Hard Money Lending - Why, When, & How
mod (Andy) note: "Blast from the past - Best of Eddie" - This one is originally from November 2011. If there's an old post from Eddie you'd like to see up again shoot me a message.
I've written the following at a reader's request (yes, I take requests as long as it's a subject on which I'm knowledgeable and experienced). It's about a fairly esoteric aspect of real estate investing. If you have an interest in real estate investing, you'll probably enjoy it and might even learn something. If not, I'll see you tomorrow.
I owned a property management company from early 2002 to late 2006. If those dates seem conveniently aligned to the explosion in residential real estate prices in the United States, I assure you it's no coincidence. Bubbles are great for making money as long as you're not the last one out turning out the lights.
Real estate investing (or speculation, as the case may be) can take a lifetime to master, so in my experience it's best to learn how to do one thing and do that very well rather than try a dozen different approaches. For some people this means buying rental property and being a landlord. For others it might be discount paper, private mortgages, foreclosures, short sales, whatever. In my particular case, I was a rehabber - more commonly known as a "flipper". I would buy a property, fix it up, and sell it for a profit. It's a little more complicated than that, but essentially that was the strategy.
I further specialized by concentrating on two relatively unpopular aspects of the market at the time: HUD foreclosures and bank short sales. A lot of folks didn't like dealing with HUD foreclosures because there was additional paperwork involved, you had to deal with specific real estate agents who were approved to work with HUD, and a number of other small hassles that turned your average real estate investor off. I found the extra hurdles to be worth the effort, because once you became known as an experienced HUD investor you could get HUD to agree to almost anything to get a property off their books.
The places I bought were generally in a shambles. For HUD to be in possession of a property, it had to have been an FHA-financed property (which means the former owners had no skin in the game and therefore very little to lose in foreclosure) and most of these places were cosmetically hideous. I bought a lot of these and my average turnaround time was less than 90 days. I got to the point where I would leave the closing table with a key to the place, drive to the property, and my contracting crew would be there waiting to be let in to gut the place and get to work.
Conventional financing doesn't always work with such an investment strategy. Conventional lenders like to see owner-occupied properties. They like properties with white picket fences and flower beds in the front yard. They generally shy away from former crackhouses and scenes of triple homicides. So in the absence of conventional financing options, you have to get a little creative.
Enter the hard money lender.
These guys have a terrible reputation and, in my experience, it is wholly undeserved. They've tried to church up their image a little bit by ditching the term "hard money" lending and replacing it with "asset-based" lending, but it hasn't caught on thus far. In a nutshell, these guys lend where banks would never even consider it. Because of that, hard money lenders are able to charge BIG interest rates and fees on their loans, and their loans are very short term in nature.
Unlike a conventional lender who is concerned with your ability to perform on the loan, and therefore analyzes your credit rating, your employment history, your ratios, etc., a hard money lender focuses on the wholesale value of the property in question. In other words, a hard money lender doesn't care about you, he cares about whether he can sell the property quickly in foreclosure if/when you default.
Because of the increased risk in these loans, hard money lenders typically charge double-digit interest rates, multiple origination points, and sometimes pre-payment penalties. Some people consider it loan sharking, but that's not the case at all.
Let's say you've found a four-plex that is an absolute mess. There's no way a conventional lender will give you the money in the property's current state. On top of that, you don't have the money to fix it up. But you've analyzed the market and know that in pristine condition the property is worth three times what you could buy it for in its present state. So you get in touch with a hard money lender. He provides a loan to you for not just the purchase price, but also the cost of all the repairs. He might not even require a down payment. So you go to closing to buy the place and you not only walk away with the keys, you walk away with a check to fix the place up. And you don't make any payments on the loan for the first six months, or even the first 12 months on larger projects.
The money to repair the place is usually doled out to you in three tranches, known as draws. You get the first draw at closing, you use the money to get one-third of the repairs done, the hard money lender checks your progress and then releases the second draw, then the third and final draw. Once the property is completely repaired you either sell it for the enhanced market value and pay off the hard money lender (and pocket a nice profit for yourself) or you refinance it with a conventional loan now that the property qualifies for conventional financing (and you pay off the hard money lender with the proceeds of the new loan).
