There are various financing options for the type of business I want to open and operate which is a Real Estate Investment company. Structuring these financing instruments accordingly is important and relevant to the overall success of the potential income-producing real estate investments. Moreover, selecting the right financing option depends upon the factors involved on each deal or transaction such as the time horizon, the volume of transactions and the type of property being purchased. All of these factors play a big role in selecting the right financial instrument. (Berges, 2004)
There are three financing instruments I could probably use depending on what I think would be the right choice for the company’s unique objectives and goals. Debt, equity and partnerships are some of the financing options available for this type of business, and each carries benefits as well as drawbacks. Furthermore, when using any type of financing options, the company must keep in mind a very important factor called leverage; being highly leverage can cause an investor to go under quickly. A quick example would be as follows: if the interest rate on a loan is 5.0 % and the expect return on asset is 10% than the leverage is positive. (Berges, 2004)
Debt financing happens when a company or an individual acquires a loan, using other people’s money, which can come in the form of debt or equity. This type of financial option is available through obtaining a loan from a mortgages company, a bank, or family members. “Financing with debt typically requires that you repay a loan with predetermined terms and conditions such as the repayment term (number of years to repay the loan)”. (Berges, 2004, p. 66) When using debt to acquire a house as an investment, a company or individual must consider the leverage factor involved in servicing the loan; since, the debt option requires you to make monthly payments on the debt, positive cash flow must occur for the investment to be successful. (Berges, 2004) “You should have a minimum of a 1.1 to 1.2 ratio of free cash flow left over after all expenses have been paid to ensure that you can adequately meet the debt requirements.” (Berges, 2004, p. 66)
The advantages of using debt as the financing tool to acquire real estate investments are that the loan can be obtained easily and at a lower cost than other financing tools; however, investors must analyze expected cash flow ratios to make sure they meet minimum desired positive cash flow expectations. (Berges, 2004) Finally, “the interest portion of the payment is tax deductible, because interest is treated as an expense for tax purposes.” (Berges, 2004, p. 67)
Equity is another form of raising money to acquire real estate investment properties by forming a partnership or a corporation. Equity financing occurs when money instead of being borrowed is raised and invested. “Family, friends, business associates, and private investors can all be good sources of equity financing”...