time. Once you do, your score should start to increase little by little. Missed payments can lower a person’s credit score significantly, which is why you’ll want to keep any late payments at a minimum. If you have any debts at the moment, you can also work to pay these debts off over time, which will help you increase your current score. Low utilization on your credit card can also keep your credit score high. If your credit card utilization is below 30 percent, your credit score should increase with each passing month.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

A private debt fund specializes in the kind of lending activity that’s handled by a variety of entities aside from banks. These funds raise money from investors before lending that money to a wide range of companies. While a private debt fund is mainly used as an alternative to traditional bank lending, it also can provide investors with access to steady returns that occur from having private debt as a separate asset class. This particular form of investment has become increasingly popular since the 2008 financial crisis. In fact, the overall value of these debt funds has almost tripled globally between 2010-2019.

After the Great Recession of 2008, private debt funds grew in popularity because U.S. banks stopped taking on investments that they deemed to be risky. Since smaller companies oftentimes have difficulty obtaining funding for their business, they turned to private investments, which allowed private debt funds to increase significantly in popularity. Private debt currently accounts for a substantial portion of the private investment markets. If you have been searching for new investment opportunities and are interested in private debt funds, this article provides a detailed guide on what private debt funds are and when they can be used with commercial real estate projects.

Who Invests in Private Debt Funds?

man and woman discussing investrments

There are many individuals who find it beneficial to put their money towards a private debt fund. For instance, this form of investment is particularly common among peer-to-peer lenders. Peer-to-peer lending allows individuals who are looking for a loan to borrow money from other individuals. When you start to engage in peer-to-peer lending, this means that you are cutting out the middle man, which is usually a financial institution. While peer-to-peer lending has a high amount of risk to it, the loans are usually able to provide higher returns because of steep interest rates imposed on the borrower.

Since banks aren’t involved in the process, borrowers have a higher chance of obtaining one of these loans when they have poor credit. Because of this, providing one of these loans to borrowers with poor credit increases the risk that peer-to-peer lenders take on. For the borrower, this lending option provides them with the opportunity to obtain money from several different individuals as opposed to a single financial institution.

Specialized Entities also Invest in Private Debt Funds

Along with peer-to-peer lenders, specialized entities and companies that focus mainly on certain segments of the economy can also invest in a private debt fund. For instance, an investment firm that specializes in real estate investments may handle private debt funds. A private debt fund will usually employ lending teams that have strong and reliable backgrounds in investment banking as well as expert knowledge of the market that they operate in. When an individual investor decides to partner with an investment firm that focuses on real estate, they can be confident that the firm will manage their investments properly.

Private Debt Funds are Different than Investing in Private Debt

Private debt funds are designed to provide and manage portfolio loans rather than invest in private debt. These debt funds don’t invest in any kind of public market, which avoids the unpredictable element of investing in stocks. Instead, these funds can provide and manage an entire portfolio of loans that are made by individual investors. A loan that’s obtained from a private debt fund can be of many different sizes and may be worth millions of dollars. Some firms that manage private debt funds will require individual investors to provide a minimum amount of money before they are able to invest, which could be anything from $1,000 to $1 million.

Strategies for Private Debt Fund Investments

There are many different ways to invest in private debt funding if you’re interested in doing so. The strategy that works for one investor may not match well with the portfolio of another investor. Before you begin investing in private debt, it’s recommended that you study each strategy available to you.

Venture Debt and Private Debt Funds

two women making a plan together on white board

Venture debt financing is provided to companies that already have venture capital backing. The majority of businesses that are able to obtain venture debt financing will have already successfully gone through at least two rounds of equity fundraising with venture capital firms. Instead of being provided with capital, investors are given warrants for common equity because of the high-risk element of this investment. These warrants allow investors to obtain a stake in the company at a later date.

Companies take out these types of loans when they want to reach certain milestones or to acquire sizable assets that are necessary to reach such milestones. When a company gets to this point, it will almost certainly have garnered a certain level of success. In fact, most startups and businesses won’t be provided with venture capital or venture debt unless they have already proven themselves in some way. The main benefit provided to entrepreneurs who decide to take out this type of loan is that it allows them to avoid diluting ownership. Since warrants provide investors with a promise that they can purchase stocks at some point in the future, the company that obtains this loan is able to retain the equity stake of existing investors for the time being.

If you want to take part in venture debt financing, you will likely need to be a part of a venture capital firm, which is easier once you’ve invested as an angel investor. Along with a relatively high-interest rate, the warrants that you obtain from your investment may allow you to eventually obtain a high return on your investment if the stock is worth more when you’re able to purchase it.

Special Situations for Private Debt Fund Investing

helping hands reaching for each other

There are also special situations where someone may be able to invest in a private debt fund. These special situations occur when debt or structured equity investments are made with the goal of obtaining control of a company. This usually occurs when the company is in financial distress. While you might find it to be counterintuitive to invest in a failing company, there are ways to make money with this kind of investment. Investing in a company that’s in financial distress can include trading within the secondary market via distressed debt or direct origination. The secondary market involves making an investment into the stock of a business through a secondary source, which means that the investment isn’t made with the company in question.

Direct origination occurs when loans are made to companies without the involvement of an intermediary. These loans will oftentimes include second liens and credit lines. As for distressed debt, this form of investing involves purchasing securities through a secondary market when the company in question is on the verge of going bankrupt or is performing poorly in general. The investor will purchase bonds that allow them to take control of the company.

If you want to invest your money into a distressed company, your main goal should be to determine if the company can get back on track once you take control. While some investors choose to purchase shares in the troubled company, it may be wiser to invest in the company’s debt. Since you will become a creditor for the company, this gives you the opportunity to direct what happens to the company during liquidation or reorganization.

Investing in Private Debt Funds via Real Estate Debt

White, grey, and red house for sale

Among the more common strategies of investing in private debt is to invest in real estate debt, which typically occurs by direct lending for real estate acquisitions. This money can be lent to existing owners of real estate property as well as prospective buyers who are currently in the market. When you invest in real estate debt, your returns will mainly consist of monthly interest payments that are made against the principal of the loan, which usually allows for steady returns. You will also receive security with this investment via a mortgage, which means that you can take control of the property if the borrower happens to default.

