Buy Now Hard Money

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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?

Hard Money Myth #3

Hard money is too expensive.

The reality:

Hard money is likely going to be more expensive than that advertized by traditional lenders, i.e. a bank.  However, bank financing may not be an option, for any of the following reasons:

1.  A quick funding date may be impossible for a bank to meet.

2.  A rental property may have just recently been leased and is not adequately seasoned.

3.  The property condition may preclude bank financing and the borrower intends to rehab and resell quickly.

4.   The borrower is self-employed and has difficulty documenting his income.

Hard money is not the expensive option if it is the only option.

Finally, hard money is not too expensive if a borrower can use the funds to take advantage of a deep discount off the property purchase price for a fast close or to buy out a partner who needs quick cash.

The cost of borrowed capital is only one of the factors to consider.   Liquidity, speed and other factors play into the equation.  An equity partner will almost certainly be more expensive than borrowing hard money.  And the quicker you exit a project, the less expensive the hard money, where an equity partner will typically take the same percentage regardless of the time frame.

Hard Money Myth #2

Borrowers are desperate, in trouble and without options.

The reality:

Most hard money borrowers are solid, successful businesses that have circumstances or opportunities that do not fit well into the rigid structure of institutional lending.  They choose the hard money route because

1.  The property they are buying doesn’t fit into conventional lending standards, or

2. The conventional lender will take too long for the opportunity in question, or

3. the hard money lenders are flexible in structuring transactions.

In our case, since we lend hard money only to investors and companies on properties in NH and MA, and not to homeowners, almost all our borrowers are savvy business people, who look at hard money as a tool in their belt.

Hard Money Myth #1:

Hard lenders are a bunch of disreputable loan sharks trying to prey on the unwary.

The reality:

Most hard money lenders are simply business people – not predatory lenders.  Most principals in hard money lending organizations are successful businessmen or women with backgrounds in law, accounting, banking, real estate development or real estate investment.  They provide a needed service.  Most are lending their own money along side money entrusted to them by friends, relatives and close associates.  Making loans is their business, and a bad reputation is counter productive to that effort.  Referrals are the life blood of the business as most are small organizations with a limited advertising budget.  That is not to say there are not unscrupulous people in the business, as in any business.  However, their numbers are small and dwindling as a result of technology.  A quick Google search will often expose the bad apples. 

Ask around for references, either among other real estate investors you do business with, or real estate agents, mortgage brokers and real estate attorneys.  Your local REIA will provide a wealth of information about who’s who in your local area.  In Massachusetts and New Hampshire, there are a limited number of local hard money lenders, so it’s not difficult to get information on any of us.