What Is Real Estate Gap Funding?
Gap funding in real estate serves as a temporary loan to provide interim financing for individuals until they can secure a more permanent solution, often referred to as a bridge loan. The primary purpose of gap funding is to bridge the financial gap between the time a borrower requires funds and when they can secure a long-term loan.
Because of their short-term nature, gap loans are commonly used by borrowers who are awaiting long-term financing approval and need immediate funds to cover pressing expenses. This financing tool has proven to be valuable for individuals seeking access to capital while navigating the time gap between deals. Consequently, an increasing number of real estate investors are recognizing the advantages of utilizing gap lending to address their financial needs during the transition between property transactions.
Many real estate investors often turn to private or hard money loans for their upcoming deals. However, it’s common for these lenders to cover only a portion of the purchase and rehab costs, typically around 70% of the property’s value. This shortfall necessitates the need for additional capital, which is where gap funding becomes crucial.
Real estate gap funding addresses the limitations of hard money lenders, bridging the gap between the initial loan amount and the remaining financial obligations. Essentially, gap funding can cover the disparity between the original hard money loan and the total costs involved, including acquisition, rehab, marketing, and selling expenses.
It’s important to note that gap loans generally come with higher interest rates compared to private and hard money loans because they are considered second position loans, introducing added risk. Moreover, gap funding lenders may require a percentage of the profits from the deal. While gap funding has proven beneficial for many real estate investors, it should be used judiciously due to its associated costs and terms.
Gap funding is specifically designed for investors involved in high-volume property flipping, offering several benefits that investors will find advantageous:
Tailored for high-volume rehabbers, gap funding is particularly suitable for those concurrently managing multiple projects. It serves as a risk mitigation tool, addressing challenges such as delayed sales or unexpected slowdowns in the rehab process. With gap funding, the traditional need to wait for one deal to close before initiating another is eliminated.
For real estate investors, gap funding can cover the shortfall between hard money loans and the remaining acquisition costs of a property. This enables investors to access deals that might have been out of reach otherwise.
Gap funding is versatile, extending beyond property acquisition to cover rehab costs, as well as expenses related to marketing and selling the property.
Investors benefit from gap funding by maintaining a more liquid position, providing flexibility in their financial strategy.
In summary, gap funding proves invaluable for high-volume property flippers, offering risk mitigation, expanded deal access, and financial flexibility across various aspects of real estate transactions.
While gap funding has proven beneficial for investors in specific situations, it is not universally applicable, and investors should be mindful of certain drawbacks:
Gap funding’s short-term nature makes it less suitable for investors focusing on flipping a single deal. The associated costs are typically structured to accommodate those engaged in high-volume property flipping. Consequently, the expense of a gap loan may not justify its use for investors with less frequent or single transactions.
Given the heightened risk associated with gap funding, investors can anticipate higher interest rates, often exceeding those of more traditional mortgages by at least 1%.
Although not a standard practice, some gap lenders may request a percentage of the proceeds from the sale of the property, introducing an additional factor that investors need to consider when evaluating the overall cost and terms of the financing.
Securing a gap loan, like any other funding source, involves the investor’s choice between traditional and alternative financing methods. Gap loans can be obtained from both institutionalized banks and private money lenders. Opting for a traditional bank loan requires a formal application process similar to that of a conventional loan. On the other hand, working with private or hard money lenders involves attracting interested investors. Given the higher risk associated with gap lending, investors must effectively convey to the lenders that their investment is worthwhile. Similar to a hard money loan, funding from gap lenders is primarily asset-based, meaning that a more favorable deal increases the likelihood of securing the loan.
Gap Lending And Real Estate
Gap lending and real estate investing are closely intertwined, with gap lending serving as an invaluable financial safety net for those looking to sustain ongoing projects or avoid delays in future endeavors. In practical terms, gap funding proves beneficial for individuals who have depleted funds from their original hard money loan but require additional capital to complete the rehabilitation process. Instead of jeopardizing profits by delaying a project, investors can opt for gap funding to ensure the successful completion of renovations. While this financing option comes with additional costs, the benefits often outweigh the expenses when it comes to successfully concluding a real estate deal.
Real estate gap funding has been a crucial asset for numerous investors, providing rapid and convenient access to cash, which is particularly vital in today’s highly competitive market. Nevertheless, it’s essential to recognize that real estate gap funding isn’t a universal necessity for every deal. Similar to other forms of funding, its relevance depends on the specific circumstances of the situation. In essence, gap funding is most appropriate when:
High-end projects are more likely to realize sizable returns.
Investors want to maintain more liquidity.
There isn’t enough cash on hand to close a deal.
Transitioning to a bridge loan can reduce interest payments from the initial loan.
Cash reserves are needed to complete any unfinished construction projects on the subject property.
Interest payments are building up due to the deal taking longer to close.
Investors need to keep enough cash on hand in the event another deal presents itself.
Gap funding has proven to be a useful tool for anyone looking to secure temporary financing. That said, the optionality awarded by gap financing doesn’t come without a price; it’s usually more expensive than its traditional counterparts. Interest rates on gap loans, in particular, can range anywhere from 3.25% to 10.5% (depending on creditworthiness). Outside of higher interest rates, borrowers can expect to incur the following costs:
Administration Fees
Appraisal Fees
Escrow Fees
Loan Origination Fees
Notary Fees
Tital Policy Fees