This type of investing is highly popular because it provides borrowers with fast turnarounds where they can purchase the property quickly without needing to go through a lengthy approval process. Banks aren’t involved in this process, which makes it much more straightforward. While it’s possible to invest in residential homes through real estate debt, you can obtain solid returns by investing in commercial real estate. There are also many different types of commercial real estate investments, which should make it easier for you to diversify your portfolio.

Private Debt Funds in Commercial Real Estate

commercial real estate with blue sky in background

Private debt funds are commonly used in commercial real estate to quicken the process of obtaining a loan. When it comes to commercial real estate, the investors who borrow will typically use the loans for bridge loans, rehabilitation loans, redevelopment costs, as well as commercial construction loans. While many borrowers will choose to obtain a loan from a bank, it’s usually faster to apply for a loan directly from a private debt fund because borrowers won’t have to deal with the bureaucracy and lengthy approval process of banks.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

Common stock market investments include stocks, bonds, index funds, and mutual funds. Another common type of real estate investment that you may want to consider adding to your investment portfolio is a real estate hedge fund.

A standard hedge fund is a kind of limited partnership of numerous investors who pool their money together before making investments, which could be something like making an investment with borrowed money. The goal of a hedge fund is to obtain substantial capital gains while hedging against the inherent risk of investing. This portfolio is managed by a professional management firm on behalf of its investors.

When looking specifically at real estate hedge funds, this type of investment has been increasing in popularity over the past decade. While hedge funds can consist of liquid assets that can quickly be converted into cash if need be, hedge fund management firms are accepting more and more real estate as a kind of non-traditional investment. Of the many hedge funds that are in operation throughout the country, nearly 40 percent of them are heavily investing in real estate at the moment.

If you are interested in real estate investment, a real estate hedge fund may be an opportunity for you to diversify your portfolio. If your portfolio is currently comprised of some low-risk, low-return investments, real estate hedge funds are a great way to balance your portfolio. Before you go forward with investing in real estate hedge funds, it’s essential that you know how these hedge funds work, which is detailed in the guide below.

How Do Real Estate Hedge Funds Work?

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A real estate hedge fund is a popular type of investing that involves pooling capital from numerous investors before making a single investment in some form of real estate. While hedge funds are very similar to mutual funds, the core difference is that hedge funds generally take on more risk than mutual funds. With any real estate hedge fund making investments in real estate, there are different ways in which a hedge fund manager can choose to make these investments, which depends on the investment strategy that each firm uses.

The most common method of investing via a real estate hedge fund is with a REIT. When you make an investment with a real estate investment trust, the company in charge of the trust essentially owns and operates various types of real estate that can produce income. In many cases, a REIT can be traded on numerous major exchanges. When a hedge fund invests in real estate, it can do so via the publicly-traded stock of existing real estate companies like REITs. When the hedge fund that you’ve invested in decides to invest in a REIT, you can be provided with long-term returns, dividend yields, and portfolio diversification.

house property investing

Along with investing in REITs, another method of investing in real estate hedge funds is through the acquisition of properties. In most cases, the properties that are acquired by real estate hedge funds are performing poorly in comparison to the wider market, which means that their value could have recently dropped by a significant amount. The benefit of investing in under-performing properties is that these investments can be made at below market rates, which helps to reduce risk. The properties that are invested in by a hedge fund can be centralized in one location or can be purchased from all over the world.

The main difference between a REIT and an investment into an actual property is that a pure real estate hedge fund owns property. On the other hand, a real estate hedge fund that’s centered around a REIT will own stock of real estate companies. Keep in mind that different real estate hedge funds can focus on different things. For instance, some hedge funds will purchase sizable hotels that they can then develop and earn money from. Others invest in debt securities. The strategy that you want to take all depends on the kind of investment you believe will be most successful.

What is the Difference Between Hedge Funds and Mutual Funds?

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Hedge funds and mutual funds are two similar forms of investing that come with distinct differences that you should keep in mind. Both of these methods for investing involve the formation of investment partnerships with many individual investors. A firm will manage portfolios that have been built from pooled capital with the primary goal of obtaining higher returns via greater diversification. When you invest into a mutual fund or hedge fund, it’s important that the investment strategy of the managing firm matches your investment strategy.

There are two key differences between hedge funds and mutual funds that you should be aware of. First of all, mutual funds are regulated by the SEC, which means that there’s a limit to how much leverage a mutual fund can take on. As opposed to liquid assets, leverage is borrowed capital that can be acquired when making an investment. Since there’s a cap on the amount of borrowed capital that can be obtained with a mutual fund, this type of investment is considered to be less risky when compared to hedge funds.

Since mutual funds are regulated by the SEC, they are available for daily trading and can be purchased by the public if you’re looking to buy shares in a mutual fund. Because real estate hedge funds aren’t regulated in the same way that mutual funds are, they are considered to be private investments that can only be purchased by accredited investors. The main benefit of investing in a real estate hedge fund is that you can generally obtain higher returns than are possible with a mutual fund. As long as you qualify as an accredited investor, a hedge fund is a way to take on more risk with your portfolio, and in turn, potentially higher yields.

How Do I Invest in a Hedge Fund?

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While it’s possible for you to invest in a hedge fund, there are some basic restrictions and guidelines that you should be aware of before attempting to do so. The types of investors who can join the investor pool in a hedge fund must have the ability to make high risk investments. Regulation D places a limit on the number of investors who can join a hedge fund, which is why the investment amount for each is generally on the higher end. The managers and general partners of a hedge fund are in charge of setting minimum investment requirements.

While the minimum investment requirements differ with each hedge fund, they can be anywhere from $100,000 to $1 million. Since real estate hedge funds aren’t regulated directly by the SEC, most investors will need to be accredited. A small number of hedge funds are listed on exchanges, which means that shares of the hedge fund can be purchased via a broker or individually.

