Real estate is a great investment, but another thing is that real estate is expensive. However, there are a number of ways to buy real estate without having much in the way of liquid cash. In this article we will cover 9 different ways that you can invest in real estate without a lot of cash, starting with more normal methods and ending with some unconventional or indirect methods of investment.
- Owner-Occupied Government Backed Mortgage Programs
- Real Estate Equity Loans
- Equity Partners for Real Estate Investing
- Financing From Friends and Family
- Have the Seller Act Like a Bank with Seller Financing
- Retirement accounts aren’t just for stocks: Invest Through an IRA or 401(k) Account
- 401(k) Loans Can Be Used to Invest in Real Estate
- Tap into Your Equity in Stocks and ETFs with Margin Loans
- Real Estate Investment Trusts
1. Owner-Occupied Government Backed Mortgage Programs
Government backed mortgages include: FHA, VA, and USDA loans. These loans are only for owner-occupied properties, and can be used to purchase 1-4 unit properties as long as you will live in one of the units for at least a year. If you really want to get to know your tenants, you can purchase a single-family home, live in one of the bedrooms, and rent out the remaining rooms.
FHA loans can get you into a property for as low as 3.5% down, with a credit score of at least 580. There is also the FHA 203k loan program, which allows you to bundle the home purchase and rehab expenses together into one loan for only 3.5% down of the total bundled cost. The one downside to these loans is that you must pay an upfront and monthly Mortgage Insurance Premium (MIP) to insure against the risk of these low money down loans. This cost is typically 0.5-1% of the home’s purchase price every year, which can really eat into the return on investment. The closing costs on FHA loans also tend to be more expensive than conventional loans. However, once you reach 20% equity in the property you can refinance into a conventional loan and no longer have to pay for mortgage insurance. And once you refinance out of the FHA loan you can then get another FHA loan to buy another property, move into it, and repeat the process.
For veterans, current service members, or their spouses, the VA Home Loan program offers $0 down payment loans that can also include repair costs. Further, no MIP is required for these loans, and the interest is usually lower than many other types of mortgages. The Department of Veterans Affairs guarantees VA loans, which enables these great benefits.
The USDA also has a mortgage program. Yes, the agency that grades your beef will also back your $0 down mortgage; as long as the property you buy is in a “rural” location. To see what areas are considered rural you can check out the USDA loan website. According to the website most of Beaufort County outside of Hilton Head may be eligible for this loan. USDA loans also enable repair expenses to be rolled into the loan. However, unlike VA loans, there is mortgage insurance required for USDA loans.
2. Real Estate Equity Loans
What if you don’t have a lot of liquid cash, but have a lot of equity in your home or other investment properties? Then a Home Equity Line of Credit (HELOC), Home Equity Loan (HEL), or cash-out refinance may be a good way to get into your next real estate deal. HELOC’s typically let you use your equity similar to a credit card where you have a line of credit and only get charged on what you use. Usually you will have to pay an adjustable rate on these. HEL’s are lump sum loans where you pay a fixed rate on the money borrowed, and cash-out refinances pay off the original loan on the property, by taking on a new mortgage, and receiving the remainder of your equity as cash. There are closing costs associated with these loans and you may have to pay for an appraisal, but the good news is that many lenders will let you roll most of the closing costs into the new loan.
3. Equity Partners for Real Estate Investing
Have any friends, family members, or acquaintances that are also interested in investing in real estate? Partnering up with them can be a great opportunity to come up with the funds needed for a purchase. You can split the equity in a variety of ways depending on who brings what to the table. Does your friend have capital, while you have construction skills? Then perhaps your partner brings all the money, while you bring the hustle and sweat equity. Or you each bring 50% of the funds needed and you each split the effort needed to close on and manage a property. Many people recommend not going into business with friends or family, but this is the method I used to purchase my first rental property, and it has been successful thus far. The key thing to remember is that this is a business and even if your friends are your business partners you should still have a written agreement on what each person’s responsibilities are and what happens if things do not work out as originally planned.
4. Financing From Friends and Family
Friends or family can act as a bank and lend you money. This method can be a double-edged sword though. If your investment turns out to be a success then your friend or family member receives their money back plus interest. However, if the investment goes belly-up then Thanksgiving dinners will be pretty awkward if you can’t pay your cousin back. If you are trying to get your first real estate deal under your belt then this probably isn’t the method to use due to the risks involved.
