Buy Now Hard Money

Underpromise. Overdeliver.

Browsing Posts tagged hard money lending

When a real estate investor buys a distressed property with the intention of rehabbing and reselling to an end buyer, those investors are frequently not agents, but they often work with agents to purchase the property.  They also get CMA’s from those agents to evaluate the end value of the property after rehab.  The end value is the beginning point of evaluating the rehab budget and how much they can afford to pay for the property. 

Their offers are not usually based on the list price, they are, and should be, based on the end price, working backwards toward the offer price.  Starting from the end price, they will work backwards taking into account the cost of

  • Rehab budget w permits
  • Contingency for unknowns
  • Finance costs
  • Two sets of closing costs
  • Carrying costs including taxes, insurance, utilities, HOA dues, grass cutting, snow plowing, trash removal, etc
  • Let’s not forget entrepreneur’s profit

If they call me for funding, the first thing I look at is end value, called the ARV, or after repaired value.  Often the investor supplies me with the CMA provided by their real estate agent.  This CMA is done for the purpose of estimating ARV.  I look at sold comps in the immediate area of the property in question, in the same size range and hopefully the same style/age.  In New England, there is frequently a huge variety of properties in the same area, so exact comps are admittedly difficult.

But time after time, I find that the agent totally ignored properties close to the subject property that are viable comps.    Included in the CMA are properties that support the end price they want to convey, but may be in a completely different part of town.  They may be larger, have more bedrooms, have more bathrooms, have more garages.  That’s ok if the agent adjusts for those additional features.  But skipping over the houses that sold for much less than the target price is not presenting an accurate picture of the neighborhood.  Perhaps they are in dated condition, perhaps they are bank owned or short sales.  But they can’t be ignored if they are truly comparable in location, size and relative condition.   

What’s really distressing is when a very close comp in size, amenities, condition and location is not included in a CMA because it doesn’t support the after-repaired price the agent wants to present.   The agent considers it to be an anomaly, and so leaves it out.  The investor-buyer relies on that CMA to work backwards toward the offer. 

What happens as a result? 

  • The agent gets their commission on the original purchase.  The borrower then tries to get funding for the deal, and the hard money lender looking at the deal values the ARV much lower than the borrower does.  He won’t lend on the property, and the borrower loses his deposit. 
  • Or, alternatively, the borrower closes with his own or private money, rehabs the property, and then it doesn’t sell because his selling price is too high. 
  • Or let’s say he does a beautiful job on the rehab, gets it under contract to an end buyer, but the end buyer can’t get financing because it won’t appraise for the selling price.  I guarantee the appraiser saw those lower comps, and appraisers are very conservative these days.

In any case, the investor/buyer is in trouble.  This seems pretty short sighted to me, because that investor won’t be back to buy another one. 

I lend to real estate investors exclusively, we don’t lend to homeowners, so the focus of my business is pretty narrow.  But those investors resell to homeowners, so the end after repaired value is a critical component.  I always pull my own comps when I evaluate a property.  And I encourage my borrowers to ask their agent to pull ALL sold properties in a small radius in the same square footage range within the past 3-4 months.  The borrower can then go through and see all sold properties and get a good perspective on the neighborhood.

A real estate investor is reponsible for creating a finished product with the end value that will sell.  It’s his money on the line.  The agent doesn’t have their own capital at risk, so the final value he/she comes up should always be subject to the investor’s analysis and judgement.

I have a favorite saying.  Lack of proper planning on your part does not constitute an emergency on mine.

At the same time, one of the reasons that real estate investors use hard money is speed.   If you find a great deal – let’s say it’s bank owned – and the seller will give you a great price if you can close in 10 days, you need either cash, private funding from friends and family, or probably hard money.

Assuming you don’t have cash or wealthy family, you might need hard money.  Here’s what you should do.
  • Don’t wait until 3 days before closing to call a hard money lender.  That reason should be obvious.
  • Make sure you have electronic photos of the property ready – you should have taken them when you first visited the property, both inside and all exterior shots.  If you don’t buy the property, then delete them, but if you are buying the property, you have saved a trip to take photos.  It will also help you document your improvements later if that becomes necessary when you resell.
  • Have a brief bio of your investing experience all ready.  Who you are and what you’ve done as an investor is important.
  • Have signed versions of P&S contracts and addendums all scanned in and ready to send.  If you’re in a hurry, why are these items unavailable?  They are critical to the closing.
  • Know your rehab budget by line item.  Be ready to explain why x improvement is needed but y improvement won’t help your resale.   Better yet, explain in your executive summary.  Have the budget in a spreadsheet that is easy to read.  No long difficult to read paragraphs that ramble.
  • Pay attention to the lender instructions for getting the deal done – they have a process they’ve done over and over, and they need to do due diligence.  Make it easier for them and it will be quicker for you.
  • Be available.  Nothing is more frustrating than working hard to pull the pieces of a deal together only to have the borrower regularly ignore his cell, or not read and answer email.  If you are in a deal that requires speed on the part of the lender, than you need to make yourself available so as to not hold up the process.  Yes, we all need down time and family time.  And if you are in another appointment, of course you need to wait to answer or reply.  But if you’re not available quickly, then you are the one holding up the works.  It could cost you a deal.  
Ask me how I know.  🙂