Why would you use a hard money lender? Because:
- Your credit sucks
- The property you want to buy is a disaster and no bank will lend against it
- You can get a conventional loan but have no money to make improvements
- You need to move quickly - most hard money lenders can turn the entire process around in 24 hours once they know you
- Your bank thinks you're over-leveraged (I'll go into this next)
If you're an active real estate investor, you're going to discover your bank's personal comfort level with you rather quickly. In my particular case, I used a local community bank and had a great relationship with bank management. I could literally call the president's cell and get a deal approved. Likewise, he'd sometimes call me out of the blue and ask me to value a yacht a customer wanted to pledge as collateral (I owned a yacht services company at the time as well). So we knew each other pretty well.
Once I got to ten properties or so, I could sense a shift in the bank's willingness to go much further. It was clear that they were comfortable lending against a portfolio of five or six investment properties, and more than 100 investment properties, but weren't comfortable in between.
So I started using hard money lenders. Since my turnaround time was short and predictable, hard money was the ideal solution. Did I pay a little more than I had to in interest and fees? Sure. But it was worth it to me to be able to pick up the phone and have the cash the next day with no hassles.
There are times when hard money does not make sense to use, however. For example, you should not use hard money:
- To purchase your primary residence
- For any property you suspect may be difficult to sell or refinance in less than a year
- For any long-term hold like a rental property
One instance I can remember in particular, and this will speak to the specific situation the reader in question asked me about, was a foreclosed condo I bought that was part of an association that had let their general liability insurance policy lapse. It was no problem to get insurance on this specific unit, but as long as there was no liability insurance on the common areas in the condo complex no bank would loan on individual units.
I considered this a short term problem, one that would easily be rectified with a new general liability policy, so I went ahead and bought the unit out of foreclosure using a hard money loan. As usual, I had the place fixed up and ready to sell in about 60 days. But there was still no general liability policy in place. So that meant that even if someone wanted to buy the condo, their bank wouldn't lend them the money to do so. That also meant I couldn't pay off my hard money loan against the place.
What I thought was going to be a short term problem took over a year to fix, and forced me to scramble to pay off the hard money loan without being able to sell or refinance the place. I was able to do it, but it was no fun. On top of that, I had to rent the place out for a year, and I hate being a landlord. After being rented out for a year, the condo I'd done such a nice job fixing up was trashed again. Tenants suck.
In conclusion, hard money is a great option for those with dodgy credit, those whose banks think they're over-leveraged, or those brave souls who can look at a hovel and see a palace. If you go into a hard money arrangement with your eyes wide open and you perform according to the terms of the loan, you can't find an easier more open-minded source of financing in the real estate market. If you use hard money where it's not appropriate just because it's easier to get, however, you can expect a lot of headaches.
Brookview Financial is probably the largest and most well established hard money lender in the US. I have dealt with them and they are very professional and helpful (I've never actually closed a loan through them, just because I had an abundance of local options available to me). Most communities have a real estate investors association of some kind, however, and you'll have no trouble finding a hard money lender there.
Hopefully this has answered any questions you guys might have about hard money lending. If you have any others, hit me with them in the comments and I'll do my best to answer them.
Comments
Feel free not to answer this,
Feel free not to answer this, but how much money would you say is sufficient to enter the 'flipper' market at a decent level? During times of economic stability it seems like a bit of a no-brainer. People always need houses, most Western countries have a housing shortage, there will always be derelict / old houses which can be improved.
See my other WSO blog posts>
very informative. cool story,
very informative. cool story, bro.
If i had a silver banana, i'd give it to you, but alas...I don't.
Man cannot remake himself without suffering, for he is both the marble and the sculptor. -Dr. Alexis Carrel
SB for you, Eddie. I'm
SB for you, Eddie.
I'm sending this link to my BF, who is actually considering a hard money loan right now to purchase a rental property. Maybe this can help him reevaluate his options.
Asatar wrote: Feel free not
Feel free not to answer this, but how much money would you say is sufficient to enter the 'flipper' market at a decent level?
That really depends on your local market. I started the company on a lark because I'd just moved to New Orleans from California and couldn't believe you could buy a decent 2-bdrm condo for $25,000. So technically I started the company with the $5,000 I put down on the first property. I put about $450 worth of paint, linoleum, and OxyClean into the place and sold it a month later for $35,000. I was off to the races from there.
I guess a good figure to start with would be to take the average cost of a home in your area, multiply that by .625 (because you're going to be bargain hunting), multiply that figure by .2 (to represent the 20% down payment that makes mortgaging the property a no-brainer for lenders) and then multiply thatfigure by 1.25 to arrive at a final figure which includes the down payment and a sufficient amount for repairs. Remember not to bite off more than you can chew on the first couple of properties until you figure out what you're doing.
