Short Summary
Also known as flash financing, transactional funding refers to an exceptionally short term loan that is used to purchase property. A transactional loan is typically repaid in an extremely short period of time. In some cases, the loan may be repaid on the same day. In most cases, the loan is paid back within a week of the property being purchased.
Table of Contents
Basics of Transactional Funding
The real estate business often moves quickly, and there may be times when you need fast funding to take advantage of a potential opportunity. However, it can sometimes be challenging for real estate investors to get access to the cash they need within a short window of time. While there may be options available, it may be challenging to access funding from a legitimate source that doesn’t charge a high-interest rate.
That’s where transactional funding can come in handy. Also known as flash financing, transactional funding in real estate refers to a short-term loan with a quick closing process that allows real estate investors to get the cash they need when the opportunity to execute a profitable real estate transaction presents itself. While transactional funding can be a useful tool in various scenarios, like any type of financing, it has its pros and cons. So, to help you decide if it’s the right method for you, here is a deep dive into transactional funding in real estate.
What Does Transactional Funding Actually Mean?
Transactional funding refers to a very short-term loan used to front the cash needed to make a real estate purchase. But unlike a mortgage or a hard money loan, the money is typically repaid very quickly. In some cases, it may be repaid the same day or, at most, within a week.
In some cases, real estate investors may need a large sum of cash to close on a transaction but want to avoid using their own money. If they are certain they have an end buyer who is willing to purchase the home as soon as the deal closes, the investor can use transactional funding to make the purchase and repay the loan once the home is sold. This can be a highly profitable strategy if done correctly, although it typically only works in specific scenarios.
How Does Transactional Funding Really Work?
Transactional funding in real estate is typically supplied by a private, hard money lender. The transactional lender will agree to provide the necessary capital needed to purchase a property under the condition that it’s repaid within a short window.
Unlike a traditional mortgage and other types of real estate loans, there is no long-drawn-out closing process that may take several weeks. Transactional lenders are willing to move quickly, and in many cases, the funds will be available the same day you apply for the loan.
However, for transactional funding to make sense, the investor must already have a committed buyer and seller participating in the deal. Otherwise, the transactional lender won’t approve the loan.
The steps involved in a transactional funding real estate deal typically look like this:
- Step 1 – The investor finds a seller who is willing to sell their home for below market value in exchange for a fast closing
- Step 2 – The investor locates a buyer who is interested in purchasing the home for above the asking price
- Step 3 – The investor uses transactional funding to purchase the home from the seller.
- Step 4 – The investor then turns around and sells the home to the new buyer and then uses the funds to repay the transactional lender.
It’s a quick process, but if handled correctly, the investor can often walk away with a nice profit, even after all the closing costs.
What Kind of Real Estate Investors Use Transactional Loans?
Transactional loans are typically used by wholesalers who plan on doing a double closing but want to avoid spending their own money. Wholesaling is a type of real estate investing where the investor collects a fee by connecting a motivated seller with an end buyer (typically another investor).
The wholesaler will go out and find distressed properties where the seller is either in foreclosure or no longer has the means or motivation to keep up with the responsibilities of homeownership. In that scenario, the seller may be willing to let go of the property for a reduced rate if the wholesaler can guarantee a fast closing.
The wholesaler will then go and find an end buyer for the home, who is usually another investor that plans on flipping the property for a profit. If priced and handled correctly, the wholesaler can collect a sizable fee for acting as the middleman.
Wholesalers sometimes use an assignment contract, which allows them to pass the title directly from the seller to the buyer without ever assuming ownership of the property. However, this isn’t possible in every scenario. Some lenders won’t underwrite a loan using an assignment contract, which would make it challenging for the buyer to fulfill their end of the bargain. In some cases, they wholesaler may prefer to keep their profits discreet and avoid letting the buyer and seller have direct contact.
In that case, the wholesaler can do a double closing – which means they will buy the home from the seller, then immediately turn around and sell it to the buyer very quickly. However, that also means the wholesaler must have the funds available to purchase the home from the seller. If they want to avoid using their own money, the wholesaler can use a transactional loan just to cover the purchase and closing costs, then pay it off as soon as they close the sale with the buyer.
Transactional loans typically don’t work for those who are trying to flip a home themselves. Renovating a property usually takes at least a few weeks, while the repayment period for transactional funding is usually at most 2 to 5 days. However, a transactional loan might work if you find a property that only needs quick cosmetic upgrades, such as a fresh paint job or deep cleaning and already have an interested buyer.
Is It Realistic to Find a Lender that Funds 100% of the Property Price?
Finding a lender that is willing to fund 100% of the purchase price can be challenging for other types of real estate loans. Yet, with transactional funding, it’s a bit more realistic. For instance, hard money loans may finance 100% of the cost of repairs but only 80-90% of the property price.
With a transactional loan, there is less risk of something going wrong because the repayment window is so short. As long as the investor has all their ducks in a row and finds a legitimate buyer with proof of funds who is committed to making the purchase, there isn’t much risk that the borrower will struggle to repay the full amount.
The same can’t be said for other types of real estate loans. For instance, if you plan to flip a home, many things can go wrong between the time you take out the loan and the time you pay it back. There could be construction issues that delay the process or a market crash that makes it challenging to find a buyer.
As a result, many hard money lenders will only lend a certain percentage of the purchase price based on how much risk they are willing to assume. That way, recouping their full investment won’t be as difficult if there are any unforeseen issues.
However, with transactional funding, the deal is often set in stone when the investor applies for the loan. So, as long as all parties follow through on their obligations, there isn’t as much risk of unforeseen problems that could impact the profits. Therefore, transactional lenders can supply 100% of the funding and feel confident they will get their money back.
Transactional Funding Example
- Bob finds an abandoned property with a potential value of $400,000
- Bob finds a buyer for the property called Steve, who is willing to pay $265,000
- Bob offers the abandoned property owner $250,000 in cash. The owner accepts.
- Bob arranges a transactional loan worth $250,000 to purchase the property
- He then sells the property to Steve for $265,000
- His gross profit is $15,000
- It costs Bob $6,000 to execute the transaction ($5,000 interest, $1,000 origination fee)
- His net profit is $9,000
In this example, we assumed an interest rate of 2% and an origination fee of $1,000. In reality, the interest rate and origination fee may differ from this example.
Alternatives to Transactional Funding
Transactional loans can be great for wholesalers in specific scenarios where fast cash is needed to finalize a deal. However, they don’t make sense in every scenario. Here are a few alternatives you may consider if you need a bit more time or if you need unique terms.
- Hard money loans: Hard money loans are a similar type of private financing that are secured by a hard asset (typically real estate). However, unlike transactional funding, they usually have a longer repayment period, which makes them better for home flippers.
- Bridge loans: Bridge loans are a type of short-term financing that helps investors who need extra cash flow to pay expenses until other funding is available. Although not meant to replace long-term financing methods, the repayment period for bridge loans is typically 1 – 3 years.
- HELOCs: A Home Equity Line of Credit is a credit line secured by the equity in a property. They can be useful for investors who already own a home and need fast access to capital with reasonable interest rates.
Final Thoughts
Transactional financing can be a great tool for investors who just need a lump sum of cash to help them close a deal. However, it is not advised for those who need long-term financing or don’t already have a solid commitment from a seller and end buyer.