How can Hedge Funds Make Big Profits in Real Estate

Before you join a real estate hedge fund, it’s important that you understand the advantages and disadvantages that come with hedge funds.

Advantages of Hedge Funds

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When you want to make money in real estate, a hedge fund provides you with the opportunity to bring in high returns for some potentially large profits. Since these investments can be made in a variety of ways with real estate hedge funds, it’s possible to obtain positive returns in both falling and rising markets. You can also customize your investment strategy in any way you see fit. These hedge funds are managed by some of the top investment managers in the world, which somewhat reduces the risk that comes with making such an investment.

Disadvantages of Hedge Funds

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However, there are some negative aspects of hedge funds that you should be aware of. For instance, the losses can be substantial if the hedge fund fails and your investments don’t pan out. There’s also much more leverage in a hedge fund when compared to liquid assets, which heightens the risk of a hedge fund. Because hedge funds aren’t liquid, your money can be locked up for long periods of time.

In most cases, hedge funds will last around five years. However, it’s possible for a hedge fund to fail in less than a year. You should start to see returns for your investment after the first year depending on the terms of the hedge fund. The key to a successful real estate hedge fund is to join a reputable hedge fund management company.

Investing in Real Estate Hedge Funds

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When you’re considering your many investment options, real estate hedge funds can be highly beneficial for your portfolio in a variety of ways. While hedge funds may be riskier than other investment methods, they also allow for the possibility of higher returns. If your portfolio is balanced, hedge funds are actually able to reduce the risk of your portfolio while increasing returns at the same time. There are also several different ways to invest with real estate hedge funds. Your investments can go into actual properties or can be invested into a REIT, which allows you to select the option that best matches your portfolio strategy.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

A 401k is an investment savings account that’s sponsored by the employer of the individual who holds the account. Workers are able to make contributions to a 401k account via automatic payroll withholding, which means that the money will automatically be taken out of your paycheck and sent to your 401k account. Depending on the account you have, your employer may match a portion or all of your contributions.

Any money that’s placed into a standard 401k plan isn’t taxed until you withdraw the money, which usually occurs after retirement. If you invest in a Roth 401k plan, your withdrawals could also be tax-free. There are a couple of different types of 401k plans that you should be aware of, which include Roth 401k plans and solo/self-employed plans. A Roth 401k plan is a special type of 401k account that’s funded with your after-tax dollars up to a certain amount. Because the account is funded with after-tax dollars, eventual withdrawals don’t need to be taxed, which is the opposite of how a traditional 401k works. Both account types have their advantages and disadvantages.

Withdrawing From Your 401k

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Before you start investing in a 401k, it’s important to understand how these accounts work when it comes to withdrawing from them. For one, anything that you withdraw from a 401k before you reach 59.5 years old will result in a tax penalty of 10 percent, which can make for a substantial reduction in your overall savings. You can make a standard 401k withdrawal if you are no longer an employee for the employer that sponsors your 401k plan and are at least 59.5 years old.

If you have invested money into a standard 401k, you will be required to pay income tax whenever you eventually withdraw your money. However, there will be no penalty applied to the withdrawal since you’re over the age of 59.5. After you reach the age of 72, you will need to take out the required minimum distributions from your 401k every year. The amount that you withdraw is based on an IRS formula that dictates the amount by the age you are at the time of the withdrawal. While you can always withdraw all of the money from your 401k account in one withdrawal, this can lead to a significant tax bill that you might want to avoid. If you’re still working in the same workplace, there are some plans that allow you to delay the required minimum distributions until the year that you retire.

Hardship Withdrawals

You should also know about hardship withdrawals when using a 401k account. A hardship withdrawal means that you can only withdraw money from your account without penalties for various emergency purposes in the event that you’re older than 59.5. The many different emergencies that would allow you to qualify for these penalty-free withdrawals include:

  • Up to 12 months of educational fees and tuition
  • Medical expenses for care and treatment that are deemed to be essential
  • Expenses related to a funeral or burial
  • Expenses that will allow you to prevent being evicted or foreclosed on
  • Home-buying expenses for a main residence

Being able to withdraw money from your 401k account without incurring a penalty in the event of one of these emergencies occurring should give you peace of mind about investing in a 401k.

Types of 401k Accounts

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There are various types of 401k accounts that you should be aware of, which include both a Roth 401k plan and a solo 401k plan. The Roth 401k plan is considered to be highly advantageous for individuals who expect to be wealthier once they reach retirement age. Since the money that’s placed into the account can be withdrawn without requiring you to pay taxes, all of the money in your account once you reach 59.5 is yours to be withdrawn whenever you’d like.

The Roth 401k is among the latest types of retirement plans. While this is a special 401k plan, it provides investors with many of the benefits that can be received from a Roth IRA. The money that you contribute to the plan can’t be written off of your taxes, which means that you should weigh the pros and cons of a Roth 401k alongside a traditional 401k. If the tax benefits that you can receive now are more appealing to you, a traditional 401k might be your preferred option. On the other hand, a Roth 401k allows you to avoid the hassle of paying taxes when you eventually withdraw from the account. The type of 401k account that you select depends largely on your personal preference.

Using Your Solo 401k Plan to Invest in Real Estate

Woman giving presentation to man

If you want to use your 401k account to invest in real estate, you will need to use a solo 401k plan. A solo 401k requires owners of the account to make contributions with their pre-tax dollars. These contributions can continue to grow within the account tax-free until you withdraw them for retirement. Keep in mind that there are limits to how much you can place into a solo 401k plan in a single year. For 2020, the limit is set to $57,000. If you’re currently older than 50 but have yet to retire, you can add an extra $6,500 per year above the $57,000 limit.

