Hello All,
How would you go about calculating this return. You are buying an investment property for 100K, with a traditional loan which covers 80% of the cost. You get a hard money loan for 50% of the current value for the down payment and rehab. Of that 50K you get in cash 20K goes toward the down payment and the other 30K goes into rehab. You sell the property in 5 months for 170K.
Hard money rate=9%
Traditional=6%
What would your return be, would it be infinite?
| +52 | Leave brokerage to be GP | 12 | 1d | |
| +46 | New Comp Database - Google Form (Now with Data Validation) | 24 | 1d | |
| +24 | Seeking Career Guidance in Real Estate Development Post-Graduation | 3 | 2d | |
| +23 | Spreads over SOFR/UST | 5 | 7h | |
| +23 | Going out on your own | 4 | 1d | |
| +22 | REPE/Development GPA | 15 | 4d | |
| +21 | Real Estate = complicated + underpaid | 15 | 1d | |
| +18 | High achiever that doesn’t want to work weekends | 9 | 3h | |
| +17 | Fisher Brothers | 6 | 1d | |
| +17 | MSRE/MSRED with no RE experience; Naive to think I’ll land a job afterwards? | 4 | 5d |
Career Resources
Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.
Hi Tungston-Hill, any of these threads helpful:
More suggestions...
If those topics were completely useless, don't blame me, blame my programmers...
The way you outlined it you are essentially suggesting you would be getting a 130% ltpp or 100% ltc. So yes, your equity return is infinite as you has no money down (the way as described). If you are having to bring in additional equity to fund loan payments during the rehab process, you would need to take those into account. But FYI, this isn’t a realistic scenario as your creditors are underwater day 1. If this was a textbook question, I would double check if the questions meant to say that your HML was 50% of your down payment (and not total purchase price), which would imply a 90% LTC.
Thanks for the reply here, its actually a deal a friend is running down in Florida. There seem to be a bunch of people in his circle that work out these wild deals.
I caution you regarding this type of leverage. It can go well until it doesn't and when it doesn't go well you can lose a lot of money...maybe even enough to send you into bankruptcy. In order to get an 80% loan from the bank you will likely need to personally guarantee the loan, which means the bank can come after all your assets. Recently I saw a deal from fairly new and aggressive developer that played a similar game to the one that you are describing (high leverage and almost zero skin in the game). He acquired 2 adjacent parcels of land (one with a triplex on it and the other vacant) for $2.5mm with the intentions of entitling it for ~20 units. The triplex and parcel are probably only worth about $1.6mm, so if he were to go to a traditional bank to finance it, he would only be able to finance $1.28mm (80% of $1.6mm), so he would need to put up $1.32mm to do this deal. He will also need to finance all the soft costs needed for entitlement and construction docs before he can get a construction loan, so probably ~$300k ($100k to entitle, $200k CD's). So total equity he needs to do this deal is ~$1.62mm and that's not including interest payments. He either doesn't have the money or doesn't want to put up that much equity, so he goes to a hard money lender and gets a one year loan for 97% LTV ($2.425mm) at 9%-12% interest rate (this was right before the rate hikes started so hard money loans were in this range). His goal is to entitle the land within a year and then based on those entitlements either sell the entitled land or refinance with a traditional construction loan. Well...things didn't go as planned. He was able to entitle the property for 20 units and I think his intent was to develop the property as opposed to sell the entitled land, but either he couldn't get construction loan financing or he calculated that he would not be able to carry the project given that interest rates doubled on him in a year. His hard money loan has now matured and the hard money lender is either unwilling to extend the loan or the developer is unable to carry it since the new rate on the hard money loan will likely be in the mid to high teens. He's forced to fire sell. At first he puts up the land for $3.5mm hoping to make ~$650k ($3.5mm - $2.5mm - $350k (interest payments and cost to entitle)). No bites. He drops the price to $3.2mm. Still no bites. Time is ticking and he is getting desperate to sell this thing. So he puts up a second listing, but only for the triplex parcel for $1.6mm and he will keep the vacant land. I smell blood. If you do the math, even if he sells the triplex for $1.6mm and all the proceeds go towards paying down the loan, he still owes ~$800k and his vacant parcel is not worth $800k, it's probably only worth about $400k. Furthermore, without both parcels together, his entitlements are voided, so the $350k he spent on interest payments and entitlement is down the drain. My guy is about to be $750k poorer in 1 year and that's not even including the cost of sale on the triplex and vacant parcel, so once you include those its almost a $1mm loss. I calculated this and figured that I could probably scoop his entitled land at ~$2.4mm (just enough for him to pay off his entire loan), but unfortunately someone beat me to the punch and bought just the triplex parcel. If he waited for me then he'd only lose ~$350k instead of $1mm. Sad :(
So anyways, as I was saying. If you are planning to leverage the shit out of your project, you better have a Plan A, B, C, D for when shit hits the fan. Generally speaking my advice is not to do deals that require you to squeeze every penny out of your wallet and bet the entire farm. Do something you can afford. I will never take a hard money loan. My rule is that if I can't do a deal with traditional financing, then I'm not doing the deal. Also idk where you are getting 9% on a hard money loan...around my area it's def in the mid to high teens
Great post... out of curiosity what do you think the entitled land would be worth and how would this guy have made a profit without doing the development?
