In this next interview, we continue our discussion with Liz Nichols and dig deeper into the topic of hard money lending with a detailed example:
“This is really a fix and flip type scenario. In hard money, classically that’s what you use it for, a fix and flip as opposed to a buy and hold situation,” says Liz Nichols, managing member of RE Advantage Capital, LLC. In this example, we compare an all cash buyer with $70,000 in their account with someone who is looking for hard money and wants to take advantage of the same deal.
The property is being bought for $52,000 and both the cash buyer and the financed buyer plan to flip it in 6 months. The cash buyer will drop $52,000 right away and save $18,000 for the rehab after purchasing the property.
The financed buyer will still need to come up with $14,000 to cover the 80% lending for the property and 80% for the repairs. There is such a thing called “holding costs”, which are costs to keep the property on hand until it is flipped. You may need to keep some utilities connected and you’re still going to need to insure the property during this period just in case. The cash buyer and the financed buyer will both have holding costs, except the cash buyer will not have financing costs on those costs during their holding period.
Both of them sell for $120,000. Now the cash buyer will get away with the $70,000, but the financed buyer will end up paying $75,525, which is $5,525 more.
“If you’re only doing one deal, definitely it’s better to be an all cash buyer,” says Liz. In this example, your purchase to ARV ratio is 43%. Remember, that is just a fancy way of looking at your purchase price as a percentage of the property’s total sale price. The cost to value (what you paid, including repairs divided by the total sale) is 58% for the all cash buyer and 63% for the financed.
Here’s where financing can be beneficial:
“The all cash buyer can only do 2 or 3 flips a year with the money as it slowly grows, so you might make a bottom line profit during the year of $100,000 to $150,000. The financed buyer who is only putting $23,000 or $24,000 out-of-pocket can multiply that several times over. They could buy in the first place maybe 2 or 3 properties and then on the second 6 month round another 4 or 5 properties, so they will be making a bottom line of $260,000 or more per year.” – Liz Nichols
The key takeaway here though is that you still are going to need to have $20-30K handy to do these deals, even if you’re financing. Yes, there are ways to buy property with no money down, but Liz states that “you can do that if somebody else is financing it for you, you’re having the owner carry back a second mortgage, or your cross-collateralizing a property.”
Should You Go with a Broker When You Are Looking for a Hard Money Deal?
“I would say first of all call me or call some other broker.” says Liz. “Unfortunately, people feel that they can do this themselves. Maybe they can. Maybe they’re very good at it, just like many investors don’t want to use a realtor.”
“I have vetted well over 100 hard money lenders, a combination of hedge funds and individuals. If you want to go through that as an investor and spend your time doing that, that’s fine, but the first one that comes up in Google may or may not be the very best lender for your particular situation. I do suggest highly that investors that are going to look for hard money do engage a broker,” said Liz.
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How Do the Payments Work for a Hard Money Loan?
Typically, lenders have a servicing company and payments are made similar to a bank loan. Since the terms are typically only 6 months, you’ll get a letter calling for the payment to be due. That’s a scary thought, especially if your property hasn’t sold yet. What do you do?
“Often [a hard money lender] will say their normal loan period is for 6 months or 12 months, but for another half a point in interest payments and another percentage point maybe to fund another extension to the loan, they’ll do it. You might be $300 or $400 dollars up front and another $50 or $60 a month during your second 6 month period, but they’re not going to come demanding the property right away. They don’t really want to foreclose.” – Liz Nichols
As shown in our examples, there is a time and place for a hard money loan. If you can’t get a traditional mortgage, and need solid cash, this is another option for you to consider if you don’t quite have the funds. Wholesaling, becoming a real estate agent, and other options in the real estate industry can help you earn money, or you can keep your day job. Sometimes you need cash fast to take advantage of opportunities that come up, which is where hard money could come to the rescue.
Whether you want to use a private money broker is up to you, but Liz makes some valid points. As with other members of your team such as a real estate agent, insurance agent, a property manager, and an attorney, these individuals help you fill gaps in your own knowledge. The choice of learning it on your own or going with a professional is entirely your call, but the most important part is to get out there and find your next investment property!
For more information on hard money lending, please email Liz Nichols at email@example.com, call her at (319) 359-0656 or visit RE Advantage Capital LLC’s website at www.REAdvantageCapitalLLC.com!
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[00:01] Jeri: Let’s walk through a financial scenario.
