Buy Now Hard Money

Underpromise. Overdeliver.

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I read once that the single biggest influence on real estate investing was legislation:  The Tax Reform Bill of 1986 that changed investment property depreciation is said to have caused the next real estate crash, because everyone had bought properties with negative cash flow because of the tax write offs.  No tax write offs, no wanna.  A flood of properties hit the market – well, you get it.  You couldn’t give them away. 

Post 9/11 reductions in interest rates were intended to stimulate the economy, which had come to a screeching halt  after the terrorist attacks.  Add that to the Clinton era mandate to make loans to people who had previously not qualified, and you have a whole large group of people who couldn’t buy a house before, suddenly qualifying way beyond their means.  Why didn’t we see what could happen?  Seems pretty obvious after the fact.

Now a bill is headed to the senate with potentially far reaching consequences to the real estate investor community.  By the time you read this, it may have passed or been defeated.   It’s impact is up for debate:  Vena Cox-Jones says it will spell an end to creative real estate investing – Bill Bronchik says that we should be complying with all of these guidelines anyway if we sell houses on owner financing.  That’s not the point of this article. 

My point is that if we don’t stay informed, educate ourselves and make our voices heard, then we’ll wake up one day wondering why something is the way it is and blaming everyone but ourselves for letting it happen.  I’m guilty of this myself, since I’m the least politically inclined animal on the planet.  But making your views heard is pretty much like voting:   If you don’t vote, don’t complain.  And if we’re not careful, we’ll wake up one day with no creative real estate investing.  So read, learn, educate yourself, make your voice heard, and don’t wake up saying Huh?  Wha’ happn?

In this financial climate, credibility becomes more important than ever.  Lenders who in the past would lend strictly on the equity in a property, are now looking at the character of the borrower more and more.  Being clear about what you plan to do, and delivering on what you say are important.  Not just for your next deal, but for all your future deals.

Here are some tips

  1. Provide full disclosure about the property and your situation.  In performing due diligence, if a lender finds you have been less than forthright with some particular aspect of the deal, it calls into question everything else you have presented. 
  2. Be prepared to take pictures of everything.  Even the worst parts.  If you leave out a photo of a boiler that is ancient, rusted and asbestos wrapped, and the lender sees it on a site visit, he’ll wonder what else you didn’t disclose.  We understand rehabs.  That’s why you got it at a huge discount.  So show it and what your rehab plan is for fixing it.
  3. There is a fine line between “fake it til you make it” and just faking it.  I’ve had many conversations with a borrower that go something like this: 
    1. Borrower: “We buy at 40 cents on the dollar, all cash, close quickly and sell at 80% of value to our buyer’s list of first time homeowners.” 
    2. Me:  “Great, how many of these transactions have you completed this year?”
    3. Borrower: <Silence>……………………”Well, we haven’t actually completed any, yet, but we’ve read alot and taken Trump University courses.”
  4. So save the sales pitch for the motivated seller.  The lender knew you were still new at this before the end of the first sentence.  Emphasize your strengths, such as a partner who is a licensed contractor, or the fact that you are a real estate broker, or whatever.  But don’t lie about it, it will come out anyway. 
  5. If you run into a snag that is going to impact your ability to deliver the project on time, be straight about it, and be able to explain your solution to the problem. 

Trust is earned over time.  And is part of relationship lending.  Starting with a few of the basics above will get you on your way to a productive and profitable relationship.

Building a track record can make a huge difference….

Once you have successfully borrowed money, met the terms, and paid the loan back to a lender, you have started to build a relationship.

Why does this matter?  In our case, we’re as much about relationship lending as we are about the equity in the property.  So borrowers who are meticulous about making interest payments on time, meeting their commitments as to construction and lease up schedule, and paying off the loan as scheduled can get better terms and rates than new borrowers.  In some cases, the LTV can be higher and the cash in requirement can be lower.

Here are some points to remember when working with us:

  1. On time payments are exactly that: on time.  You may have a grace period before a late fee is assessed, however, if you want to make an impression, send your payment early.  Small hard money lenders notice these early payments. 
  2. Stick to the construction schedule, and if there are delays, communicate with the lender.  Your lender is in effect your partner in the deal.  His money is at risk, and good communication goes a long way.
  3. If your exit strategy is to refinance and hold, start your refinance process right away.  It can take a long time to get conventional loans approved these days.  Waiting until 30 days before your hard money note is due is a sure fire way to go beyond the term of the loan and incur penalties.

