Capital plays an essential part in the establishment of any business. Capital in the form of money or asset that is invested in any organization to make it capable of standing on its own. Running a business depends on the raising of the capital, and well-raised capital is an integral part of any business.
Like any other business, when discussing real estate business, you must have a clear knowledge regarding your source of finances. Investing in real estate business can prove to be highly beneficial for the property investors and developers.
Property development attracts many investors, and, in many countries’, real estate development contributes to their GDP by trillions of dollars.
Research suggests you need a greater passion and a sound education related to real estate before moving into the lane. A greater capital needs to be invested, but it does not mean the money of your own, and in fact, it’s wiser to invest the money generated and sourced from other resources.
Usually, any investor invests with those who give them a higher rate of return. So, the primary objective of you as a property developer is to make the investors believe in you, confident that you are the one who will give them a worthy return.
In this article, we dwell into the ways Real Estate Developers Raise Capital for their developments and answer the question ‘How to Raise Capital for a Real Estate Development?’.
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Firstly, let’s look into the main types of capitals that developers use to support developments.
What Are The Main Types of Capital Developers Raise?
There are two main kinds of the capital real estate developers raise; debt and equity.
When you take loan, usually from a bank, or borrow money from wealthy personnel (or organization) that is considered ‘debt’.
Borrowing money from such resources (bank or wealthy personnel) have some disadvantages. For example, if the project is not favorable in the hand of developers it may cause loss to the individual/organization who lent money; however, profit will be higher if capital is raised properly with a safer risk profile.
Tip: Do you know all the Risks involved in the Real Estate Investment?
Equity is a high-risk capital because there is no certain limit of the project being favorable or unfavorable; if the project faces downhill, then it may suffer loss and will be closed. However, the advantage is, if the project gaining anticipated profit, your limits become wider to the sky.
The ratio of the equity market is quite low compared to the ‘debt’ market, and it is also less transparent.
Sources of Equity Financing
There are four primary sources of the equity market.
Friends and family (F & F)
The money generated from ‘Friends and Family’ source is usually in a small amount and only popular within beginner property developers.
By this way, you generally collect money from the people you know well. F & F is the ground source or the source from which one start investing.
Tip: Here is our Guide to Safer Start in Real Estate Developments.
Funding from crowds (Crowdfunding)
In this case, money collected through fundraising or connected sponsorship.
(More details of property crowdfunding is below)
Real estate developers believe this as the best source of capital.
In this way, small offices generated by wealthy families fund and manage the capital of the property development. They usually closed ‘unions’ deal privately and have strict terms and conditions to work within, but if they decide to venture with you, it can be beneficial immensely your career as a property developer.
Money generated through institutional investors
When you need to raise a sufficient amount of capital, you may able to do so through institutions such as universities, colleges and fundraising agencies.
The flip-side is that they are very careful when investing because most of them are low-risk takers.
When taking investments from such institution, be prepared, they usually demand high security, and thoroughly verify it from strict audits and investigation your financial reports.
However, the greatest benefit that comes with institutional investors is that they ask for a comparatively low rate of return, as compared to the other types of equity investors noted above.
Options for Raising Capital
Fundamentally, when you as a property developer trying to generate capital, you need to make yourself worthy enough in the market. If you have a solid track record and ‘successful’ with your recent developments, the chances are there will be many lenders lining after each other willing to make investments in your developments.
The opposite of the coin is pretty harsh – if your track record is ‘poor’ everyone will turn around.
Following are the options in raising capital.
Private and hard money lenders
Hard money is the form of an asset by which a mortgagor receives funds tenable by property. Private companies usually allot it.
Hard money lenders are the ones who are licensed to lend the money to those who are in need; however, private lenders refer to the term is who are working privately or an individual. They are those who have the capital and a right of investing that.
In our experience, the private and hard money lenders are the easiest and reliable sources of raising capital.
However, you should not forget the profit private, and hard money lenders take a return of 12 – 15% as the rate of interest for lending their money. This amount of prepaid interest is almost three times higher than the amount charged by the banks.