In order to qualify for this type of plan, you will need to be self-employed without having any employees that require W2 forms. However, it’s possible for your spouse to work with you. When you have a solo 401k, your investing possibilities will be broadened significantly since this type of account allows investments to be made in any asset that’s not disallowed under IRS regulations. The types of assets that you can invest in with a solo 401k plan include:

  • Deeds
  • Tax liens
  • Private loans
  • Private businesses
  • Limited liability companies

This gives you investment leeway that’s not possible with other 401k accounts. After you save for retirement for a certain number of years, you might want to think about investing in something with high returns and relatively predictable cash flow, such as real estate. By making these investments before you reach retirement age, you should be able to increase the amount of money that you have when you eventually retire. The types of real estate investments that you can make include:

Each of these real estate investment opportunities can provide you with stable returns as long as you make smart investments. There are many benefits that come with investing money in real estate. These benefits are compounded when you invest in commercial real estate properties. The main reason that you should think about investing in real estate is that these properties generally appreciate in value over time, which allows them to increase in value with inflation. The average appreciation amount per year since 1968 is right around six percent.

If you invest your money into an apartment building, you can collect money from tenants, which will provide you with monthly payments. You could also make a debt investment in these properties, which would give you the opportunity to collect monthly payments from the interest on the loan that you’ve provided. Whether you like to make risky investments or safe ones, real estate investing accommodates both types of portfolios. Real estate gives you a predictable cash flow and offers equity growth via debt reduction. If you invest into the equity of a property and are in charge of upkeep for the building that you own, the money that you spend on maintenance, improvements, and property upkeep are considered to be tax-deductible, which you can use to reduce the amount of taxes that you owe each year.

Ready to Use Your 401k to Invest in Commercial Real Estate?

If you would like to use your solo 401k to invest in commercial real estate, it’s important that you focus on making the right investment decisions. The real estate that you invest in should be heavily researched so that you can be confident that the property and real estate market surrounding it are in good condition. While it’s not possible to eliminate all risk that comes with making an investment, the research that you do now should help you mitigate risk, which can assist you in maintaining a balanced portfolio.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

The United States is known for having an open economy, which essentially means that the domestic community is able to engage in investing and trade with most foreign countries. Individuals and businesses in other countries can also choose to trade and invest with entities in the U.S. While most entities and individuals who invest in U.S. real estate are located in the same country, there are numerous reasons why a foreigner might want to invest in U.S. real estate as well.

The total combined value of all residential homes in the country comes in at around $33.6 trillion. To understand just how large this value is, it’s greater than the total 2020 GDP for the U.S., which is around $19.39 trillion. As this country has one of the more sizable economies in the world, the higher value of residential homes says a lot. The short answer to this question is that foreigners can invest in real estate throughout the U.S. However, there are numerous things to consider if you wish to do so. This article details what you need to know about investing in U.S. real estate.

Difficulties That Foreign Investors May Face When Purchasing U.S. Real Estate

While it’s relatively easy for foreign investors to purchase and invest in U.S. real estate, there are some difficulties that any foreign investor must overcome if they want the process to be smooth and straightforward. Even though it’s perfectly legal for foreigners to invest in U.S. real estate, it may be difficult to obtain a loan for the investment.

It’s also common for foreign investors to run into difficulties understanding U.S. taxes, which can lead to substantial problems when it comes time to invest in a property. Foreign investors will generally have a more difficult time investing in real estate as compared to U.S. citizens. With this in mind, let’s talk about all of the drawbacks and hurdles that you will face as a foreign buyer of U.S. real estate.

Obtaining Real Estate Loans As a Foreign Investor

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Likely the main issue that foreigners face when attempting to invest in U.S. real estate is that it can be difficult to obtain a loan from a bank or other financial institution. When it comes to residential properties, both Freddie Mac and Fannie Mae are government-sponsored corporations that guarantee most home loans. The standards that are set by these two institutions are followed by the majority of banks and other financial institutions. The problem is that neither Freddie Mac or Fannie Mae will purchase loans from individuals who aren’t U.S. citizens. Instead, you’ll need to find lenders that don’t work with Freddie Mac or Fannie Mae.

The majority of banks will also forego providing loans to individuals who have never paid taxes within the U.S. This reduces the number of financial institutions that could provide you with the necessary loan. To counteract this issue, you’ll likely need to perform extensive research to find financial institutions that will lend to foreign investors. Keep in mind that you’ll need to provide proof of strong financials. Most foreigners likely don’t have a credit score, which is a top consideration among most banks when they are deciding whether or not to lend money to someone. If you don’t have permanent ties to the U.S., you’ll likely find it difficult to get the loan you’re looking for.

Another reason that banks are wary of lending to foreign individuals is that it’s nearly impossible for the lender to take a foreign borrower to court if the borrower defaults on the loan. While you could try to obtain a loan in your own country, many foreign lenders will avoid providing a loan in this situation. Banks don’t like to provide borrowers with loans outside of their home country. There are also many countries where the laws and regulations dictate that loans can’t be provided outside of the country.

When you’re searching for the right lender in the U.S., it’s important that you’re aware of the costs that come with getting a loan, which typically includes:

  • An Appraisal fee
  • An Origination fee
  • Prepaid interest fees
  • Closing fees
  • Insurance fees

These costs could be higher for you than for U.S. borrowers because banks view foreign investors as being riskier to lend to. In order to offset some of this risk, lenders will usually charge relatively high-interest rates or require a substantial down payment before providing you with a loan. The approval process for the loan could also be more stringent, which you should prepare for. If you were a U.S. citizen, the approval process would likely involve the bank looking at your total expenses, your income, and your entire credit history in order to ascertain if you are wholly qualified for the loan.

As a foreign investor, it’s much more difficult for the banks to verify these aspects of your finances. You’ll need to provide much more documentation than is normal, which can include your bank statements and yearly tax returns. Because of the larger amount of documentation that needs to be provided, the approval process will likely also take longer to process.

Navigating Taxes As a Foreign Investor

The U.S. requires foreigners to pay a certain amount of taxes in the country on any real estate gains. You might also be required to pay these taxes in your own country depending on local laws. If you are considered to be a non-resident alien, you won’t need to file your tax return in the U.S. unless you’re currently employed in the country or have source income from the U.S. In accordance with this term, source income includes income that you earn from renting real estate that’s located in the country.