I saw a post the other day from an investor who was told he had to get the contract (deal) before he could get funding. Another poster disagreed, and told him that wasn’t true. In the interests of not hijacking the thread, I thought I would post some information that might be useful.

It is very desirable to line up funding for your deal before you sign and contract and put up your earnest money. If you are using conventional residential funding for that deal, it is easy, since pre-approvals are the norm in the conventional residential financing world. If you have a private source of funds – an equity partner or a private lender you have worked with – it might also be easy because of the one-on-one relationship you have developed.

If you are being told you have to get the deal before you can get the funding, you are probably hearing that from hard money lenders. With a few specific exceptions, I don’t know any hard money lenders who will look at and actually approve a deal until there is a likelihood of it actually becoming a deal. And here is why:

I get sometimes a dozen calls in a day from people who want me to approve the deal before they’ve made the offer. Remember, this is a hard money loan based on the property, the amount of cash in the deal (skin in the game) and the experience level and exit strategy of the borrower. In order to tell if I’m likely to approve a deal, I have to know all about the cash available, the rehab plan, and then I have to pull comp sales to figure out the ARV. I have to decide which sales are true comps and which skew the results. I then look at the available houses on the market that are going to be competition based on the projected selling price and location, and time of year. And all before the buyer has even made an offer! In the best of circumstances, this takes about 1/2 hour if I have no interruptions, sometimes up to an hour depending on the deal. If I did nothing else all day, there goes 6 hours of my day. And of these inquiries, maybe one in 30 or 40 actually becomes an accepted contract.

I can spend my entire day looking at deals that never happen, or I can spend my day approving funding for deals under contract where the buyer needs to close quickly. If you are a buyer who needs to close quickly because the clock is ticking on your deal, which would you rather?

An exception that was referenced above would be a repeat borrower that I have done business with already. In that case, I of course will look at a deal while they are in negotiations.

We all have to make decisions on how to prioritize our time, but the above illustration is to explain why you may be told that you need to get the deal before you can get the funding. If you can get true project approval before you sign on the dotted line, all the better, but if you can’t, this may be why.

Part 7 in a series of 7 posts

Ok, we’re getting down to the last three questions here. 

Should I form an entity to lend?  It is not the same thing to lend as to borrow.  Even though we can’t lend to end homeowners, and lend to commercial entities only, we don’t have to be a commercial entity to lend.  The issue here is about liability protection.  So once again, consult with your attorney about the liability incurred in lending, and the two of you should discuss together whether you will lend from an entity.  My personal feeling is that since this is a business transaction, I want to do business from my entity, but that’s my personal situation. 

Should I lend outside of my geographic area?   Ok, on this one, there are strong feelings on both sides.  Certainly, when you buy stock through your broker, you don’t worry about where the company is, simply if they are making money.  But depending on how you lend, the answer can be quite different.  If you are contributing money to a pooled fund, and have no control over where your money goes, then where the fund lends is also outside of your control.  In that case, the costs of managing a loan in a particular location are the only considerations.  Since you aren’t managing the loan, the fund is, it is probably not an issue.  However, if you are lending directly or through a local hard money company, then there are numerous things to think about:

  • You should always go to the property before you lend on it.  How far do you have to go to put your feet on the dirt?
  • Do you have a network of attorneys, title companies or real estate brokers in the area where you are lending?  You will need an attorney or title company, depending on the state, to close the loan.   
  • Do you have contractors to finish a rehab in that area?   If the property is in disrepair, and you need to take it back for non-payment, you’ll need to manage contractors to finish it if that’s part of your exit strategy. 
  • If you have to foreclose, you’ll need an attorney for that, and an auctioneer.
  • Then you’ll need to resell.  Do you have a network of potential buyers in that location, or a real estate broker to get it sold quickly? 
  • Are you familiar with the laws in that state?  It’s easy to get tripped up by assuming they are the same as they are in your state.

