Using Hard Money Lender to purchase SFH/MF unit as 1st rental property
Rental Property Investor · Spartanburg, SC · Member since 2013 · 253 posts · 56 votes
What are the downfalls of this as from what I know would be greater than the benefits? I know it can be done successfully and has by experienced investors? If the deal is a strong one, does that matter even if investor is fairly new to the game?
Hard money is short-term money – typically for six months to a year. You pay through the nose for it, want to minimize your exposure, and know well in advance how you will get out.
The problem is that hard money is easier to get than conventional financing and can draw you in. I’d be careful using it to fund long-term investments; especially if you’re new and unused to obtaining conventional financing. I can think of a few exits.
Bruce Norris, a local HML here in southern CA, offers a "Refinance Rental" program at 9.9% for 8 years here. Unfortunately it’s only local, but you might search around for some innovative HML’s in your area and suggest a program like this to them. As flips dry up, smart lenders will be looking for safe uses of their cash.
Alternately, if you know anyone, there are always private money loans you might obtain from personal contacts if you offer them higher than CD/savings account rates. I bet you know more people upset at earning 0.1% right now than you think.
Partnering with someone that has cash but no interest or knowledge in real estate might also be an option.
If you can purchase a portfolio of properties at once (yes, it happens) it will likely find be easier to find a lender willing to fund these long term, than if you buy one SFR at a time. In general, you'll have to bring some money to the table and also show some experience. This will almost certainly mean a partner, in your case.
Unfortunately, the money’s not going to fall from the sky, Junior, and there are no secrets to finding it. You should be as aggressive looking for money as you are for properties. Good luck.
Jeff
Junior, you need to make sure you have an exit strategy when using hard money. How are you going to pay them back/
Your question is kind of vague in the sense that it doesn't tell you much about the property in question.
Some of the questions that pop into my mind are:
1. Do you qualify for conventional financing?
2. Does the property need repairs?
3. Are you getting the property under market valve?
4. Are you capable of refinancing out of hard money once repairs are complete?
If the deal is strong and have enough of spread most hard money lenders will lend to you. That being said they will want you to have some skin in the game. So they will require some form of down payment (25% to 30%).
They will also make sure that you will qualify for a conventional mortgage once the renovations are complete.
Dawn A. That's exactly what I was thinking and I knew that in order to pay them back because it would be a short term loan would be to refinance and get a conventional loan. But of course that means I would need a pre-approval letter before getting the hard money loan. Is that correct? I guess I should've term this post "what are some exit strategies if one uses a hard money lender etc..?"
Prashant P. I don't have the exact property yet as I was more or less questioning through procedure and methodology behind it. All the things you bring up help what I was getting to which is knowing I would need some skin in the game and having to re-fi with a conventional loan.
I agree the carry cost and interest rate are not appropriate for a buy and hold strategy.
Mathematically it only works were some form of forced appreciations is occurring...generally fix and flip in the sfr arena.
Commercial Real Estate ie 5 units or more of multifamily does have a hybrid lending category called bridge financing. This is only appropriate when you have a turn around strategy with a clearly defined exit. For example if the project is only 60% occupied and you have a clear plan to lease up to 95% then it is the way to go.
In this case long term takeout financing is NOT available at 60% occupancy, therefore you have to get creative.
Hard money is short-term money – typically for six months to a year. You pay through the nose for it, want to minimize your exposure, and know well in advance how you will get out.
The problem is that hard money is easier to get than conventional financing and can draw you in. I’d be careful using it to fund long-term investments; especially if you’re new and unused to obtaining conventional financing. I can think of a few exits.
Bruce Norris, a local HML here in southern CA, offers a "Refinance Rental" program at 9.9% for 8 years here. Unfortunately it’s only local, but you might search around for some innovative HML’s in your area and suggest a program like this to them. As flips dry up, smart lenders will be looking for safe uses of their cash.
Alternately, if you know anyone, there are always private money loans you might obtain from personal contacts if you offer them higher than CD/savings account rates. I bet you know more people upset at earning 0.1% right now than you think.
Partnering with someone that has cash but no interest or knowledge in real estate might also be an option.
If you can purchase a portfolio of properties at once (yes, it happens) it will likely find be easier to find a lender willing to fund these long term, than if you buy one SFR at a time. In general, you'll have to bring some money to the table and also show some experience. This will almost certainly mean a partner, in your case.
Unfortunately, the money’s not going to fall from the sky, Junior, and there are no secrets to finding it. You should be as aggressive looking for money as you are for properties. Good luck.
Jeff
At first glance, hard money would not be MY ideal strategy, as most I deal with are 6-12 months in timeframe. However, if you can find a HML who has a 3-6 year time frame, you might be willing to do the deal, if you can make all the numbers work, and I mean all the numbers, taxes, insurance, vacancies, etc. You might also want to check your local REIA for hard money sources and see what you have available locally.
