It’s short-term funding – as little as one day directed at one thing: Closing the deal. It is often referred to as “flash funding” or “same-day funding.” Transactional Funding is usually applied to back-to-back closings – an essential ingredient for many trading in the real estate markets.
The methodology is a favorite of wholesalers and property investors who want to avoid using their own funds in the transaction.
The make or break of Transactional Funding is this:
It only works if the lender is satisfied that a legitimate end buyer is willing and able to buy the real estate under focus. Engaging with a professional lender experienced in the space is riskless to the wholesalers and relatively inexpensive. On the face of it, this option is an intelligent way to go.
How did transactional funding enter the picture?
Before the financial crisis (i.e., around 2008), the go-to way for closing deals was “pass-through” funding. It worked like this:
- The wholesalers look to sign a contract with the “original seller” to buy a property at price X
- They sign another agreement to sell the same property at price Z to an “end buyer” (higher than X)
- They then use the end buyer’s money to fund the first transaction with the original seller.
Here’s the disruptor: Recently, regulations tightened up in many states with the condition that each part of the transaction (i.e., the wholesaler buying, then selling) must stand separately. The immediate implication was that wholesalers had to bring their own funds to the closing. Almost as soon as the obstructions appeared, an innovative formula under the label “transactional funding” entered the arena to bridge the gap. It lends the money to the wholesaler to buy the real estate from the original seller before transacting with the end buyer, thereby paying back the loan with the latter’s payment.
How transactional funding works
So let’s look at the process step-by-step with an example:
- The wholesaler enters into a contract to buy a single-family home from the original seller (let’s call him A) for $300,000 – Part 1 of the transaction.
- The end buyer (call her C) signs a contract to buy the wholesaler’s property for $350,000 on the same day as Part 1 (i.e., Part 2 of the transaction).
- The wholesaler delivers a proof of funds letter facilitated by C to the transactional lender (who only requires that plus the wholesaler’s proof of identity.)
- On the day of settlement, the transactional lender lends the funds to the wholesaler to pay A.
- Immediately after completing Part 1 (of the two-part transaction), the wholesaler closes Part 2 and collects C’s money.
- C’s payment pays back the transactional lender plus the latter’s fees. The balance goes to the wholesaler’s bank account as the realized profit.
- It may look like a complicated procedure, yet it’s quite simple. A closing entity (e.g., an attorney or title company) is generally the middle entity acting for the wholesaler in Part 1 and Part 2 of the entire deal. They deal directly with the lender, the original seller, and the end buyer – removing the wholesaler from the heavy lifting.
The benefits of transactional funding
As an investor (i.e., to reiterate, the wholesaler), the benefits are considerable.
- There’s no risk.
- If, for any reason, the deal implodes, there are no penalties or fees.
- Also, there’s no investor money in the mix. The lender takes on 100% of the funds involved in getting the deal closed—even any earnest money deposits that the agreements call for.
- Generally, with traditional borrowing, the wholesaler’s FICO scores and credit due diligence kicks in as loan deciding factors. Not in this case. All you need is a proof of funds letter from your end buyer and driver’s license or passport.
The disadvantages of transactional funding
Yes, there are one or two.
- It can cost around 1% of the loan value, deducted from the wholesaler’s profits. Some wholesalers offset this by charging an assignment fee to the end buyer for finding the property.
- Timing is a critical consideration. Few transactional loans endure past 48 hours (seldom more than two weeks). These days, one-day transactions are common.
- Suppose the wholesaler can’t get the parties on both ends of the transaction to fit in with this finely-tuned timing. In that case, it won’t work unless extended transactional funding can be arranged ( i.e., up to a year – a notable exception and a discussion for another day).
Alternatives to transactional funding?
There are funding options outside of transactional lending, but in most cases they:
- Carry more risk for the wholesaler
- Demand “own money” as a critical requisite
- Sometimes look at credit scores more closely.
Hard money lenders – a popular option
Hard money loans are asset-backed (i.e., Part 1 of the transaction described above) and include:
- A high interest rate of around 14% (often as high as 20%). The dollars-and-cents interest may be low because you’re only borrowing for approximately thirty days or shorter. Still, it’s there ticking over together with the investor kicking in around 30% of the commitment.
- The lender has the first lien on the real estate. If the deal doesn’t go through and the investor can’t settle the loan, repossession is in the cards.
- There’s generally more time latitude to get the deal settled (up to 18 months) – taking the edge off orchestrating a 48-hour two-part transaction.
- Most hard money lenders support deals that make sense, pushing creditworthiness into the background.
Pass-through funding transactions
In some cities and states, the old system of concluding wholesaling deals still works. Check the laws and regulations as they apply to the challenge of separating Par1 and Part 2. Your attorney is the best bet to know what you can and can’t do.
As a wholesaler initiating transactions described above, transactional funding is a viable methodology that works seamlessly if you can get the timing right. Understand the rules going in, particularly the limited time window and the original seller and end buyer’s receptiveness. Talk to a reputable company in this arena like Wholesalers Transactional Funding to help you navigate deal closings as they emerge. You’ll find their professionalism is head-and-shoulders above most, and they provide stellar end-to-end service.