Last Updated on February 7, 2023 by Kravelv
If you’re planning on working in real estate development, you’ll have to find a source of financing because using your own money for developments is ludicrous. Not only is the amount of money required for a multi-residential building absurd, but developing such a large project is extremely risky. Many things could make the project unprofitable, which puts your capital at risk. That’s why understanding the financing behind a multi-residential development is essential.
How Financing works
Residential development is usually financed in two stages. The first stage is a short-term construction loan used to finance building the project. During the short-term portion, developers can pick between interest-only or standard payments, which will depend on the financial circumstances of the project itself. With interest-only payments, you only have to make an interest payment each month, but once the short-term stage is over, you will have to start paying off the principal balance as well.
With standard payments, you will have to make both principal and interest payments each month and the loan will amortize regularly throughout both stages. Once the project is complete, the income earned from the building can be used to pay off a regular long-term amortizing loan. When looking for financing, you can get a loan that lasts for the duration of both stages or you can get separate loans.
But before you look for a method of financing, you need to figure out how much it will cost to build the project. Depending on how much you need, the best financing method may vary. Once you’ve figured out how much the project will cost, it’s time to start preparing for a loan.
Using a Bank
You can finance a multi-residential development project through outside financing from a variety of lenders, but the standard way of financing development projects is by simply going to a bank and submitting a loan request. If this is your first development project or you haven’t developed a reputation, then lenders will evaluate everything about your project. This is so lenders can assess how likely it is that the project will succeed and that you will be able to repay the loan. Lenders will look at the project specifications, your development team, and your financial proposal or loan request.
To successfully get approved, ensure that your loan request is professional and detailed. It should include every aspect of the project and you should address any notable risks. If successful, you should get financing for about 60-70% of your project.
Crowdfunding
In 2012, Congress passed the Jumpstart Our Business Startups (JOBS) Act that lets developers use crowdfunding to finance their projects. This is a somewhat unconventional method that involves receiving financing from several small investors online. This is a fairly recent strategy for seeking investment, but it can be helpful in some cases.
While you will still have to disclose details of your project to potential investors, the process for receiving funding is a little less formal than an application with a lender. Unfortunately, since crowdfunding requires many investors to participate for you to receive full financing, there is a high probability that you will not receive enough capital.
Other Sources of Financing
There are many other lending sources as well. You can use private equity funds, credit unions, finance companies, mortgage REITs, pension funds, the Small Business Administration, or life insurance companies. All of these investment groups could be options for financing a residential development project, but banks are still the conventional source. If you choose to use an alternative source of financing, you will have to research the best way to approach them. Since these groups are private investors, they take on quite a bit more risk when investing in large real estate development projects.
Which to Choose?
The method of financing you choose ultimately depends on you and the needs of your project. Banks are a very standard method of financing, but without a good reputation, the process of getting approved for a loan may be very time-consuming and difficult. Crowd-funding is very useful for smaller developments because projects with lower capital requirements are much more likely to be fully financed. Smaller lenders vary quite a bit, but you have many options available.
Once you’ve decided on the details of your project and what methods of financing you are considering, you should do in-depth research on each one to ensure that you are making the right decision.