The financial benefits of leveraging financing versus cash investments are obvious. Your ROI is always much higher with debt financing versus investing cash. Other benefits of financing include reduction of risk, retaining cash reserves, and additional liquidity that can produce added income. The question is not whether you should secure financing, but how to best position your project to effectively secure funding and obtain the best terms.
The following basic example illustrates how the financing approach can generate over 58% greater return than funding the project entirely with cash. I have been involved in projects where the benefits of financing was 126% greater than funding it entirely with cash or securing all funds from cash investors. While it may be obvious that financing is more profitable than cash funding, the disparity between the two is important to keep in mind, and maximum efforts should always be made toward effectively securing debt financing.
Sample Project – Uses and Sources of Funds
Cash Investment Approach
- Project Cost: $1,000,000
- Cash Investment: $1,000,000
- Months: 12
- Net Revenues (From Sales): $1,300,000
- Capital Gain: $300,000
- Percent Return: 30%
Project Financing Approach
- Project Cost: $1,000,000
- Bank Loan (LOC): $700,000
- Cash Investment: $300,000
- Months 12
- Net Revenues (From Sales): $1,300,000
- Bank Loan Payment (P&I): $735,000
- Capital Gain: $265,000
- Percent Return: 88%
The cash investment approach shown above required risking $1,000,000 and yielded a 30% net return on the amount invested. The financing approach in the same project required a cash investment of only $300,000 and it rendered a much greater return on investment of 88%. This approach significantly reduced risk and tied up substantially less capital that can be put to work and can generate additional income from other projects.
In order to realize the benefits of project financing, a real estate project must be effectively positioned, structured and presented in a way that makes “financial sense” to lending institutions. The ability to leverage financing for property acquisition, pre-development work, construction, marketing, and/or re-financing a real estate property has a direct impact on your profit margin and on your level of risk and exposure. Obtaining the most advantageous financing terms will also help boost your project and reduce risk. For this reason it is important to appropriately structure your project to effectively secure financing. The key to successfully structure and secure financing for your real estate project will be discussed in my next article.