5. Have the Seller Act Like a Bank with Seller Financing
Seller financing can be great for deals where the seller is not looking for a lump sum of money, but instead is willing to act as a bank. Typically the buyer puts a downpayment down on the property and the seller “carries the note”, which means that the buyer pays the seller just like a buyer with a mortgage pays the bank. The payment to the seller will consist of a principal amount and interest amount, also just like a regular mortgage. Further, if the buyer fails to make a payment then the seller has the right to foreclose on the property and will get the property back. Seller financing can be short term, or for however long both parties agree to. Most sellers are not interested in seller financing, but it’s definitely a good idea to ask as most sellers think the only way to sell is to take a lump sum.
6. Retirement accounts aren’t just for stocks: Invest Through an IRA or 401(k) Account
Creating a solo 401(k) or self-directed IRA and rolling over funds from your IRA or 401(k) into these accounts will enable you to invest in real estate in them. Just like all 401(k)s and IRAs, you are not able to take this money out without penalty before age 59 ½. This means that you have to be meticulous in ensuring that the money generated from these investments is kept separate from your other assets, or risk getting hit with an early withdrawal penalty. There are other rules and possible taxes pertaining to using leverage in retirement accounts, which is why it is important to discuss using this method with a financial professional before investing in real estate this way.
7. 401(k) Loans Can Be Used to Invest in Real Estate
Have a lot of money tied up in your 401(k) and don’t want to roll it over into a solo 401(k)? A 401(k) loan may be just what you are looking for. These fixed rate loans allow you to act as your own bank. This is because when paying back a 401(k) loan the interest goes into your 401(k) account, instead of the pockets of a lender. There are a number of downsides to using a 401(k) loan though. The biggest downside is that the money borrowed does not stay invested in your 401(k). This is unlike most loans where what you’re borrowing against stays invested and you receive money from a lender. This loan is literally your own money coming out of the 401(k). However, there are rare exceptions to this. Some companies have their 401(k) loans set up to where your money remains invested in your 401(k), and the company lends you the money instead. You would have to look at your plan to see if this is an option. The maximum 401(k) loan is 50% of the vested account balance, with the max loan amount being $50,000. Another downside is that your loan must be paid back with after-tax dollars.
8. Tap into Your Equity in Stocks and ETFs with Margin Loans
Own lots of stocks or ETFs and don’t want to sell them to buy real estate? Then some brokerages allow you to take out loans that are backed by your stocks and bonds. These margin loans give you quick access to capital, but there are a number of drawbacks to using margin loans, which make them very risky to use. One is the risk of being margin called. If the equity in your brokerage account drops below a certain threshold then you will receive a margin call in which you must either sell off stocks, or add cash to the account. Brokerages are allowed to raise their maintenance requirement at any time, which means that in a volatile market, such as what was seen in March of 2020, your brokerage could change the maintenance requirement, just as your portfolio drops. Even worse, your brokerage may not allow you enough time to transfer money into the account before they liquidate your shares. Another downside to margin loans is that they are adjustable rate loans. When money is cheap to borrow, margin loans can seem like a great idea, but if interest rates increase quickly you can find yourself scrambling to pay off the loan.
9. Real Estate Investment Trust
Real Estate Investment Trusts (REITs) were created specifically to allow everyone to participate in real estate investing, not just people that are wealthy enough to directly invest in real estate. For more background information on how REITs work check back at a later date for an article on the differences between REITs and direct real estate investing. Long story short: You can buy shares of a REIT, which owns real estate and participate in the cash flows generated from rental properties. REITs can easily be found on the stock market and many specialize in certain sectors such as apartments, triple net properties, farmland, long-term care facilities, and more. However, REITs trade more like stocks than real estate, which means they can be very volatile, and are easier to liquidate. REIT stock investing is a great way to diversify across a vast number of rental properties, with very little money invested. Some brokerages allow you to buy partial shares of stocks for as little as $1.
Don’t forget that you can combine different methods. For instance, you can team up with some friends as equity partners and use a HELOC to come up with a down-payment for a conventional loan.
(1) https://guide.freddiemac.com/app/guide/section/4203.4