Attorneys, title companies, auctioneers, real estate brokers, and even buyers are all over the place.  If you are comfortable setting up this network in an unfamiliar location, have at it, but it is much more difficult to find these people, and find good ones, from 12 hours away.

Now, just to give some perspective on the other side of the argument, if where you live is not a good location for lending, and assuming you wish to lend, then you have two choices:  move, or lend in another location.  And there is no reason to invest in your backyard simply because it’s convenient.  I know many people who are comfortable investing all over the US.  Certainly it increases the pool of available deals.   But it also exponentially increases the complexity, because of logistics and the need to educate yourself and make connections.  I wrote a post on “Grief to Revenue Ratio“.  Everyone has to decide how much extra aggravation is worth it to them.  It’s a personal choice.  But most experienced real estate investors seek local lenders, because a local knowledge of the market is critical to making an informed decision.  Local lenders make quicker decisions, and that’s how more business gets done.

 What about business loans instead of real estate loans?  Auto loans?  Personal loans? 

  •  The reason we make real estate loans is because the loan is secured by a hard asset (hence the term hard money).   With a business loan, if the owner lets the business decline or shut down, the asset is gone.  Poof.   Take a restaurant for example.  If the restaurant isn’t operating because it gets shut down by the health department, then there is no income, and pretty much no asset.  If the restaurant pays rent and doesn’t own the building, then all that’s left  is the sign over the door and a lot of used restaurant equipment.  And in this economy, used restaurant equipment or office furniture isn’t selling.  Believe me, there is a surplus.
  • Auto loans?  Well, it’s an asset, but a depreciating one.  And the problem with autos is that they have wheels.  And I think the laws that effect debt collection and the repossession are going to be determined by where the vehicle is at that moment.  Do you really want to be repo man in Alabama?  Alaska?  Minnesota?  (choose a state that’s not near you to fill in this blank)
  • Personal loans?  Just donate the money to to needy and be done with it.  You’ll have no unmet expectations.

There are many considerations in whether to buy, borrow or lend.  If you want to talk about lending some more, get in touch with me.  My phone and email are posted on my website.    I’m happy to chat and answer your questions

Part 5 of a series

First, let’s define a real estate investor, for purposes of this series of posts.  Buying real estate to hold for income, or buying real estate to resell – both of these are called real estate investors.  Also, wholesalers, who get properties under contract and then assign the contract.  We’re not going to get into the debate about whether these people qualify to be called “investors”, I’m simply defining the word for my purposes.  For my purposes, a financial investor or lender is the person putting up the money.  So I’m differentiating between a real estate investor, who may or may not have money, and a financial investor, who is putting up the money.

Ok, you’ve decided you want to consider lending as part of a real estate investing strategy.  Here are some points to consider as you work through the process.

How do you find these good deals to lend on?

  1. This can be a challenging process.  If you belong to your local Real Estate Investor Association (REIA), you know dozens of real estate investors. At the REIA’s, you’ll find dozens of people who have deals and are looking for funding.  They don’t want to pay hard money rates, so they seek private money lenders or partners.  Also check your local Property Owners Association.   Ask your friends and family – they may know real estate investors that you don’t even know about.
  2. Find a local hard money company.  Most of them use OPM to lend – either they have warehouse lines from institutions, or they lend pension fund money, or they have pools of financial investors, or a combination of these and other sources.  You would be one of these financial investors.  But be careful!  Get references, and be sure you have transparency from the lender.  In New Hampshire, a well known private lender was recently sentenced for fraud in a large Ponzi scheme.  I know people who invested with him and lost hundreds of thousands before he was shut down by the FBI.  So ask around, and get lots of references from people you know and trust.
  3. Some companies, (like mine!) lend out other people’s money on individual deals.  The financial investor (you) gets to choose which deals they are comfortable with on a case by case basis.  The source of those funds is frequently your self-directed IRA, or perhaps capital that you’ve earmarked for real estate investing.  Instead of buying a property and rehabbing it, the financial investor lends money on a deal screened by the hard money company.

How do you choose the deal you will lend on?

Are all of these people that invest in real estate good candidates to lend to?  NO!