It’s also important to understand that any owner of real estate in the U.S. is subject to the estate tax. This particular tax is paid once the owner of a property dies. The total amount of the estate tax can be as much as 40 percent of the property value. The exact amount that you pay depends on what the estate is currently valued at.

US Real Estate Holding Structures Foreign Investors Should Consider

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There are a variety of holding structures that foreign investors are able to use if they would like to avoid paying certain taxes on the real estate that they invest in. Keep in mind that the exact structure type that you select should align with your investment goals if you want to make the most out of this investment.

Individual Direct Ownership

This type of holding structure allows for a foreign investor to own real estate in the U.S. in their own name. This is a very simple type of ownership that’s considered to be beneficial if you want to keep costs down. The main issue with individual direct ownership is that the long-term benefits are minor and could open you up to liability, estate taxes, and various tax reporting requirements. If your property is ever rented out, you will be tasked with paying income tax. If damages occur on the property, you will be held liable for any repair expenses.

Forms of Corporate Indirect Ownership

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As mentioned previously, corporations are fully exempt from paying the U.S. estate tax, which is why it’s highly recommended that you place your real estate investment into some kind of corporation holding structure. Here are examples of different corporations that can help protect foreign investors from taxes and liabilities.

Foreign Investors Can Create an LLC

You could choose to create a limited liability company (LLC) to hold your investment. This type of corporation allows for the lowest amount of income taxes when compared to other types of corporate indirect ownership. There is also limited liability for your wealth as an investor, which is directly limited to the value of your property.

You’re not held responsible for any of the damages that occur since your property and the assets within are protected under an LLC. The privacy of the property will remain fully intact since you won’t need to register the name with the state. The main issue with creating an LLC is that it will still be subject to the estate tax. The income tax and sales tax consequences for the property are the same as if you owned the property directly.

U.S. Blocker Structure

This structure is appealing for individual investors who would like to avoid the estate tax that typically occurs upon death. You will have both privacy and asset protection if you decide to use a U.S. blocker structure. If the corporation that you create with this structure is willing to wait for a required five-year period following the sale of your property, you can distribute the cash that was collected from the sale to yourself without any tax consequences. However, the corporation will be subject to a very high capital gains tax rate when the property is eventually sold. .

Leveraged Blocker

This is a complex holding structure that you can use with your U.S. real estate investment. It’s very similar to the U.S. blocker structure with some key differences. This type of holding structure is solely recommended if you’re going to be making larger investments in real estate throughout the U.S. In general, this structure is used when the investments involve several different investors or a type of fund.

In order for this structure to be successful, a substantial amount of planning will need to be done. For one, the investor will need to also have a U.S. corporation. Part of the investment must be loaned to the U.S. corporation, which allows the corporation to obtain certain tax deductions. Since the corporation is able to deduct the interest, the effective tax rate is also lowered.

Ready to invest in U.S. Real Estate?

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If you’re interested in investing in U.S. real estate but don’t classify as a citizen of the country, you can still invest as long as you’re aware of what this process involves. The primary difficulties that you’ll face when attempting to invest in U.S. real estate include finding the right loan and being approved for the loan once you’ve found it. You may also be required to make a down payment of 30 percent or more.

While foreign investors will encounter numerous hurdles when investing in U.S. real estate, the benefits of making these investments can be fantastic and may allow you to obtain high returns on your initial investment. To lower your expenses, consider creating some kind of holding structure to place the investment in. With these guidelines, you should be able to get started with your U.S. real estate investment.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

Opportunity zones are communities wherein new investments can take advantage of certain tax benefits. Opportunity zones were created in 2017 when the Tax Cuts and Jobs Act was officially passed. This legislation lessened income tax rates for the majority of tax brackets while also providing corporations with larger tax breaks. It was in this piece of legislation that “Qualified Opportunity Zones” came to be.

These zones are meant to facilitate job creation and economic development in certain communities. These communities can be situated in the U.S. or any of its territories. Any investors who place capital within opportunity zones are provided with extensive tax benefits. If you’re looking for the right investment opportunity to add to your portfolio, you might want to consider opportunity zone investments, which will be discussed further in the following article.

What Qualifies as an Opportunity Zone?

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Before you get started with investing in opportunity zones, it’s important to understand what qualifies as an opportunity zone. Since these zones are meant to assist with the growth of areas that have generally been economically depressed, there are some restrictions on which tracts of land are able to qualify for designation. For one, the areas will need to qualify as being low-income areas, which requires a poverty rate that’s at least 20 percent or a median family income that doesn’t exceed over 80 percent of the average family income in metropolitan or non-metropolitan areas throughout the state.

For the census tracts that qualify as low-income areas, as much as 25 percent of these tracts can be nominated for the possibility of being designated as opportunity zones by the U.S. Treasury. When looking at the neighborhoods that would qualify as low-income areas, over 55 percent of all neighborhoods in the country were at least considered to be designated as opportunity zones. From all of the neighborhoods and tracts that the U.S. Treasury considered for opportunity zones, around 8,700 were certified as qualified opportunity zones. Once you’ve found the area that you’re interested in investing in, it’s important to know about the tax incentives that will be available to you.

How to Invest in Opportunity Zones

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Investing in opportunity zones is relatively straightforward if you make the right investment decisions. It’s possible to invest in these zones by placing your capital into opportunity zone funds, which will act as a vehicle that will allow you to invest capital gains into various opportunity zones. When you invest capital gains into these funds, you’ll be able to defer tax payments until 2027 or until the asset is sold, which can save you a significant sum of money in the meantime.

When you defer tax payments on capital gains, you can invest more of your capital gain for at least a few more years, which can help you increase your earning potential in a manner that wouldn’t be possible if you were required to pay taxes on your capital gains when they were first realized. Along with getting more out of your investments, deferring tax payments gives you the opportunity to invest in opportunity zone funds with this money for at least five years.