Buying an investment property with hard money requires an exit strategy out of the hard money loan….

(I said I would talk about relationship lending today, but this came up, so I’ll talk about it tomorrow)

Hard money is expensive, and if you haven’t planned ahead for refinancing, you can find yourself in a pinch between a rock and a hard money loan.

If you plan to resell the property right away, you should plan to sell at a discount from the current market price in order to sell quickly.  If you plan to hold as a rental, you should have your end financing lined up before you buy the property.

This means you should identify end lenders with short seasoning time requirements. You should also know your credit score and get prequalified by your lender of choice.  Finding out you can’t get financing after you have already bought, rehabbed and rented a 4 unit property is a recipe for disaster.

Besides a mortgage broker you trust, try local banks and credit unions, as in this credit challenged environment, portfolio lenders are more likely to be flexible enough to meet the needs of investors.

Sometimes a deal won’t wait – and to capture a good deal, you have to move quickly.  Then it might make sense for a real estate investor to use hard money even if you could get conventional financing.

Here are a couple of examples:

  1. A bank-owned property (REO) where the selling bank will take your offer if you close before xx/xx/xx.  Typically they are trying to get non-performing loans off their books, so 12/31/xx is sometimes a drop dead date
  2. A property you bought at auction – you have limited time to close, and financing is moving very slowly these days, if you have to wait for the lender, you could exceed the time limit.
  3. A deal where the seller is simply in a hurry – maybe to move to another area, sell a property to pay off the IRS, or maybe a court ordered payment because of divorce.

There are more reasons a seller could be in a hurry – my grandmother used to say “the hurrieder I go, the behinder, I get”.  Well that applies to sellers too, and it can work in your best interest.

Once you have a loan commitment, a hard money deal can usually be closed as soon as we get clear title, just a matter of days.

 Next post:  relationship lending

The answer to that depends on who you are dealing with……. 

The best way to know the answer to that question is to ask up front, and to try to negotiate that into the commitment from the begining.  If we have a good borrower who is making his payments on time, and the project is progressing appropriately (assuming it is a rehab or stabilization project) we typically will extend a loan at the same interest rate for a set amount of time, and the borrower pays additional points.

There are reasons why you may need to extend, such as: 

  1. Building inspector held up the project

  2. more work needed than expected

  3. you haven’t reached stabilization in a multi yet so you can’t refinance with conventional funding yet

  4. you tried to do all the work yourself and found out that carrying costs more than eat up any savings, etc.

  5. House didn’t sell as quickly as you thought

  6. House sold but buyer couldn’t get financing

As an example – if a borrower was making interest only payments on a $200,000 loan, plus had paid 4 points up front ($8000) to borrow in the first place, then we would typically extend for 2 more points ($4000).  Usually only a note modification is necessary, not a mortgage modification, so the legal costs are minimal. 

Understand, the lender makes money by turning over the capital and charging points and interest every time.  Yes, I know it’s expensive, but remember, these are deals that no one else will do.  Either the property condition rules out conventional lending, or the borrower’s financial state rules it out.  The house may have no kitchen, or no septic, or whatever.  We don’t ask for credit reports unless the exit strategy is to refinance.  These are high risk deals that unfortunately run into trouble more frequently than average homeowner loans.  (Well, given the number of foreclosures, I may have to re-think that statement.)

Here is why this works for both the borrower and lender.

  1. The lender also has a borrower who is already paying as agreed, and sometimes will take reduced points (two instead of four) because there is an advantage in having a customer you know.
  2. The borrower benefits, because refinancing hard money with another hard money loan is even more expensive:  Think a whole new set of closing costs plus new points, plus the new lender may be even more expensive.

Of course it is best not to stay in hard money any longer than you have to.  We don’t want you to stay in the deal, we want you to finish the project, make money, and do another one.  It is in fact true that some hard money lenders use extensions as an excuse to charge much much higher rates and fees because you are already in the deal.  Again, ask around, get references and know who you are dealing with.  I think I’m going to repeat that in every post I make.  Not all lenders are the same. 

Don’t assume that any lender will extend.  There are many factors involved in why a loan might or might not be extended, including market conditions, cash flow of the lender, external financial considerations, etc.

Hope I didn’t sugar coat this too much.  😉  But I think knowing what’s going on is in everyone’s best interest.  Know who you are dealing with, and get it in writing. 

Next time, I’m going to discuss some times that hard money might make sense even if you can get conventional…….