  • First, disqualify first time investors.  If you are a first-time lender, and they are a first-time rehabber, for example, there is greater potential for disaster.  Everyone needs to get started, but let the experienced lenders lend to them for their first time out of the gate.
  • Trust your instincts.  If you don’t feel right about the investor or the project, let it go.  It might be totally legit, and the person might have the greatest integrity, but if the deal makes you uncomfortable, move on to the next one.  Your instincts will evolve as you learn more, anyway.  And that includes deals you might look at that I present.
  • Consider the worst case.  If you have to foreclose, heaven forbid, and take back the property, consider what you will do to get your money back.  Can you finish the rehab if it’s not done?  Can you find a buyer?  Will you keep it and rent it out because you liked the neighborhood and property anyway?  Will you sell it “as-is” through the large network of real estate investors looking for deals?  Can you pay the taxes that the real estate investor didn’t pay?  Can you afford to pay the attorney and auctioneer and media for the foreclosure process?  (Hint:  if you can’t, you shouldn’t be doing the deal.)
  • Decide on a return that works for you.  You may be getting only 1/2 a percent on your money market fund, but if the borrower is offering only 6-8%, that may not be anywhere near high enough to compensate for the increased risk.  Your money market fund is much less volatile.
  • Don’t put all your eggs in one basket.  Yes, you’ve heard it a million times before, and it sounds corny.  But the reason you’ve heard it so many times is that it’s true.  If you have $300,000 to lend, don’t put it all in one deal.  Consider several smaller deals to diversify.  And while we’re at it, don’t take your entire savings or capital and put it into lending until you are more experienced.  If you are an experienced real estate investor, then my recommendation would be different, because you know what you are doing.  Experienced real estate investors can make money in up or down markets, and the rich don’t get rich by diversifying into money market accounts.  They get rich by concentrating on a niche.

Should you ever lend in second position?

  • No.  I’ve seen so many second position mortgages get wiped out, that after lending on one, where I got out by the skin of my teeth, I thanked my lucky stars and never did another.  The more you know about investing, the more you realize just how risky a second position is in this market.  If the borrow runs out of time, money or know-how, the liens ahead of a second position can grow quickly.  Taxes, utilities, interest and penalties on the first position, foreclosure expenses on the first position, etc.
  • Maybe.  The reason for the maybe is this:  If you are determined to be an equity partner in a deal, then at least take a second position to protect your capital.  Remember, the mortgage gets paid before the equity investor.

Next post we’ll continue on the rest of the questions.  If you are reading this and want to see the earlier posts in the series,  the rest are on my Active Rain blog and my website blog starting with Lending, Borrowing or Buying.

•What about business loans instead of real estate loans?

•How do you protect yourself from fraud or incompetence?

•How much of my portfolio should I allocate to lending?

•What happens if the borrower stops paying?

•Should I form an entity to lend?

•Should I lend outside of my geographic area?

Part 4 in a series

Lending money to real estate investors can be a lucrative way to participate in a project without running the project yourself.  It can lessen your risk, because of where you stand in the line of people waiting to get paid.

First, lets make it clear we are talking about real estate investment deals here – not a homeowner purchasing a home to live in.  The real estate investor will probably sell to an end buyer, but a lot happens before that.

Irving Investor is going to buy a property in disrepair, using some of his own money and some of yours.  He’s going to fix it up, probably using your money, and then sell it to an end buyer in this example.  When he sells to an end buyer, everyone gets paid off:  The taxes, the utilities, the mortgages and the agent if Irving used one.  Irving pockets what’s left over.  For purposes of this discussion, we’re going to leave the agent out of the picture, simply because it’s not relevant to the issue I’m illustrating.  If there is not enough money, someone at the end of the line is left out in the cold.

Here is the order of payment:

  • Property Taxes
  • Condo fees
  • Utility Liens
  • 1st position mortgage holder
  • Mechanics and medical liens (The contractor you didn’t pay, Medicare, etc)
  • Additional liens
  • Equity investor

So since you are not the town levying the taxes and you’re not a condo association, the next best position is first mortgage holder.  Notice that the owner and/or equity investor gets paid last.  He takes the most risk.

Now, I’m not saying that the equity investor won’t make more profit – he might.  Or if something goes wrong, he might not.  The point is, the lender is paid before Irving Investor is paid.

Before you jump into lending with both feet, there are some things you need to know.  I’m going to cover a few here, and then some more over the next couple of posts.

First the disclaimer:  I am not an attorney, don’t play one on TV, and am not dispensing legal advice.  But I know lots of them in New Hampshire and Massachusetts and consult them regularly.  This information is presented as educational only, and if you are considering an investment, alway consult a professional.  A good real estate attorney is essential, as is an accountant.  If you are a real estate investor and are not a licensed agent, find a good investor-friendly agent or broker.

