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Gap funding is one way to use other people's money and make it work for you. If a project is profitable there is a good chance that there is a gap investor willing to work with you on a mutually beneficial transaction. with Gap funding is one way to bridge the gap between the cash you have available for a project and the total project cost when a typical rehab loan leaves you with a shortfall.
Gap Funding Structures
As mentioned above, there are three basic structures to gap money. The first is annualized interest. This works like a typical loan, there is an interest rate and that rate is applied to the loan balance and paid monthly by the borrower, just like a typical loan. As a slight twist, these loans can also be set up so that this interest accrues to be paid at the time of sale.
A second structure would be a flat return. This is simply a flat percentage return on investment. So if we had gap funding of $100,000 and a 25% flat return, you would simply pay off $125,000 when the property sells.
The other common way to structure gap funding is with participation. Participation means the gap investor participates in your project like an equity partner. Basically they would take a percentage of the profits on the deal. So if we had gap funding of $100,000 with 50% participation on a project that had a profit of $50,000, you would pay the investor $125,000 when the property sells ($100,000 principal, plus 50% of the profit).
In addition it is not uncommon for more than one of these elements to be part of the structure on a gap loan. For example, with gap funding of $100,000 and a structure that takes 12% annualized interest plus 20% participation on a project that takes 6 months from purchase to sale and makes a profit of $50,000, the gap funding would be at a cost of $16,000 ($1,000 per month in interest times six is $6,000, plus 20% of the $50,000 profit, which is $10,000. $10,000 + $6,000 = your total cost of $16,000.
Gap funding is one way to use other people's money and make it work for you. If a project is profitable there is a good chance that there is a gap investor willing to work with you on a mutually beneficial transaction.