Transactional funding and how it can be applied to startups
Investing in real estate takes excellent credit, lots of cash, and the instinct to know when to act fast. House flippers, REO investors, and wholesale real estate investors have a tool up their sleeve—transactional funding. This short-term lending alternative is useful when an investor wants to quickly seize an opportunity without tapping into their own funds.
What is transactional funding?
Transactional funding is a borrowing process where an investor borrows short-term capital to close a deal. It’s also known as ABC funding, flash funding, same-day funding, or a one-day bridge loan.
The lender will typically make a hard-money loan to the investor for 100% of the capital required for a period as short as 24 hours. There’s no credit check or down payment required, but the investor must have an end buyer to complete the transaction.
Same-day funding is popular for investors who want to purchase property for wholesaling without tying up their personal funds. Since the loan is for a short period of time and an end buyer is waiting, transaction funding lenders are willing to finance such a transaction for a fee.
A lender will usually charge a percentage of the loan plus a minimum fee. In most cases, flash funding terms of 1-14 days are typical. If the investor does not complete the transaction within the time set, the loan converts into an interest rate loan.
When transaction funding is executed properly, a real estate investor can earn a significant amount of profit without investing their personal capital into the deal. The secret to its success is in the simultaneous or concurrent closing. Two back-to-back closings must occur.
The rapid-fire succession of two closings is necessary for scenarios such as bank short sales, when wholesale investors buy properties from government entities like HUD and FHA, or when the purchase of one property is contingent on selling another.
How startups can use transactional funding to their advantage?
Transactional funding is used in real estate investing, but the concept itself could be applied to startups. An investor is essentially leveraging the interests of two parties and working as a mediator to materialize the transaction. The concept of transactional funding boils down to the leveraging of people and resources.
Relationships are key—an investor must be the intermediary who finds the interested buyer and convinces the seller to release the asset. Having relationships with venture capitalists, private lenders, or financial institutions who are willing to lend or invest the funds is vital.
Transaction funding example
The following example will give the term ABC funding some context. An investor is interested in a property and they have a buyer waiting to purchase it. The original seller is “A.” The investor who wants to purchase the property from the seller is “B,” and the waiting end buyer is “C.”
The investor needs to complete a double closing—an A-B transaction followed by a second closing—the B-C contract. The investor (“B”) is leveraging the borrowed money as a bridge.
The bank (“A”) agrees to short-sale the property for $150,000. The investor (“B”) has a buyer who signed a contract that they will pay $200,000 as the purchase price for the property. The investor must coordinate for both sales to happen on the same day to meet the terms of their short-term bridge loan. If the simultaneous closings are a success, the investor (“B”) pockets a profit of $50,000.
This example is overly simplified because it doesn’t account for closing costs, realtor commissions, and the transactional funding fees. Accounting for an average closing cost of 15% to buy and sell the home and another 2% for the transaction loan, the investor potentially made $20,000 after fees—all without investing any of their money.
How does an investor qualify for flash funding?
Qualifying for transactional funding is different from getting approved for other traditional types of lending. Funding requests are approved or denied based on the strength of the deal and not on the investor’s credit score or income.
To qualify for hard money, an investor must provide the lender with the signed and executed contracts from the seller and, most importantly, the end buyer. Hard-money lenders want to see that the seller (A) and end buyer (C) are locked in and ready to go.
The ease of accessing this type of funding is what attracts investors. The funding is completed in as little as one or two business days because traditional loan underwriting isn’t required. An investor does not need to provide proof of employment, credit verification, personal collateral, or appraisals to get a transactional loan.
What are the benefits of transactional funding
Investors typically use transactional funding to capitalize on a time-sensitive investment. But there are four other reasons why transactional funding is compelling.
1. Allows you to close on a property without using your own capital
Using a third-party transactional funding lender saves you from having to invest your own capital to close the deal. You can leverage someone else’s money in exchange for a small fee. The fee is usually 1 to 2 points of the loan, but it may be well worth the cost to preserve your personal capital for other investments.
2. Your offer may have an edge over other buyers
If you’re investing in real estate, you’re likely looking for investments with good value. In most cases, other investors and private lenders are considering the same deals and creating competition through multiple offers on the same property.
Transactional funding gives you 100% funding, similar to cash buyers. Coming to a bank’s or seller’s table ready for a quick close with 100% financing gives you an edge over your competitors to close the sale.
3. Funding depends on your contracts—not your credit score
A transactional lender is looking for executed contracts from the seller and your end buyer. You don’t have to worry about credit history checks, employment verification, and collateral. This is beneficial if you don’t want any hard pulls on your credit, which may affect your credit score.
4. Real estate wholesalers can sell non-assignable contracts
A non-assignable contract restricts the assignment of a security interest in a property, such as with a foreclosure or short sale. Real estate wholesalers can use transactional funding to release a bank’s security interest in a property by purchasing it. As a result, the property will be free and clear of its non-assignable clause. A second closing to sell the property will then be possible.
Transactional lending cons
Quick turnarounds, no holding costs from hanging on to a property, and preserving your capital for other investments are some of the advantages of using bridge funding for real estate transactions. But there are drawbacks as well:
- Transactional lender fees may be as high as 2 to 4 points of the money borrowed
- Not closing in the agreed time frame could cost you additional interest charges
- Your purchase offer may need to be in the name of an entity such as an LLC or a corporation
- Some title companies are not familiar with double closings and may not be willing to process them
Utilizing transactional funding as a business concept
Transactional funding is all about connecting people. Schedule a discussion with your team on how the concept of transactional funding could apply to your business. You may potentially uncover valuable insights on how to leverage and trade resources, skills, and tangible assets, leading to new and visionary solutions for your company.