Do you need to be an accredited investor? No, not if you are lending directly to a borrower.  But by all means, take this to your attorney and speak to him about it first.

Do you need to be licensed?  What about the SAFE Act? Ok, here is another “consult your attorney” disclaimer.  But I’ve consulted several, and the concensus seems to be that commercial transactions are exempt from licensing requirements.  Since all my loans are made to companies acquiring property for business purposes, the licensing requirement doesn’t come into play.  All of our borrowers take title in an entity, such as an LLC, and do this as a business.

Should you buy into a “pool” or lend directly? Well, that depends on how much you are allocating to the endeavor, your experience level and your comfort level with the deal.  You should always make sure than anyone you do business with comes recommended by others and is someone you trust.

Buying into a pool may require (generally speaking) that you be an accredited investor, because you are pooling your funds with others, and that is considered to be a security.  You are likely to get a lower return in a pool than lending directly, because the fund keeps a larger part of the return.

Buying into a pool removes any decision makng about individual loans or borrowers, because the fund managers make all those decisions.  Individual lending leaves the control and the decision making about a particular deal in your hands.  You are also free to set the interest rate and terms, within state usury limits.

Here are some of the questions I’ll address in my next post, this one is long enough for today.

  • How do you choose the deal you will lend on?
  • How do you find these good deals to lend on?
  • Should you ever lend in second position?
  • What about business loans instead of real estate loans?
  • How do you protect yourself from fraud or incompetence?
  • How much of my portfolio should I allocate to lending?
  • What happens if the borrower stops paying?
  • Should I form an entity to lend?
  • Should I lend outside of my geographic area?

Part 1 in a series

I come into frequent contact with people wanting to make the jump into real estate investing, but not knowing where to start.  I’m on the Board of several Real Estate Investor Associations, and co-founded one of them, so my network includes many new investors.

Sometimes they ask where they can find deals. (That’s the mother lode, by the way.  It’s sort of like asking Coca-Cola for their formula.)  Finding deals- really good deals, I mean – is the skill that investors need to cultivate.  Great deals are found off and on market.  They are frequently found by speaking with sellers directly, some of whom don’t want to list their property conventionally with an agent for many reasons.

If you have the personality and the persistence to seek out sellers directly, this will probably be your best source of good deals.  You will need to make possibly hundreds of contacts per actual deal realized.  There are many trainers who teach these skills, and I am not the expert in this arena.

If you can find the deal, and have no funds, there are huge networks of investors who will buy your deal without your ever having to close.  Selling the deal is easy, finding the deal is the key.

Good deals can be found on the MLS if you are working with an investor-friendly agent.  But remember, if that agent has been in the business for a long time, they have a huge buyer’s list of real estate investors ready to snap up the best deals, and they call these investors first if they have proven they can perform.

Sometimes they ask if we lend their purchase price plus the fix up money. A new real estate investor frequently comes into the game with little to no cash.  They find what they think is a great deal on the MLS, and want to buy it, but have no cash for purchase or repairs.  They are told by the “gurus” that a hard money lender will lend them 100% of the purchase and rehab costs.  While that may have been true 5 years ago, it ain’t happenin’ now.

If you are determined to buy a property and rehab it for resale, but have no cash, you should partner with someone you know who does have cash but doesn’t want to manage a rehab.  Hard money will seldom lend out the full amount for a project, but if your partner puts up the needed downpayment, then you can use hard money for the rest.  If you are one of these people who have the funds but don’t want to manage a rehab, then read on.

Sometimes they ask if I will lend out their money, because they want to be involved but are not sure when to pull the trigger on a deal, and aren’t sure they want to be a landlord, or do a rehab and flip.  So this series will discuss what you should know before you decide to lend out your funds, either directly to a real estate investor, or through a hard money company.  Here are some of the issues we will be covering:

Do you need to be an accredited investor?

Should you buy into a pool or lend directly?

How do you choose the deal you will lend on?

How do you find these good deals to lend on?

Should you ever lend in second position?

What about business loans instead of real estate loans?

How does the SAFE Act impact your lending?

How do you protect yourself from fraud or incompetence?

How much of my portfolio should I allocate to lending?

What happens if the borrower stops paying?

Should I form an entity to lend?

Should I lend outside of my geographic area?

Covering all this is beyond the scope of one post, so I’m going to write a series.  If you have additional questions you’d like me to address, please, by all means, jump in and let me know.