[00:04] Liz: This is really a fix and flip type scenario. In hard money, classically that’s what you use it for, a fix and flip as opposed to a buy and hold situation. Let’s suppose you’re comparing an all cash buyer, somebody with $70,000 in an account that they want to use to buy and fix up a property, versus somebody who needs to be financed and is going to get hard money for the deal.
[00:38] Liz: Let’s say the property is being bought for $52,000. You need 6 months to fix it and then it’s going to be flipped. The cash buyer is putting immediately at closing $52,000 down, whereas the financed buyer … Let’s just say that their deal is something like the lender will finance 80% of the purchase price plus 80% of the repairs. They would still come out-of-pocket about $14,000 for the property itself and the rehab cost. There would be hold costs on both sides for a 6 month hold.
[01:25] Liz: There would be no finance costs for the cash buyer, but in addition to having some money down that would have to be paid out at closing for the financed buyer, you would looking at 6 months of interest at maybe 15% per year and they would be paying 5% at closing. Hard money lenders will typically charge anywhere from 3 to 5%, or points they’re often called, at closing. Sometimes that will include the broker fee, which is usually 1 to 3%. Sometimes it won’t. I’ve got a split let’s say at 5% or 5 points. That’s a combination of the broker and the loan origination point.
[02:24] Liz: You’ve got maybe $3,875 for a 6 month hold on the interest only that is being paid in monthly payments and $2,650 that’s actually put in at the closing table. So while the out-of-pocket costs for the all cash buyer is that whole $70,000, the out-of-pocket costs for a 6 month hold for the financed buyer is only $23,525. Let’s say that they both are able to sell this. They get a sale price offer at $120,000. Therefore, the total project cost for the all cash buyer is less. It’s going to be $70,000, whereas the financed buyer, the total project cost would be the original $52,000 plus the $23,525. It’s going to be more, the total project costs. I think I added up $75,525.
[03:38] Liz: If you’re only doing one deal, definitely it’s better to be an all cash buyer, but you’re still going to have a profit of financed deal of $44,475. Now this was a very good deal. The loan to after repair value is 43%. The cost to value for the all cash deal is something like 58% and 63% for the financed buyer, 58% for the all cash buyer. But you have to look at it in terms of what you’re planning to do.
[04:18] Liz: The all cash buyer can only do 2 or 3 flips a year with the money as it slowly grows, so you might make a bottom line profit during the year of $100,000 to $150,000. The financed buyer who is only putting $23,000 or $24,000 out-of-pocket can multiply that several times over. They could buy in the first place maybe 2 or 3 properties and then on the second 6 month round another 4 or 5 properties, so they will be making a bottom line of $260,000 or more per year.
[05:04] Jeri: So if you don’t have endless income, having the ability to finance and potentially use some hard money to do this might facilitate your growth of your finances.
[05:14] Liz: Absolutely. I’m not really giving the message that you can use hard money and find a deal that is truly no money down. You can do that if somebody else is financing it for you or you’re having the owner carry back a second or you’ve got a partner or your cross-collateralizing a property. Most of the time, even when you have a smoking hot deal like this, you do need to plan on having $20,000 or $30,000 out-of-pocket that you can spend.
[05:53] Jeri: That was very helpful. If you’re looking for a hard money lender, what should you do and what should you not do?
[06:02] Liz: I would say first of all call me or call some other broker. Unfortunately, people feel that they can do this themselves. Maybe they can. Maybe they’re very good at it, just like many investors don’t want to use a realtor. There are specializations. Sometimes you’re very good at property marketing, but if you’re not you really should involve a realtor, especially if you’re going to sell a property and you don’t have time to do it yourself or the knowledge. The same is true with brokers. They can provide a value added service to you in helping you structure the deal and helping you find the best lender for your particular deal.
[06:51] Jeri: On these situations where you do have a hard money lender, who do you make the payments to?
[06:57] Liz: Usually they are very much like a bank. If you’re dealing with a hedge fund, that kind of hard money lender will have a servicing company. You send the money into the servicing company usually on a monthly basis. It’s interest only. Then when you start wrapping up the end of the term, they’ll give you a payoff letter just like a bank would.
[07:28] Jeri: What if you get to the end of that term and all of a sudden you realize I’m not quite done with my rehab. I need 6 more months. What do you do then?
[07:36] Liz: A hard money lender is usually accommodating in a case like that. They realize things do happen and they don’t always wrap up on time. Often, they’ll say their normal loan period is for 6 months or 12 months, but for another half a point in interest payments and another percentage point maybe to fund another extension to the loan, they’ll do it. You might pay $300 or $400 dollars up front and another $50 or $60 a month during your second 6 month period, but they’re not going to come demanding the property right away. They don’t really want to foreclose.
