When an investor has a contract to purchase a property and a sales contract to resell it, he has two separate transactions. If they are completed on the same day, these are considered a whole flip. However, if the purchase contract closes on day one, but the sale can’t be completed until day three, there is a gap between closing dates. This is the most common type of so-called GAP funding.

In this situation, the investor must have the complete amount of money necessary to purchase the property. His options are to borrow from friends and family members, from a partner who has the cash, or from a GAP lender. In this case, if he can find a GAP lender, this person or entity is a hard money lender and will often require the investor to put in 25% or more of the funds needed to close.

The options to overcome this dilemma are for the original property owner (seller) to extend the closing date or for the end buyer to shorten their closing date so that both dates fall on the same day. The easiest way to do this is to give price concessions to either the seller or the end buyer. But what happens if both parties don’t agree to change their closing dates? The investor must get the funds to close on the purchase and then sell the property in three days. This gap of time is what he also focused on in the initial purchase.

The issue for the GAP lender is, “What happens if the end buyer doesn’t close?” The investor wants his profit, but he can only make a profit if he finds another end buyer ASAP. This wasn’t the plan, and finding another buyer can take weeks, months, or not at all. This is the danger of GAP funding for lenders, especially when the original seller and the end buyer are related and never intended to close on the end buyer’s side. This risk is what makes GAP loans expensive or unavailable from savvy lenders.

GAP funding is most common when a real estate developer initiates a construction project and has the initial capital to fund the project’s groundbreaking and some of the construction costs. When he is short on funds, he will go to his original lender and request funds to complete the project. Sometimes, the original lender would only lend a certain amount and no more. The developer must now get additional funding from another source to move forward. This funding is also referred to as GAP funding.

The issue with getting and using GAP funding is that the final funds to complete the closing may not be available, and the project can’t be completed. There are usually three ways that GAP funding is financed:

  1. Depending on the size of the project, sometimes, a GAP lender will become an equity partner in the transaction, requiring 10% to 50% of the project.
  2. The Gap lender may take a second position behind the original note holder (lender), or
  3. In rare cases, the GAP lender will take an unsecured note and mortgage at hard money rates of 10% to 12% plus 5% or more points for the loan.

In summary, plan for the contingency of your end buyer not being able to close in a timely manner. If you are already in the construction phase and running out of money, start prospecting for a GAP lender or equity partner before you need one.

Frequently Asked Questions

It has been our experience that when a wholesale double closing can’t happen on the same day, at least 70% of the transactions fail and the investor loses their EMD and profit in the deal. Make sure you choose the closing agent (title company) or closing attorney who alerts you to any suspicions that they may have about the original seller or the end buyer. This way you can be ready to get GAP funding, or extended transactional funding, to make sure your deal closes.

Investors use hard money lenders to finance fix-and-flip and BRRRR loans. Part of the loan package is dedicated to funding for the construction or renovation of the property. These funds are advanced only when a certain amount of the construction is completed, effectively eliminating the need for GAP funding.

GAP funding most often arises unexpectedly due to issues with the end buyers or cost overruns. These are usually desperate situations and not a credit problem, and should be planned for before they happen as a contingency for the unexpected.

Average cost for GAP funding is heavily dependent on the credit worthiness of the borrower, the project’s completion, the developer’s experience, and the desperation of the situation. Interest rates from hard money lenders can run from 3 to 5 points to close and 10% to 15% annually. Commercial lenders for large projects usually run from 8% to 10% plus closing costs of three to five percent.

GAP lenders face substantial risks of default by their borrowers. To offset these risks, they will get personal guarantees, notes, and mortgages, and clauses in their notes to allow ease of foreclosure.

The best deals suitable for GAP funding are those where a developer receives construction funding and then secures GAP funding to market and sell the individual homes. In transactions where the investor buyer has little or no money in the deal (subject-to or wholesale-to-retail flip, or a novation), some sort of GAP funding is needed to complete the rehab before resale.

In our experience, the speed of a GAP lender is a function of their completed due diligence. In large projects, this time can range from two weeks to two months. When hard money lenders are involved, the lending approval process typically takes between one and three weeks. Private money lenders can do these loans in as little as 24 to 48 hours.

Repayment of GAP loans is most often paid back at the sale of the property, but are issued to the borrower in a balloon note due in a specific period, either 6 months or a year. If multiple units are involved, a requirement of each sale may be a partial repayment of the GAP funding.

Some red flags are the quality of the work done to date on the property, the contractor’s credit, projects he has completed, unwillingness to sign contractual agreements, inability to give credible references, and any bankruptcy he may have had. All these are signs you don’t want to be a lender for his project.

Using personal credit cards is the worst form of GAP funding, as their interest rates can exceed 30% if you are forced to miss payments. It is better to partner with someone who provides the necessary funds. Using HELOC money will have a reasonable interest rate, but the homeowner runs the risk of foreclosure if the project doesn’t succeed. I wrote an eBook on finding private money at DaveDinkel.com/Products.