This article is all about how you can increase the amount of low-interest funding you can get for your real estate deals.
This guide also contains:
• Tips on how to use loans without harming your credit scores
• Advice on separating your personal and business finances to limit your risk and increase your fundability.
• Specific pitfalls to avoid that are unique to real estate investors
How to Build Business Credit
Business credit works just like personal credit. Your business has a credit report with each of the credit bureaus. (Or at least it should.) They produce credit scores based on the information in that credit report.
If you make steady, on-time payments, then your business credit scores go up over time. If you miss payments, pay late, or default on loans, then your credit scores will tank, and it will be very hard for you to access financing.
Your business needs to have a file open with the three major business credit bureaus to begin building business credit:
Create a Business Entity
The first thing that you need to do is set a firm foundation for your business credit by getting a business entity.
Business entities include:
• Limited Liability Companies (LLCs)
• Corporations (like traditional C-Corporations or S-Corporations)
• Limited Partnerships (LPs)
• Sole proprietorships
Naturally, you'll want to consult with an attorney and CPA about the best entity for your business. LLCs, S-Corporations, and trusts are very popular in real estate.
Of course, this is Business 101 stuff, but many landlords neglect to create an entity. Many landlords with 1-4 rental properties still have all of those properties in their names.
This not only increases the legal liability of the landlord but also makes it challenging to get business credit.
The business credit bureaus and lenders want to see that your business has the following identification points:
• Phone number
• Website and/or social media profiles
All of this business information needs to be separate from your personal information. Your business address and phone number should be separate from your personal ones.
Separate Your Business and Personal Finances
Similarly, you should have separate personal and business bank accounts.
When applying for a business loan, the length of time your business has been operating matters. The longer that you've been in business, the better. And many lenders won't lend to businesses that are less than two years old.
Many lenders regard the start of your business from the date that you opened your bank account, not when your organization filed its LLC or legal entity.
Again, this may seem like Business 101, but many property owners have tenants write them checks that go straight into their personal bank accounts. You don't want to do that!
If you manage your properties, you will probably have lots of little expenses accrue that you will want to write off on your taxes. Expense tracking software is highly recommended for managing those expenses.
Online software services like Freshbooks can automate your expense tracking so that you don't have to spend as much time working on your books. The best part is that web-based software like this is super cheap and within reach of even the most cost-conscious investors.
Once your business entity and finances are correctly established, it's time to start opening credit accounts. In a nutshell, building your business credit is as simple as following these steps:
1. Get different types of credit
2. Keep your utilization low
3. Make early payments
4. Keep errors from cropping up on your credit report
Get Business Credit Cards
Business credit cards are one of the easiest types of funding to obtain, and they also help to build out your business credit profile. There are a few pitfalls to avoid here, but they represent an incredible opportunity.
I once worked with a real estate investor who had over 30 credit cards. He showed me his massive spreadsheet to keep track of all of them. He was able to keep his credit scores high and still use his credit cards to fund his deals.
In a recent analysis that my associates performed, small business owners in the Nav database averaged 4.78 credit cards and a total credit limit of $35,291.
That means that their average credit card limit is $7,383.
If you were to open up five credit cards with that credit limit, how many more deals could you fund this year?
To leverage credit cards for your business, keep these pitfalls in mind.
• First, make sure that you get a business credit card that reports to the business credit bureaus. Some business credit cards don't report to some business credit bureaus, and you need to get your payments reported for them to show up on your credit reports.
• Second, keep your utilization low. What this means is that you want to use as small a percentage of your credit limit as possible.
That advice is incredibly counter-intuitive. However, when lenders assess your credit report, they look back at your credit usage over the past 24 months. (This is called the lookback period.)
If you max out 100% of your credit limit regularly, they think that you're a risky borrower, and are less likely to approve your credit application, or at least will lower the amount that they give you.
That's why it's advisable to keep credit limits below 50%, and, if possible, even below 30%, if you want to keep increasing your credit limit over time.
• The third pitfall is to, of course, make your payments on time. Like in personal credit, your track record of on-time payments is the most significant single factor influencing your business credit score.
Open Vendor Credit Accounts
Vendor credit, also known as trade credit or supplier credit, is when your vendor gives you time to pay back a purchase. It's typical for a vendor to offer net-30 terms for payment, meaning that you have 30 days to pay back your purchase.
Net 15, net 30, net 60, and even net 90-day terms are quite common. And many of the companies offering these terms will report your payments to the business credit bureaus.
This is great news because it gives you the opportunity to build your business credit by buying the supplies that you would already buy for your business anyway.
Want to build your business credit fast? Get net 30 accounts with 5 different vendors and make consistent, early payments on them.
Here are four companies that offer net 30 accounts that report to credit bureaus:
• Crown Office Supplies
All of these companies accept new businesses with no credit history.
Home Depot and Lowe's also have in-house financing options for businesses, which I highly recommend to real estate investors. Even though many new businesses may not be able to qualify, you'll want to build toward qualifying. Since you're bound to shop there anyway, why not build your business credit as you shop.
Build Lines of Credit
It can be hard to qualify for traditional bank lines of credit.
Most banks want to give lines of credit to businesses with substantial revenue, at least two years in business, and strong credit scores.
However, the good-ole line of credit is the holy grail of real estate investing.
Business lines of credit come with low-interest rates and can be used for anything. They can be used for property repairs, a down payment on a property, or if your credit lines are big enough, even for an entire property purchase.
Quick note: I know that most traditional mortgage lenders don't accept borrowed funds for a down payment. However, you can borrow funds for a down payment with alternative lenders and in seller financing situations.
Some investors who use the BRRRR method will make their initial property purchase with credit line funds, and then refinance the property with a traditional mortgage later.
After you've built up your business credit through vendor credit accounts and business credit cards, you'll want to get some credit lines opened up.
The trick is to start with what you can qualify for, and then to ask for credit limit increases every six months. After a few years of this, your business will be eligible for quite a bit of funding.
This is how you finance your real estate empire.
Specific Pitfalls for Real Estate Investors
The biggest pitfall to avoid is maxing out your credit cards and lines of credit.
This can be difficult when you want to buy a six-figure property, and your credit limits will enable you to make the acquisition.
However, because of the lookback period, maxing out your credit limits is a bad habit to get into if you want to grow credit lines continually.
Another common pitfall has to do with mortgage loans. Banks don't like to see more than two property loans on your credit report, so your credit scores could drop quite a bit after purchasing your third property.
If you build your business credit and keep your finances in order, the right lender will lend to your business and not to you, which will keep the property loan off of your credit report.
The last pitfall is to be careful of paying off property loans all at once. If you do it right, having multiple property loans on your business credit report can significantly strengthen your credit profile.
If you're not careful, you could pay off one property loan and see a considerable drop in your business or personal credit score.
I spoke to an entrepreneur the other day who paid off his own house's mortgage loan with the proceeds of a business sale. This is smart financial management, right?
Rather than being rewarded by the credit system, his credit scores dropped quite a bit. If you have extra funds and you're looking to pay off some debt, it may make sense to finance your next property before paying that debt off, so that you can keep that valuable mortgage account on your credit report.
Alternatively, it may be smarter to make extra payments on your credit cards or lines of credit, rather than to pay them off all at once.
Since real estate investing is a game of high finance, it pays to build your business credit. Stick with these tips if you want to grow your business.
About the Author: This article was contributed by Garit Boothe, a Nav Certified Credit & Lending Specialist in the business credit industry. He is a regular attendee at the local REIAs in Salt Lake City, where he lives with his wife and family.