Example: Average home price in your area is $200,000.
$200,000 x .625 = $125,000 target purchase price
$125,000 x .2 = $25,000 down payment
$25,000 x 1.25 = $31, 250 total includes down payment and $6,250 for repairs
$160,000 target sale price - $125,000 purchase price - $6,250 in repairs - $10,000 closing costs = $18,750 profit
Hope that helps.
Asatar wrote: Feel free not
Feel free not to answer this, but how much money would you say is sufficient to enter the 'flipper' market at a decent level? During times of economic stability it seems like a bit of a no-brainer. People always need houses, most Western countries have a housing shortage, there will always be derelict / old houses which can be improved.
During the boom, you needed about $10k out of pocket. I bought my first house w/ 3k down, and then put 3k in for cosmetic repairs and easy upgrades like a washer/dryer in the basement. If you are looking for an arbitrage type opportunity, buy a cosmetically shitty house in an area that isn't wealthy- upstate rustbelt cities are perfect for this. You can get labor for dirt cheap. For 3k, I patched and painted all the walls, redid the floors, replaced a bunch of old baseboards, and did other similar light cosmetic work and preventative maintenance in a duplex, and the places went from renting for $500/mo to $650 a month (x2, so $300/mo increase in cash flow). At the time I wasn't making that much, so the cash flow was nice, and the places I bought tripled in value over the next few years, due to a combination of the housing boom and the neighborhood becoming trendy. I was doing one a year, but I stopped buying as prices rose, the numbers didn't work anymore for rentals, and I was looking more for long term passive income, not quick profits from flips. I could have flipped it and made about $30k though.
Opportunities like that are much harder to find these days. Had I gone full throttle and bought 4 a year, I would have some really nice cashflow right now, but I was just out of school, and with each place I bought, I was pretty much clearing out the bank account. By the time I had a little money in my pocket, the boom was in full swing, and prices got stupid.
someotherguy wrote: Asatar
Feel free not to answer this, but how much money would you say is sufficient to enter the 'flipper' market at a decent level? During times of economic stability it seems like a bit of a no-brainer. People always need houses, most Western countries have a housing shortage, there will always be derelict / old houses which can be improved.
During the boom, you needed about $10k out of pocket. I bought my first house w/ 3k down, and then put 3k in for cosmetic repairs and easy upgrades like a washer/dryer in the basement. If you are looking for an arbitrage type opportunity, buy a cosmetically shitty house in an area that isn't wealthy- upstate rustbelt cities are perfect for this. You can get labor for dirt cheap. For 3k, I patched and painted all the walls, redid the floors, replaced a bunch of old baseboards, and did other similar light cosmetic work and preventative maintenance in a duplex, and the places went from renting for $500/mo to $650 a month (x2, so $300/mo increase in cash flow). At the time I wasn't making that much, so the cash flow was nice, and the places I bought tripled in value over the next few years, due to a combination of the housing boom and the neighborhood becoming trendy. I was doing one a year, but I stopped buying as prices rose, the numbers didn't work anymore for rentals, and I was looking more for long term passive income, not quick profits from flips. I could have flipped it and made about $30k though.
Opportunities like that are much harder to find these days. Had I gone full throttle and bought 4 a year, I would have some really nice cashflow right now, but I was just out of school, and with each place I bought, I was pretty much clearing out the bank account. By the time I had a little money in my pocket, the boom was in full swing, and prices got stupid.
So are you still a landlord? If so - how many properties and do you manage them yourself?
just a quick question, do you
just a quick question, do you hire real estate agent to sell your property as well? I would think that you need to include that into your cost as well right? 6% is not cheap, and the transfer sales tax is abou 3 % as well right? do yu actually include those costs in your calculation as well?
Well, you only pay closing
Well, you only pay closing costs on the sell side (aside from a few little ones on the buy side). Yes, I included sales commissions and closing costs in my above illustration.
You can choose to go the For Sale By Owner route and save the 6%. I know plenty of people who do it that way. I never did, however. My Realtor was an integral part of my team and when you find a good one they're invaluable. A large part of the reason I shut my company down in 2006 was that my Realtor was murdered. She was a close friend and often more like family.
accountingbyday wrote: So are
So are you still a landlord? If so - how many properties and do you manage them yourself?