Jack
Thanks guys! Jack Bobeck Jeff S
Also, I just looking at different avenues of financing outside the normal. I know that hard money lenders usually deal more with flips and larger acquisitions.
The other question I had that I proposed to Brandon Turner as well was if (just for numbers sake; saying all numbers worked and actually being able to get a loan), just kind of curious how it works if i had a rental i wanted to purchase for 25,500 cash and ARV was 50Kand the HML would give me 70% of ARV and it only needed 3-5K in repairs (turnkey with tenant-rent at 625), how much money would I need to bring to the table? I know I need cash for reserves for bigger, unexpected events which is why I'm saving money and doing wholesaling now as well. I have some money put away but wouldn't want to use it all on the purchase of the property.
Also add this lender charges 10% interest and time frame is 6 yrs. I know this is a lot of info, but using an example is the only way I think I could grasp the concept.
This situation currently is hypothetical, property is not. Also to add, Previous owner's total expenses for a year were also $2,737.50 which includes property management fee.
anyone feel free to input!
Junior Salters,
You said:
I suggest that you spend some time in the following forum:
Landlord and Rental Property Questions.
Here is the link:https://www.biggerpockets.com/forums/52-rental-property-questions-landlording-issues
I suggest that you spend some time reading the first 4 "stickies," and the first one that you should read is the "50% rule."
Raymond
Junior Salters - I would consider shopping around for small local banks and talk to their commercial lending department. There are quite a few posts about doing that here on BP. I've done that a number of times, putting down 20-25% and getting draws to complete the rehab work. Then the loan is permanent after the last draw, no need to refinance under a tight timeline. The loan will prob be 15 or 20 year, adjustable every 5 years, but far cheaper than hard money.
Make a lot of phone calls!
Raymond's post above is also excellent advice, in addition to the numbers and financing on the purchase + rehab, you have to make sure it will be a good rental as well.
- Tom
Thanks for all your replies! Raymond B. I have read those stickies and I know that. I know this process isn't first choice but I know it's possible. I'm more looking for someone to show me how the #s work with this process. I grasp the convention way of financing. As I said this is hypothetical and I'm seeing how it could work.
Hey Junior Salters here is how I would break down the numbers:
A $25,500 purchase + $10,000 repairs (always double your budget) would be $35,500. Add $1500 in closing costs and you'll be at $37,000.00.
If the ARV is $50,000 - conservatively (remember, hard money lenders are going to be ULTRA conservative. So you might think it's worth $50k and they might say $39k. So #1 importance in this whole thing is being 100% absolutely positive in the final ARV amount, confirmed by at least 2 different real estate agents and supported by at least 3 comparable SALES, sold within 3 months and within half a mile.
So, if $50k is the After Repair Value, a HML will likely fund 70% of that deal, or $35,000, which means you'd be "technically" expected to come to the deal with $2,000 worth of repairs.
However...
Most hard money lenders are not going to fund all the purchase price AND most of the repairs on your first deal. Most likely, the repairs will be 100% on you, even if the 70% and the ARV support it. You might find a lender to do it - but it's very unlikely. (Ann Bellamy would you agree?)
So, I'd say most likely, the lender would say:
"Junior - I will fund $20,000 of the deal. You will come to closing with the remainder, and the repair costs will be on you."
The HML will then charge you their points as well, and add it to the loan. Let's say the HML will charge 5 points and 12% interest. So the total loan is going to be $21,000 and you'll come to closing with $7,000 to cover closing costs and the rest of the purchase. Then, you'll pay the $10,000 for repairs (hopefully it's less than that - and if it is, awesome! But don't expect it!)
You'll also pay the lender $210 per month for the first couple months, plus another $100 for taxes and insurance, so $310 per month in holding costs. Figure it will take 3 months to close, clean it up, and get a renter in it (probably less, but always double your timeline).
SO in the end, you'll have spent:
$20,000 loan
$1,000 HML points
$7,000 cash you brought to closing
$10,000 repairs
$1,000 holding costs
------------
Total cost: $39,000
At this point, you get the house rented out for $625 per month. Using the 50% rule, figure $300ish goes out to expenses, and the remained pays the mortgage ($210 per month). So, while using the HML, you are getting around $100 per month in cash flow. Not too shabby.
Then you go to the bank to get the refi (banks will typically require you to wait 6 months to 12 months, depending)
At that point, they do the appraisal, and it comes in (hopefully) at $50,000. They agree to do an 80% loan to value loan, on a "Cash Out Refi" (which means you get the original HML loan paid back, plus cash to pay yourself back) so they will loan $40,000 - which covers everything you've put into it. However, the bank is also going to charge a couple thousand in fees and closing costs because they all suck like that. So you may be a couple grand short in the end.