[08:33] Liz: I also deal with some hard money lenders who actually have kind of almost like an insurance policy for their lenders. They’re pooling the money with private individuals, who are then backing the loan. If a loan starts to go into default, actually, part of the loan costs that you may be absorbing initially would be essentially the $1,000 or something that is the insurance policy for the investor that’s backing that loan.
[09:17] Liz: Now, if you don’t default, then you get that money back. It’s just money that’s held in escrow as an insurance policy against the failure of the loan. That particular hedge fund manager will give the private lender who is backing the loan the choice of whether they want to go through the foreclosure process and take over the property or they just want essentially their money back. They are really kind of sophisticated. The hedge funds who are private lenders are pretty sophisticated in protecting both you as an investor and also the private lenders that are working with them to help build up their funds.
[10:15] Jeri: When you go into this, your goal is to estimate as accurately as you can the amount of time that you need this money?
[10:22] Liz: Exactly.
[10:23] Jeri: In the event that you are a very rapid flipper and you finish early, is there any penalty for completing your work and selling the property early?
[10:34] Liz: Only with certain long term loans. There are some soft money lenders who do have pre-payment penalties, but very few of the hard money lenders do. If your loan period is for 6 months and you finish it in 3, you only have 3 months’ worth of interest payments.
[10:55] Jeri: Okay. When you think about looking for a lender, is there some things you should know or take into account?
[11:03] Liz: I have vetted well over 100 hard money lenders, a combination of hedge funds and individuals. If you want to go through that as an investor and spend your time doing that, that’s fine, but the first one that comes up in Google may or may not be the very best lender for your particular situation. I do suggest highly that investors that are going to look for hard money do engage a broker. Yes, you will probably be paying 1 to 3% of the amount of the loan to the broker, but that would be very similar to what you would be paying a realtor to sell your house.
[11:56] Liz: Secondly, I’d say make sure that you’ve got a good deal. If you’re going to be using hard money you really want to find a deal that is at 65% of after repair value or better. The more above that amount that you are with your project, the more money you’re going to have to take out-of-pocket or cross-collateralize with some other property.
[12:25] Jeri: I imagine now having seen many, many deals, it’s easy for you to spot something where you recommend someone not pursue it?
[12:34] Liz: Oh, absolutely. It happens all the time, sadly more often than taking someone on and saying, “Yes, this is a perfect deal. I can get it done for you.” People don’t really think about what they’re doing all the time and it’s a little bit counterintuitive the way the lenders think. I can understand how it can be confusing.
[13:02] Liz: For example, you would think that if you get yourself a house for $25,000 you’re doing really well. The problem is that’s almost unfundable. You better have cash yourself or a private investor who’s willing to fund it for you, because it isn’t worth it. That’s too little a loan to be worth it for most hedge fund type hard money lenders. Or someone who wants to do a total gut job of a property; it is hard to find … If your expenses for rehab are going to cost more than the cost of the house in the first place, it’s going to be very much unfundable.
[13:55] Liz: I would say look for properties where the purchase price is $50,000 or above. Ideally the after repair value will be $75,000 to $100,000 or above, and you’re getting a deal where you’re at 65% loan to value on “as is” value. It’s really kind of hard to find something that’s just a real junky project that needs a whole lot of repairs. It’s just too risky for a lender to do that kind of deal.
[14:41] Jeri: Okay. Those are good parameters to think about. What is your role at RE Advantage?
[14:48] Liz: I’m the managing member. I take care of the day-to-day work and really I’d be the go to person for most decision making. I deal directly with the investors as well as with the lenders.
[15:10] Jeri: What area do you service?
[15:12] Liz: Actually all over the United States. There are about 42 states that allow loan brokers who do not have mortgage licenses within their state to handle non-owner occupied or investor type properties or commercial properties. I can work with commercial properties and non-owner occupied in about 42 states. I have actually brokered a loan that closed recently in Massachusetts. The investor happened to be in Tennessee and her sister who was in Massachusetts was managing the rehab project for her.
[15:54] Liz: I do a lot of long distance stuff. I can figure out values over the internet using specialized tools that most investors don’t use. I can get pretty accurate even online with property any place in the country and dealing with lenders any place in the country as well.
[16:15] Jeri: So you’re everywhere!
[16:17] Liz: I’m everywhere, even though most of my advertising goes out to a 5 state area or so right around the upper midwest.
[16:26] Jeri: Okay. Excellent. Thank you so much Liz.
[16:28] Liz: Sure.