Yeah I am- I have 8 1-3 br units. I don't manage them myself. I used to, but its pretty tough to do that since they are upstate. I had some guys up there that worked cheap and were generally trustworthy, but became lazy over time as they knew I wouldn't be there checking on their work all the time. They did sloppy work, told me it was done when it wasn't done until a week or two after I asked, things like that. So I went w/ a property management company. They take 7% but they take care of everything for the most part. I go up and visit them once or twice a year. Unless something bad happens, I get two emails from them a month- letting me know the rent has been deposited, and an invoice for their management fees. The cash flow is pretty good, but its fairly insignificant these days compared to my comp.
These being >100 year old houses in a cold upstate city, the winter is the worst. Cold snaps in jan/feb are the only thing that I really worry about. Pipes bursting, heaters giving out (at the worst time), ice damns, snow removal costs, are always my biggest worries, as they happen more often than they should, and those can all be multi-thousand dollar hits. If I get to march 1st without an emergency, I know it will be a good year. An upgrade project last year was insulating pipes where I could and blowing insulation into the attic to help prevent these types of things (there is not a spec of insulation in most of these houses, but the tenants pay for heat so there is little incentive to insulating).
Tenants not paying rent are an issue as well. Its an up and coming area, and while rents have risen considerably, the boom brought lots of renovated units into the area, and the yuppies don't want to live in my places, so I get the locals and college students. Mid winter is when they are likely to fall behind as they can't afford to heat the place and pay the rent. I don't even evict non paying tenants until spring if they stop paying. I would rather them pay the heating bill all winter, and no one is looking for an apartment in the winter, so either way its going to be non-performing until spring. The local governments up there rival NJ with corruption as well. Somehow I got on someone's shit list for about a year, and I had fines and code violations hitting me every month. Not sure why that happened, but after I appeared in court to contest a fine and then went to the buildings office to ask them what the deal was, they stopped.
Anything HUD related is a
Anything HUD related is a license to steal, hard money lending is tantamount to savage rape where you buy the victim a value meal first. You sir are a motherfucker and I mean that as the greatest of compliments.
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Edmundo... so you have lived
Edmundo... so you have lived a pretty awesome life... arent you living in France now or something like that... but anyways, I may be asking a dumb question (that has already been asked and answered) but can you just share in chronological order all of the companies and/or ventures that you've been started / been a part of / worked for?
"Know what to do, know how to do it, and do it hard." - Juan Castillo
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ConanDBull wrote: can you
can you just share in chronological order all of the companies and/or ventures that you've been started / been a part of / worked for?
That list would be longer than this blog post.
Midas Mulligan Magoo
Anything HUD related is a license to steal, hard money lending is tantamount to savage rape where you buy the victim a value meal first. You sir are a motherfucker and I mean that as the greatest of compliments.
Tip: go to hud auctions in the freeze your balls off part of winter. If its snowing/sleeting/tornadoing, all the better. I won a hud auction for $500 once.
ok fair enough... but a quick
ok fair enough... but a quick run down wouldnt hurt... I think it is safe to say that you are a "hustler" and not afraid to take the necessary leaps in the pursuit of money so there are too many examples... so how about sharing what industry you started out in and a just a few of the more lucrative ventures... pretty please with a cherry on top?
"Know what to do, know how to do it, and do it hard." - Juan Castillo
If you are in the Toronto Area join my group "Toronto Prospective Monkeys"
http://www.wallstreetoasis.com/group/toronto-prosp...
Great post -wish we had more
Great post -wish we had more like these.
I have a rental house in a
ConanDBull wrote: ok fair
looking for that pick-me-up to power through an all-nighter?
awesome thread
Ranger375 WOW!!! thats one
"Know what to do, know how to do it, and do it hard." - Juan Castillo
If you are in the Toronto Area join my group "Toronto Prospective Monkeys"
http://www.wallstreetoasis.com/group/toronto-prosp...
tagged. Great info for a
someotherguy wrote: Midas
accountingbyday
Ranger375 wrote: I have a
Yeah, I'm not too worried
Ranger375 wrote: I have a
LIBOR wrote: Eddie, awesome
How viable is the "flipping"
I worked at a hard money
Kools wrote: How viable is
I am interested in building a
Great stuff Eddie, thanks for
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In The Flesh: Great stuff
Were these loans entirely
relinquis... Killing the GMAT this December; Over/Under set at: 725 GMATs.
Relinquis: Were these loans
Edmundo
Practically, its a good
Awesome post, this is the