If you’re a real estate investor looking for gap funding, I can’t help you with the money, but I can commiserate. It’s not a spot anyone really wants to be in—taking out a second loan to cover costs a first one didn’t—but sometimes that’s where you end up.
In my case, I skimped on my inspection and underestimated my repair costs. I needed gap money to finish renovations. (Ever heard of knob and tube wiring?) I got the renovations done, but by then my costs were so high that even though I sold for my estimated ARV, I didn’t take anything home. Gap funding kept me from defaulting, but it didn’t keep me from wasting months on a dead-end deal.
Sympathy may not help you much if you’re in a similar position. If you’re like I was, you’re mostly concerned with getting out from under your property. Gap funding may be able to help, but what helped me most was learning how to avoid situations where I’d need to cover a gap in the first place.
Reasons to Avoid Gap Funding For Real Estate Investments
Gap funding for your real estate investments has several downsides for both you and the lender. And, since the lenders are the ones with the money, their problems become yours. The burden is yours to find someone willing to lend, convince them they can reasonably expect a return, and manage the loan in a way that makes good on that return. All of this is easier said than done.
The reason gap funding is so problematic comes from the structure of the loan. Gap funding is a form of hard money lending, which is an asset-based lending category. Instead of securing their loan with a long-term mortgage and credit check, lenders secure by claiming rights to collateral—usually the investment property.
But, gap funding your real estate investment takes place after an initial hard money loan, meaning lenders are second in line to recoup costs should you default. In some states, they may not be able to recoup at all. All this adds up to a very risky loan, which means a very costly loan for you—if you can find one at all.
And, you may well not be able to find one at all.
Gap funding provides a slim margin for profitability. Investors take it out when they’ve already gone over their expected costs. Remember, ARV – Costs = ROI. Gap funding is a bet that even with the increased direct costs of repair, the ARV will be large enough to pay back both lenders. If the amount requested for gap funding takes the total above the market value of the home, someone is certain to lose money.
So why does anyone seek out gap funding?
Reasons Real Estate Investors Seek Out Gap Funding
Very few investors intend to take out gap funding before starting a project. Taking out gap funding increases project costs, eats up time and energy, and can tarnish your reputation if things don’t go well. Those who are willing to swallow that pill might use the funding to keep their cash free for another project. This strategy, however, walks a tightrope above risk and reward—yes, it can increase your portfolio, but as you stack your debt, you stack your risk.
Most investors seeking gap funding are forced to do so by mistakes or unforeseen circumstances, which in many cases, can be the same thing. If a tornado hits, okay that’s not your fault. But, even if you call undetected cracks in a fieldstone foundation at the bottom of a hill an unforeseen circumstance, not detecting those cracks was a mistake. An inexperienced investor may say that paying excessive holding costs because a property won’t sell at the price they listed is an unforeseen circumstance. But, a seasoned investor should have seen that coming.
Making mistakes as a real estate investor isn’t cheap. Even breaking even on a project, like I did when I had to take out a gap loan, amounts to months of time lost for no gain. After that, I realized that if I wanted to make it without making any more big mistakes, I would need some help.
Gaining Knowledge and Experience To Avoid Costly Mistakes
I think my biggest mistake was trying to go it alone. It never occurred to me to check for an outdated, out-of-code wiring system. But knob-and-tube wiring is nothing new, and if I’d had a mentor to help me learn what to look for, I could have identified it and estimated my costs correctly. I could have saved months just by listening to advice.
So, before I started another project, I became an independently owned and operated HomeVestors® franchisee. HomeVestors® provided me with comprehensive training, tools to correctly assess home value, and a mentor I respect to guide me through the process. With all this in my corner, I could approach hard money lenders with more confidence—and better numbers. I haven’t needed gap funding for my real estate investments since.
Ready to say goodbye to gap funding for good? Learn to make real estate investments the right way—contact HomeVestors® today!
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