If you are an investor who wants to invest in real estate without the risk of putting your own money and also want to avoid rehab, then transactional funding is for you.
In the year 2020, the US real estate market saw around 41.7 % of home flips being purchased with financing. This signifies the number of investors opting for financing options like transactional funding to gain quick profits.
But before you opt for one, it’s better to understand what is transactional funding? How does transactional funding work? What are its advantages and disadvantages? And a lot more. Let’s have a closer look at transactional funding in real estate investment.
What is Transactional Funding in Real Estate?
Transactional funding is a short-term loan provided to finance an investor’s simultaneous (one day) closing. This usually involves two ‘transactions’ in a single day to close the deal.
This type of funding is suitable for a real estate wholesaler or investor to buy and sell a property in a shorter time frame. Most of the lenders will provide 100% finance, only if the investor can prove that he has a legit ‘end buyer’ willing to purchase the property from them. This way an investor can gain quick profits without putting money from their own pockets.
History of Transactional Funding
Before the financial crisis of 2008, investors would use transactional funding on a pass-over basis to flip properties through double (blind) or simultaneous closings. Back then, this type of funding was easily available for the large investors with connections of a private investor or an individual with spare money to entirely finance their flip.
Skip to 2021 and now the real estate financing industry regulations are stricter than before and require an investor to close the deal in two separate transactions. This means an investor will initially have to put their own money to purchase a property before selling it to a buyer. This makes an investor consider transactional funding to finance their purchase. With private lenders providing hard money loans to smaller investors and house-flippers, transactional funding has also become more available.
How Does Transactional Funding Work?
Transactional loans are provided by private hard money lenders to finance real estate investment projects. These type of loans are generally opted to flip properties like,
- Single-family homes
- Multi-family apartment homes
- Commercial properties (Strip malls / Mobile home parks)
- Undeveloped Land
Besides the lender, there have to be three parties involved for the transactional funding to be functional.
A – Owner / Seller
B – Investor / Wholesaler
C – End Buyer
This is why transactional funding is also known as ‘ABC funding’. To get a better understanding of how transactional funding works, let’s have a look at the following example:
An investor B will sign a contract with seller A to buy their property for a purchase price of $150,000, obviously after some negotiations.
On the same day, buyer C (who investor B has already lined up) will sign a contract to buy the property from investor B at the purchase price of $200,000.
Now, investor B will take up a transactional loan from a private lender and meet the closing dates.
Investor B will use the transactional loan to buy the property from seller A at the purchase rate of $150,000 and on the same day will sell it to buyer C at the selling price of $200,000.
In this way, an investor has gained a quick profit of $50,000 excluding any lender fees. Assuming the average closing costs of 15% and 2% loan fees, the profit margin of an investor can be somewhere around $40000 that too without putting any of his own money.
How to Qualify for Transactional Funding?
Getting a transactional loan is way easier than the traditional one. You don’t need to go through a rigorous underwriting process, a credit check, or need a lot of paperwork to be eligible for a transactional loan. A lender will also provide a proof of funds (POF) letter to the seller stating that you have the required funds to buy their property.
Keeping that in mind, there are some essential things that you must have, in order to qualify for a transactional loan.
- A motivated seller that you can negotiate the purchase price with
- A signed B-C contract proving there is a buyer lined up
- An end buyer ready to close the deal.
What are the Advantages of Transactional Funding?
There are some significant advantages of transactional loans for real estate investors. Such as,
1. Low costs
Since there is no requirement of title reports, any kind of appraisal, or insurance there are no transactional costs involved in it. This makes transactional funding a cost-effective way for real estate investors and wholesalers.
2. Easy qualification
There is no compulsion of credit check or income verification for a borrower to acquire a transactional loan. Investors don’t need to list any assets or provide their debt-to-income ratio to qualify for a transactional loan.
3. Fast financing
With a simple underwriting process and less paperwork to be done, transactional loans can be obtained in a matter of days or a week.
4. 100 % financing
An investor won’t have to put his own money as most of the lenders offer 100% funding with transactional loans.
What are the Disadvantages of Transactional Funding?
Flipping houses with transactional funding has its own drawbacks, every investor should consider those before investing in real estate.
1. Lining up an end buyer
To avail transactional funding, an investor must have an end buyer lined up and be able to prove it also.
2. Shorter time frame to close
Transactional loans are short-term loans primarily provided to close the deal quickly in order to repay the loan. Generally, it may take 1-14 days for the loan to come due, but in some cases, it can be only 24 to 48 hours for completing both the closings.
3. Origination fee
The borrower will have to pay an origination fee for the loan, typically 0.5% to 2% of the loan amount upfront.
4. Closing costs
A lender can charge a borrower up to 15% of the loan amount as a processing fee at the time of closing.
Is there any Alternative to Transactional Funding?
Transactional funding is a great way to finance back-to-back closings, but the shorter time frame to close the deals can be riskier for a real estate investor. If you feel there is a great risk in opting for transactional loans, you still have the alternative of hard money loans to fund your real estate investment project.
Hard money loans
Hard money loans are also a type of short-term loan but with little to no risks. Provided by a private lender, it is an asset-based financing option where a real estate property can be used as collateral to avail of a loan.
The process to obtain a hard money loan requires less paperwork and faster approvals allow an investor to raise funds in a few days or a week, perfect for a quick house-flipping project.
Hard money loans can be typically repaid in a time of six months up to two years. This gives it a bigger advantage over transactional funding as you get more time to find an end buyer and close the deal.
Now that you understand what transactional funding is, you can easily determine the benefits and risks involved with these types of loans. If you are an investor and find transactional loans riskier, that doesn’t mean you cannot fund your real estate investment project. Remember, you always have the option of hard money loans.
Seasoned lenders like 14th Street Capital provide quick and hassle-free hard money loans to fund your real estate investment project. Get the fastest preliminary approvals that assure loan closures within 5 to 10 days. Rated one of the best hard money lenders, 14th Street Capital is a reliable funding source for your real estate investment.