Nevertheless, the advantage of taking money from this source for property development is that they (that is, private and hard money lenders) grant money faster as compared to the banks as the money taken from banks need lengthy procedures to follow, which may take a month or sometimes two. So, it is no brainer why many property investors and developers turn to them, and why the trend has been growing noticeably over the years by attracting many developers.
Many of the investor developers can now use their own retirement funds (for example, superannuation funds) and funds from personal user account for investments. But of course, the account must be governed by the custodian.
The internal revenue service and the tax office allow them to invest their savings in real estate, and the advantage is that they are free from penalty, if they withdraw money earlier before retirement for investment/development purposes.
The condition that implies is that the profit must be returned to the account from which the money is generated, but their profit will increase over the years in a more controlled and secure manner.
Private placement memorandum
Private placement memorandums are those who sell securities to the selected investors/developers. They sell securities to the other investors for raising capital.
In this strategy, the wholesale deals are sold out without using investors’ money. However, it has no guaranty.
The Strategy to Raise Capital for Property Developments – A Quick Glance
The foremost rule of raising capital in real estate business is to invest your money of your own. The sources of investment are savings, equity, bonds (long term and short term) and funds.
Generally, liquid assets are the backbone of your real estate development business. Taking a loan is possible when only when your own investment is sufficient.
Ideally, you must raise your liquid assets (assets which can be converted into cash easily) in order to raise capital for real estate business. For this, knowing the market is essential.
Once you are done with this option, then start making a list of those who are willing to invest in your project or grant you a loan. As noted, people are ready to invest only when they are assured of receiving their money back with a considerable amount of return.
Then, as the third step, make a project for raising capital and describe the needs and requirements well for potential lenders. Estimate the total amount that you need for your project. Include all the working capital, and solid profit and loss statements. The raising of capital entirely depends upon the demonstration of your project well; as good as the demonstration is, the higher your capital raising will be.
Pre-launching projects play a significant role in stimulating investors and lenders as they can guarantee the investor about the capital and profit that can be gained.
To be successful in all the above strategies, the most important thing is your market relationship as an excellent reliable character (your standing). Better your credibility it will be easier for you to find investors for your developments.
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Property Crowdfunding – An Internet-based Capital Reach-out
Crowdfunding is the technique in which you collect a small amount of capital from a group of people but through the internet. Although the market is small yet, it is growing rapidly. Research and statistics suggest that in 2015, approximately US 34 billion dollars were collected through crowd funding.
The model of crowdfunding is based on three major ‘players’.
1. The one who proposes the idea or the source from which fund can be generated,
2. The one who provisions the idea, and
3. The third one who is the crowdfunding platform.
Generally, we do not know many investors, but through crowdfunding, you can display the project in front of everyone, and you can attract as many investors from all around the world.
To be successful in crowdfunding, one of the main tactics you must be perfect in is marketing. The better your marketing skills are successful you will be in crowdfunding.
Crowdfunding platforms do not provide any liability or any source of expensive advertising, but it just uses internet/web platform to connect ‘the source’ (i.e. investor) and ‘the idea’ (i.e. the developer).
There are two ways of getting started.
1. The first way is to create your crowdfunding website, and
2. The second way is to keep your ears open. Stay active within the crowd funding portals.
In our experience, the second way is more effective unless if you prefer to make your own website and grow it over time.
Raising capital plays a vital part in real estate development. At your early career as a property developer when your reputation is not established, lenders/investors will be are reluctant to lend their money until they feel comfortable to do so.
However, after your pass those initial hurdles as a property developer, you will find it’s much easier to ‘reasonable’ investors, asking for realistic returns and lining up after you to lend you more. It is a dream come true of a real estate developer and obviously an opportunity that you need to grasp well.
Loans are the most challenging part to get and may need a lot of paperwork. So, most of the people move towards the private investors though as they could make the process easier for you.
After all, if you need to stay active and thriving in the field of property development, you must be tactful and exercise the strategies we noted above regular basis.
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