What Other Tax Incentives Do Opportunity Zones Offer?

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Tax liability refers to the amount of tax debt that a corporation, individual, or other entity owes to the IRS. If you invest in opportunity zones, you may be able to decrease your overall tax liability, which means that you won’t need to pay as much on your yearly taxes. In the event that you hold an opportunity zone fund for at least five years before the December 31, 2026 deadline, you will receive a reduction in your tax liability of 10 percent. Overall, it’s possible to receive a tax liability reduction on capital gains of up to 15 percent. Keep in mind that you will need to invest in an opportunity zone fund by December 31, 2021 if you want to take full advantage of the tax benefits available to you.

If you want to protect your capital gains on a long-term basis, investing in opportunity zone funds is a good avenue to explore. The tax liability that comes with capital gains can actually be wholly eliminated if you hold your opportunity fund investments for ten years or more. Any appreciation that you earn from this investment will have zero capital gains liability to it. When looking through a historical lens, real estate typically appreciates over a long period of time, which means that it’s likely the investment you make will increase in value as you hold it.

Five Notable Opportunity Zones in the US

Bay bridge with blue sky

The following are five of the more notable opportunity zones that are considered to be primed and ready for almost instantaneous growth.

Oakland, California

Oakland is situated near San Francisco and provides commercial and residential real estate developers with some fantastic opportunities for investment. There are already many large technology companies that are based out of Oakland, which include Pandora, VSCO, and Gravitational, the latter of which is a cloud-data service provider. There are also a variety of BART stations situated throughout Oakland that allow for far more convenient commuting in the Bay area. The presence of these stations in Oakland provides residents of the city with more job opportunities as well as easier mobility around the area. Over the past five years, the increase in home values is 48 percent, which is almost double than the rate of previous years.

Seattle, Washington

Seattle is currently in critical need of new investments in commercial and residential properties, which is due mainly to the lack of development when compared to the substantial population growth throughout the city. The opportunity zone for this area is located in South Seattle and is large and contiguous, which means that urban development is possible alongside residential developments.

While you may want to invest in the development of apartment buildings, you should also consider investing in improved transit systems, which could allow for high returns. Condos are also in high demand throughout South Seattle. In the city, the increase of home values over the past five years was 46 percent.

San Jose, California

San Jose is a city in the Bay area that’s experiencing rapid business and housing growth since many of the regions that are slightly north of San Jose, like Palo Alto, San Francisco, and Mountain View, have become increasingly expensive in recent years. In fact, the average price for a San Francisco home in 2000 was around $420,000. As of January 2019, home values in San Francisco skyrocketed by over 300 percent to $1.38 million. At the moment, these areas may not be ideal for investment when compared to San Jose.

Downtown San Jose is home to offices for large companies like Adobe as well as a new Google campus. While this campus is still in development, investors can expect the construction of the campus to create high demand for housing and walkable businesses that are able to support the large number of employees that will be needed by these companies. Throughout the past five years, home values have increased in San Jose by around 39 percent.

Los Angeles, California

While many areas of Los Angeles are teeming with investment opportunities, the possibility of opportunity zone investments is mainly available in Downtown Los Angeles. This particular area experienced a boom in hotels and residential apartments back in 2018. Two of the more recognizable companies that are based out of Downtown LA include Soylent and Spotify, both of which are more popular than ever.

When looking specifically at South Los Angeles, many of the neighborhoods in the area are developing at the moment, which is ideal since these neighborhoods are situated nearby the 10 Freeway and allow for convenient mobility around the city. Los Angeles is also busy working on the creation of additional E Line stations all over the city, which is going to benefit mobility even more. Home values across Los Angeles have increased by around 36 percent over the past five years.

San Diego California

San Diego is yet another city in California that’s becoming increasingly expensive. While San Diego has usually been highly resistant to new developments, the presence of opportunity zones should give you the incentive to consider investing your money into a development project regardless. South Park, Barrio Logan, and Golden Hill are three areas in San Diego that are considered to be opportunity zones. When looking at the increase of home values over the past five years, San Diego has seen an increase of 30 percent. These trends are lasting ones that have yet to display any signs of slowing down.

Do You Want to Diversify Your Portfolio With Opportunity Zone Investing?

worms eye view of buildings

If you’re looking to diversify your portfolio with opportunity zone investing, it’s easy to get started with this type of investment. Your main goal should be to invest a realized capital gain into an opportunity zone fund within a period of 180 days after realization has occurred.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

If you want to invest in real estate, a bridge loan can be a great source of financing for you. A bridge loan is a kind of short-term loan that can have a term of anywhere from two weeks to three years. However, the majority of bridge loans last for six months to 12 months. When taking out this type of loan, you’ll be provided with short-term funding that you can use to close on a property that you’re investing in or purchase another property while you wait for your current one to be sold.

Many homeowners encounter a two-step transaction that involves purchasing a new building while trying to sell an old one. You should consider seeking a bridge loan when you need to bridge two separate financial transactions. If standard bank financing isn’t available to you, or you need to move quickly to close on a transaction, a bridge loan may be your best bet. This article takes a closer look at how bridge loans work as well as the pros and cons of this specific type of loan.

How Bridge Loans Work

man having concept explained to him

When looking at how bridge loans work, they usually have the same requirements as a standard mortgage. For one, you’ll need to have at least some equity in the property in question. Let’s say you have a home that’s worth $500,000 but still has $300,000 left on the mortgage. You would have $200,000 in equity. The loan needs to be backed by collateral, which is why it’s important that you have access to equity.

The terms of your bridge loan will likely last for around six to twelve months until you will be required to pay back the loan. These loans are designed specifically to be used on a short-term basis to assist you during a period of transition. Keep in mind that the majority of lenders that can provide you with bridge loans won’t go higher than a loan-to-value ratio of 70 percent, which means that you will need to maintain at least 30 percent equity within the current asset that you own in order for a bridge loan to be provided to you.

