Buy Now Hard Money

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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 6 of a series

I’m continuing a discussion of lending money to real estate investors. My company lends money exclusively to real estate investors in a specific geographic area. This allows us to be local to any property used to collateralize the loan, stay on top of legislative changes through our network of local attorneys and professionals, and to understand local trends, since all real estate is local.

How do you protect yourself from fraud or incompetence?  First of all, know who you are dealing with.  If you are lending directly to an investor, ASK AROUND!  It’s amazing to me how many people invest or lend with one real estate investor without getting references from other people who are in a position to know.  If you are going to put money into a deal, the people involved should be 100% transparent in their dealings.  Both from an ethical perspective and from a competency view.

  • Google them.  You can’t always find everything about them that way, but you might see a pattern one way or the other.  I once was approached by an investor for a loan, and when I googled him, it turned out he was a disbarred real estate attorney who had twice misappropriated escrowed funds.  Not someone I want to do business with.
  • Ask around.  Ask at local Real Estate Investor Associations.  Ask your network of attorneys and accountants.  Sometimes what they won’t say tells you a lot.  People are careful about giving bad references, but will usually give you enthusiastic recommendations if everything they know is positive.
  • Do your due diligence.  If you are investing with one person, you have to research the property ad market yourself.  If you are investing with a hard money company, the company does the due diligence.  Ask the company how much of that research on each deal is available for you to review.  If you are investing in a fund, the answer is probably none, because you aren’t investing in an individual deal, but if you are working with a company where you get to choose the deal your money goes to, you should be able to get information about the person and the deal.  
  • Go to each property yourself.  Each deal is different, and a property photo can be edited to not show the railroad tracks in the back and the auto junk yard next door. Pay attention to the neighborhood as you drive there, and leave the property in another direction.  
  • Trust your instincts.  I don’t want to get all fuzzy here, but if you get that uncomfortable little niggling doubt, then do more research to find out why.  You should reach the point at which your discomfort is resolved.

What happens if the borrower stops paying? Well, you are going to take the necessary steps to resolve the situation.  If you are working with a borrower directly, then you should talk with the borrower to get to the underlying problems and then determine the appropriate actions.    If you are working with a hard money company, the company will be the intermediary working with the borrower.  If you are in a pool, you won’t be involved at all, because you are not the lender, the pool is.  In a declining market, time is not on your side, but since this is a business transaction, you are not dealing with a homeowner, you are working with a businessperson.

How much of my portfolio should I allocate to lending?   I’m not a financial advisor, so you should speak to your own professional for personalized investing and allocation advice.  However, if you are a knowledgeable real estate investor yourself, you probably are comfortable with a large percentage in lending, because you have the expertise and resources to finish the project yourself.  In fact some lenders hope to take the property.  We don’t “loan to own” be be aware that some do.  If you have limited real estate investing experience, then limit your exposure by doing just one or two deals at a time.

These questions have partially addressed some of the risks in lending.  A much more detailed discussion is beyond the scope of an education blog post.  If you have interest and want to know more of the what if’s, then contact me.  It will help you decide if lending is for you.

Next post we will discuss the following questions:

•Should I form an entity to lend?

•Should I lend outside of my geographic area?

 •What about business loans instead of real estate loans?

Hard Money Myth #4

Hard money lenders make risky loans.

The reality:

While the collective wisdom, even among real estate and mortgage professionals, is that hard money lenders make risky loans, our experience is that the opposite is true.  Because such lenders are typically lending their own money (as opposed to a bank employee lending someone else’s money) they are particularly risk averse.  Unless a hard money lender really understands how to value the collateral against which he is lending and the prevailing market, he will likely not make the loan, regardless of the strength of the borrower or the LTV.  Infrequently a hard money lender will consider history with a borrower because of the borrower’s consistent performance.

On the other hand, with understanding comes knowledge, and a hard money lender may make a loan that others consider risky because he simply has better information.   If a lender understands a market and has an exit strategy himself should he/she have to take back a property, the lender perceives less risk and might lend where others won’t.

This is why many hard money lenders are truly local, and don’t use conventional appraisals to make decisions on valuation.  They may use the appraisal as a source of information about the property, but they will value the property themselves based on their knowledge of the local market and the trends in a neighborhood.

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.