Tbh, when he dropped the price to $3.2mm I didn't think the price was crazy. However, the issue isn't necessarily price, but it's the uncertainty during these economic times. Construction loans are at 9% now and are trending towards 10%. The Fed says that they will supposedly stop rate hikes after 2 more quarter point hikes, but that's what they said last time and now they are raising it again. At the same time, inflation has caused construction costs to soar. Pre-covid you could expect to develop a 20 unit development like this for $250/GSF in my city (Tier 1 market), now its at $300-$350. Some GC's are even telling me to use $400 to be safe. I don't have my underwriting in front of me, but if i recall correctly, i estimated cost of carry at ~$60k/month when the loan is fully drawn down...that's the average household income in the country...in 1 month...it's scary to be on the hook for that. Furthermore, most developers are probably in a world of hurt right now and trying to figure out how to make it out alive, let alone hunting for new projects. Finding investors is also a lot more difficult. I think maybe if he dropped his price down to $2.8mm, maybe he'd get an offer between $2.4mm-$2.6mm. I was interested in his deal around this price. I'm also a dickhead. I wanted to see blood and would have only offered him just enough to get out alive ($2.4mm). I was told by the agent that the reason he listed only the triplex for $1.6mm and not the vacant land was so that he could develop the vacant parcel. I think what he wanted to do was sell the triplex and pay down the loan to significantly ease his interest payments and then develop the vacant parcel and hopefully generate some "profit" to reduce his total loss.
[EDIT] Forgot to answer your question on how he makes money without doing the development. Well the ideal situation would have been that once he entitled the land that the entitled land is worth significantly more than what he paid for it + any soft costs he put in to entitle it. So if he found a buyer at $3.2mm then he would have made ~$350k, which is donkey shit for the amount of risk and effort he put into this, but at least he's not losing money. This guy needs to sell the entitled land at ~$2.85mm to break even and maybe he would have gotten that or close to it. But put yourself in his shoes. This guy spent over a year trying to entitle this project, fighting against the neighborhood, etc.. and after all that work not only is he going to not make money, but lose money? It's a tough pill to swallow, so rather than do that, he decides to sell the triplex and reduce his loan and then maybe wait for the market to turn and develop the vacant land. He may try to entitle the vacant land for 10 units or something and develop that because it is a lot easier to finance a 10 unit development than 20 unit development. That's his whole problem right now. He can't finance the 20 unit development. The only way for him to not lose money and actually make money is by developing the 20 units and selling them. There is actually decent profit if he can do it. But he can't finance it. Prior to all this rate hike stuff, what would have happened was that after entitling the land, he would go to the bank and the bank would appraise the entitled land for at least $3,281,250 and lend him 80% of that ($2,625,000). He would then take $2.425mm to pay off the hard money lender and have $200k to draw up CD's and then refinance again into a construction loan. This was his initial plan. With only 3% equity, he would be able to develop a ~$10mm project and make millions (by my calculation $5mm-8mm). But banks are no longer doing this because of the economic environment. They won't finance land based on the entitled value or at least not as aggressively. This guy needs an equity injection of ~$1.6mm, someone to personally guarantee the loan, and someone to pay the carry cost. No one is going to do that for him in this environment
That makes sense thanks for the response! That's a different perspective than my experiences in my area (HI). Lenders here are either very conservative or unsophisticated and don't understand entitled values v. non. Construction costs are exactly in-line with what you quoted and I have seen similar spikes which killed a development I was working on pre pandemic.
Bold strategy to be overleveraging at this point in the cycle, Cotton. Let's see if it pays off for him.
Voluptates dignissimos et ipsum. Est nobis asperiores quidem molestiae optio et ullam porro. Dolorem et ut reprehenderit et ut. Earum temporibus sequi in in quia.
Consequuntur perferendis ut enim animi saepe aut doloremque. Expedita libero hic temporibus assumenda. Nam excepturi aut voluptate quo. Veritatis esse quo rerum enim eos commodi reiciendis unde. Dolor neque cumque accusantium cum nihil qui quisquam culpa.
Fugit harum atque repellendus. Amet corrupti qui aliquid omnis voluptatum dolorem. Perspiciatis eos voluptatem perspiciatis delectus. Dolor dolorum vitae sed blanditiis maxime velit.
Natus corrupti pariatur rerum enim quo ex unde. Cumque nihil explicabo aut culpa. Repellendus cupiditate et accusamus tenetur ea nam illo dolore.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...