You don’t need to be wealthy to get into commercial real estate investing. A variety of nontraditional financing options have opened the door for small businesses and investors. Read on to learn about traditional and nontraditional options for property development funding.
Types of financing
Traditional financing is when you take a loan out from the bank to cover some of the cost of the development. Typically, 60-80% of a project’s capital stack comes from traditional financing. However, it does depend on the project’s risk and size. Developers must use other funding options such as equity financing, alternative debt sources, or use their capital to fund the rest of the project.
This type of financing can be used in two different funding situations. It usually means there is a six to eight percent return on the capital investment and a stake on capital gains later. Here are the two ways syndicated financing can happen:
- Real estate syndication- A developer would create a deal with court investors who would put capital towards the project.
- Syndicated financing- Capital can be funded by private equity sources or through a lender.
Crowdfunding has been a new way for developers to fund their upcoming properties. The Job Act of 2012 allows small-time investors to invest in bigger projects which established investors would normally buy into. Under this legislation, developers can contact investors without having a relationship through different social media sites. This source of capital makes difficult projects easier by allowing the public to invest in the property.
A sponsor will take a more active role in a project compared to limited partners. Before the project begins, this is when sponsors will put their capital into the project. Developers may seek other forms of financing because many sponsors do not have 20-40% of the cost in cash.
Joint venture funding is when multiple contributors combine their assets to form a deal with the developer. Contributions can include but are not limited to cash, land, and an experienced partnership. Any type of contribution can be made if the developer agrees on the asset.
Mezzanine debt is a way for developers to increase funding if they already have sponsor equity and traditional financing. Mezzanine debt is more expensive and has a shorter period than senior debt. This type of loan can lower a developer’s investment while increasing their return.
More Options for Small Businesses
Small businesses have a few more options when trying to get property development funding. Here are three funding options small businesses can benefit from:
- Build-to-Suit- This is when a business will not have ownership over the building but will be able to operate within it.
- Sale-Leaseback- Sale-leaseback is when a new owner takes control of the property, and a new lease must be created.
- Private Placement- This is like syndicated funding; however, a business would be the project’s sponsor instead of an investor.
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