Pros

There are many reasons why it could be ideal for you to obtain a bridge loan, which includes:

  • It will provide a safety net in the event that you sell your old home before purchasing a new one so you won’t have to rent
  • Allows the purchase of a new home, without notable restriction, while placing a current home on the market
  • Being able to put a down payment on a new home without using the profits from selling your old one
  • Payments can be deferred or interest-only until you are able to sell your old home, which provides a certain amount of flexibility

Cons

While bridge loans can be beneficial for a variety of situations, there are some negatives to this type of loan that you should consider before applying for one. These cons include:

  • Bridge loans have exceedingly short lifespans and require a significant amount of work from the lender, which is why the loans can have relatively high-interest rates that can be around 8.5-10.5 percent of the complete loan amount
  • The closing costs and fees pertaining to this loan can be high and may drive up your costs
  • The lender that provides you with the loan could decide to use a variable prime rate, which means that your interest rate would increase over time
  • There’s always the possibility that your home wouldn’t be able to be sold during the six to twelve month term of the loan, which would put you in a problematic situation
  • These loans are generally considered to be more expensive than a traditional home equity loan

Bridge Loan vs. Home Equity Loan

home with for sale sign in front

Before you consider applying for a bridge loan, it’s recommended that you compare bridge loans with home equity loans, which are somewhat similar in how they work. Just like bridge loans, a home equity loan is secured, which means that your current home will be used as collateral. While it might sound risky to use your home as collateral, you should have enough time to sell the current property before the term of the loan ends.

While both of these loans are considered to be secured loans, they are otherwise very different. For one, home equity loans are generally long-term loans. The majority of these loans will come with longer repayment periods that can last anywhere from 5-20 years, which is much higher than the six to twelve months that is standard with a bridge loan. Because of the longer terms with home equity loans, interest rates are typically lower as well. If you are able to effectively qualify for a standard home equity loan, you can expect the interest rates you pay to be around six percent, which is decidedly lower than the 8.5-10.5 percent that comes with bridge loans.

A home equity loan is actually riskier for you when compared to a bridge loan. While bridge loans also come with the risk of being unable to sell the property, a home equity loan puts you at the risk of paying for three separate loans in the event that your old home doesn’t sell on time, which include the original mortgage, the new mortgage, and the home equity loan that you’ve received.

If you’ve built up a significant amount of equity in your current home by paying a substantial amount of the old mortgage, a home equity loan might be the better option for you. There are risks to both loan options that you should keep in mind. However, a bridge loan is typically the better option as long as it fits with your situation.

Find the Right Lender for Your Bridge Loan

city scape with blue sky

The key to obtaining the right bridge loan is to make sure that you choose the correct lender. Likely the easiest way to identify the right lender is to take some time to compare various rates and terms. While the lowest interest rate doesn’t always equate to the best deal, it should be a heavy consideration. If you can find a lender that will provide you with a loan that has interest rates of 7.0-8.0 percent, these would be considered good rates. Short-term loans invariably have high-interest rates, which may cause some anxiety when you’re looking for the right loan. However, doing your research for the best rates will help you in the long term by saving you a substantial sum of money.

It’s also highly recommended that you obtain referrals from friends and family members who may have worked with a lender in the past. Keep in mind that not all lenders offer bridge loans, which will automatically reduce the number of options available to you. Before you agree to a loan from the lender you’re interested in, you should think about visiting their offices to gain a better understanding of their operations and to make sure that they’re legitimate. While it’s important that you obtain low-interest rates with your bridge loan, you might also want to think about looking for lenders that offer low origination fees.

Once you’ve found the right lender, all that’s left for you to do is apply for the loan. Bridge loans can be very beneficial if you’re searching for short-term financing that will bridge the gap between two financial transactions. If you are wholly confident that your current home can be sold within a few weeks to several months, bridge loans are an excellent way to help you get out of your old home and into a new one without needing to worry about an uncertain period between the two transactions.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.

When you’re searching for ways to invest in real estate, likely one of the most important terms related to the investment is the capital stack, which refers to the various types of capital that are invested into a real estate investment project. When looking specifically at a commercial real estate project, the types of investments that make up a capital stack include senior debt, mezzanine debt, preferred equity, and common equity.

While some real estate investors will focus solely on one type of investment, it’s also possible to spread your investment across different sections of the capital stack, which will help you diversify your portfolio. While the common equity and preferred equity layers of a capital stack come with more risk, they can also provide you with higher returns. Despite the lower returns of mezzanine debt and senior debt, making investments in one of these layers allows you to acquire much less risk. If you want to maximize your returns while making sure that the risk doesn’t spiral, having a well-structured capital stack can affect how well your portfolio is diversified, various tax considerations, and the amount of risk that you take on.

stacked books

For an investment that you make on a real estate project to be worthwhile, it’s important that the return you obtain is higher than the amount you invested. If you’re the main equity holder of a property and are in charge of its development, having an optimal capital stack can be highly important if you want to minimize your losses. If all of your investments go into the riskier common equity layer of a capital stack, your portfolio won’t be very diversified. You also risk losing much more than you make if the project doesn’t pan out. An optimal capital stack is one that has the right mix of debt and equity to it. The following will provide you with seven considerations to consider for an optimal capital stack.

1. Your Business Risk

chess game risk

One of the top considerations that you should take into account is the business risk that’s associated with your investments. If the type of property that you’re investing in comes with lower risk and steady cash flows, you’ll likely want the capital stack structure to have a higher amount of debt in it. If your investments mainly include mezzanine debt and senior debt, your returns should be consistent. If the property happens to fail and payments aren’t met, any senior debt holder will have the ability to foreclose and take ownership of the property in question, which helps to minimize risk. Apartment buildings and commercial properties that are credit-tenant leased are considered to be examples of low-risk properties with steady cash flows.

If the property that you’re investing in is an office building that’s located in a highly competitive market, you should expect that the building will have an extensive amount of turnover. With this type of property, it’s highly recommended that the capital stack structure of the building is focused more on equity than debt, the latter of which is borrowed money that must be paid back to the lender.