The new mortgage of $40,000 at 5.5% for 30 years is $227 per month (just the principle and interest.)
Now, using the 50% rule again, and assuming a rental price of $625 per month, you, you are left with around $90 or so per month for cash flow.
Not amazing, but knowing that you have no money into this thing, it isn't a bad thing either.
---
So, this whole deal hinges on a few things:
1.) The property really being worth $50k. This is a big deal.
2.) Having the, roughly, $18,000 of your own money needed to do the deal. Or finding a partner with the $18,000.
3.) Finding a HML that will fund 70%. Most will only do up to 60-65%. Maybe less on a first deal. Fyi.
4.) Being able to get the refinance from the bank. This is vitally important if you are going to use this strategy. Lending practices could change - so be sure to have multiple exit strategies. At the end, you'd only have $39,000 into the deal. Could you quickly sell it for $45,000 if you had to unload it fast? Are properties in that price range selling quickly in that neighborhood?
Anyways - that's my analysis of such a hypothetical deal. Hope that all made sense!
If anyone see's any problems in my numbers- definitely let me know. I'm tired, so I'm sure my math could be off somewhere!
"Most hard money lenders are not going to fund all the purchase price AND most of the repairs on your first deal. Most likely, the repairs will be 100% on you, even if the 70% and the ARV support it. You might find a lender to do it - but it's very unlikely. (@Ann Bellamy would you agree?)"
Junior, since you are new and have no track record, you're going to have a harder time, not an easier one. No criticism, it's just the way it is. Lenders want any loss to come from your cash, not theirs. As a newbie, you are more likely to make more mistakes. As a result you are in general unlikely to get 70% of ARV, more likely 60-65%, possibly even lower. Some HML's don't want anything to do with funding repairs, some prefer it, because as they disburse the construction draws, their security increases in value.
But here is the thing: Hard money terms are VERY local. So you need to talk to some local lenders. Bill Worsley lends in SC, touch base with him. Even if he doesn't lend in your specific town, he may be able to connect you with someone who does. When you talk to lenders, simply ask them their preferred type of deal and what they like to see. That will give you your specific answers and you may find that Brandon Turner's assumptions are right on, or they may have different criteria.
So it's possible you may need a money partner (friends/family/other real estate investor) for your first deal, which will significantly reduce your return. But once you have been through the process successfully, the next transaction will be easier, and you will have learned tons.
Brandon Turner Thanks for the in-depth answer. Looks like there really wouldn't be a lot of cash flow to be had and the investor so I would prefer to this conventional, but the offer was for a cash buyer only. Maybe they would consider owner financing...worth a shot down the road!
Ann Bellamy Thanks alot! I will definitely get in touch with Bill when I need to pull the trigger or really going to make a firm step forward. Probably a money partner would be best case scenario for a deal with low margins like this. Thanks alot for your input! I' do have some money saved, but probably not for the total purchase of a home.
Junior Salters I would recommend you start building up your private money list. Get this deal done with hard money, but then see if you can get a fix and flip going to get private money working for you AND so that you can have some cash on the side of your own to invest. HML like to see that you have some of your own money tied up in a deal, lowers their risk.
Stay out of banks, the personal guarantee is like a noose around your neck. You don't want or need that pressure. There are trillions of dollars sitting in IRAs earning less than 1% return, when you can offer then, say 8%.
#JackBobeck
Jack Bobeck, if you are going to borrow money from a "private lender" who, for purposes of this conversation can be assumed to be less financially sophisticated than a bank, I feel you should be willing to stand behind your signature. So I feel you should be willing to personally guarantee any loan for real estate investing except one to your SDIRA.
Ann Bellamy There is quite the difference in a personal guarantee with a bank and an investor. With the investor, you lay it out that the money is used to rehab the house, and that the investor has the 1st lien holder on the property. With the bank, they will be the 1st lien holder but if something happens to you, they will take the property and come after you for all of your assets, to cover the note. Banks are very different in their lending programs, I want investors to know that the bank will not stop with just getting the property back, they will want to take everything you own to pay back their investment.
#JackBobeck
That's true, but that's the case with any lender: Bank, Hard money or private lender, if they have a recorded mortgage and a personal guarantee, they all have that right. Hopefully if the deal goes south, the borrower makes good without the lender, whoever he is, having to exercise his rights under the personal guarantee and go after other assets. But regardless the lender should have that right. And the borrower should be willing to stand behind it. After all, the private lender shouldn't be the one who's funds are at risk without the borrower assuming that same risk.