Businesses with a high amount of equity will have ownership rights for the property itself, which means that the equity portion of the investment won’t need to be paid back. For properties that have a higher chance of failing and not bringing in the right amount of returns, more equity can be preferable compared to a higher amount of debt.

If you analyze the risk of your investment, you’ll be able to more accurately determine what your optimal capital stack should be. When you’re thinking about funding a new project, understanding the capital stack structure of the property in question will allow you to keep your risk profile at the appropriate levels.

2. Interest Rates

calculator calculations money

It’s also important that you take the interest rates into account for the different levels of a capital stack structure. Debt is going to be less expensive than equity. If the owner of the property doesn’t provide you with consistent payments, you will be able to sell the property in order to recover some of your investment. When you hold equity on a property, you will have a claim on any remaining assets of the property. However, all other obligations to debt holders will need to be satisfied beforehand.

This is where the interest rates of a capital stack come into play. The interest rate or return rate for a senior lender will be around 4-8 percent per year, which is a relatively low rate. While the interest rate that you receive is low, you also have less risk and more security with your investment. As for a mezzanine lender, interest rates are typically around 9-13 percent, which allows for a much higher return. Interest rates for preferred equity investments can be upwards of 18-20 percent, which allows for a significant return on investment.

When considering the common equity layer of a capital stack, you can expect returns to be as high as 25 percent. Even though preferred equity and common equity investments can provide you with high returns, the business risk is also much higher. In the event that the real estate project fails, every other type of investor will be paid back before you. The interest rate and return rate that’s best for you all depends on the level of risk that you want to take on. You could also invest in several layers of the capital stack to ensure that you receive consistent returns with senior debt and potentially high interest rates with common equity.

3. Understanding the Credibility of the Assets

cash coins currency

In order to be certain that you’ve made the right investment with a real estate property, it’s essential that you understand the credibility of all of the assets that are placed in the property. While it’s easier to determine the credibility of assets for the capital structure of a business because of the extensive balance sheet they have, you should be able to identify the credibility of real estate assets without too much difficulty. Whether you’re investing in commercial real estate or infrastructure, the credibility of the assets depends on the credibility of the property. If your investment is going into a biofuels energy project, you can be fairly certain that the asset is a riskier one when compared to a standard real estate investment.

No matter your position in the capital stack structure, determining the credibility of the asset is key to understanding if you’re making a wise investment choice. If the quality of the property or asset that you’ve invested in becomes impaired, it’s possible to lose your entire investment, which is true whether you’re a senior debt holder or an equity holder. To determine the credibility of an asset, it’s recommended that you perform regular valuations.

4. Bankruptcy

petition to file for bankruptcy paperwork

It’s possible for you to declare bankruptcy if you are unable to repay creditors. When this occurs, the debt could be discharged or restructured. As an investor in real estate, it’s important that you understand what happens in the event of a bankruptcy. There are two main types of bankruptcy that you should be aware of, which include Chapter 7 and Chapter 11 bankruptcy. With Chapter 7 bankruptcy, the property that you’ve invested in will be liquidated, which means that any mortgage holders or senior lenders will be paid back before any remaining money is provided to equity holders. With this type of bankruptcy, there is typically very little capital left over for holders of common equity.

If you currently own the building because of the amount of equity that you’ve invested into the property, filing a bankruptcy can cause you to lose the property and the money that you’ve invested into it. Chapter 11 bankruptcy focuses on the restructuring of debts, which allows lenders to be paid back over a lengthy period of time. The best way to minimize the possibility of bankruptcy and potentially prevent it from occurring is by heavily cutting your expenses, using debt management services, and attempting to negotiate with your creditors.

5. Trade-Off

balance rocks

The trade-off consideration is one that determines how much debt and equity are placed into a building by the benefits and costs that come with both. When debt increases in a building, the benefits become lower while the costs increase. Even though equity starts out as being more expensive because of a lack of tax savings, higher amounts of equity will lessen in risk over time compared to high amounts of debt.

6. Financial Flexibility

stacks of money

If you own a property that has a mortgage on it, you need to consider the financial flexibility of the capital stack structure. Loan payments will need to be made every month. If you can’t make these payments or pay off the loan in full once it reaches maturity, you will risk the need to file bankruptcy or even lose the asset altogether. If the economic signs in the area for the property that you’ve invested in are currently mixed or even negative, you should consider a lower debt-to-equity ratio. Lower debt means that you’ll have more flexibility during tough moments in the economy.

7. Lender Appetite

business people

Lenders don’t always have a strong and aggressive appetite for making loans with a real estate property. If the surrounding market is currently going through difficult times, lenders will usually be less interested in providing loans for a property. The key to discerning how much debt you’ll use for your real estate investment is to first identify how willing lenders are to provide you with a loan.

When lenders and investors are highly aggressive, you may be able to obtain the money that’s needed for a riskier project. However, this can be a problem at times. When lenders are aggressive and agree to provide you with a loan for the property, they might require much higher returns and even control of the project, which you should consider when investing. It’s recommended that you maintain a healthy balance of equity and debt.

Building an Optimal Capital Stack Structure

You want to focus on building an optimal capital stack structure with your real estate investments if you want to have the right combination of risk and steady returns. While each individual investor has a different capital stack structure that’s right for them, it’s recommended that you avoid becoming too focused on just one layer of the capital stack. If all of your investments are common or preferred equity investments, the risk of losing everything that you’ve invested is greater. If the majority of your investments go into senior debt, your returns will most likely be lower. A healthy mixture of the two gives you a chance to obtain high returns while also lessening the amount of risk that you take on.

You should take all of the previous considerations into account because of the general risks that come with making any kind of investment. Real estate investing is never easy. However, you can mitigate the risks by better understanding what goes into a capital stack structure. For instance, if the asset that you invest in turns out to be worthless, it won’t matter that you’ve made a low-risk senior debt investment. You’ll still lose most or all of the money that you’ve invested. Making smart investments in real estate means understanding everything that goes into the capital stack structure of a property.

*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.