Hard money strategies I'm not accustomed to...

4 Replies

So the title of this thread is based on the fact that I'm a new investor and it's quite probable that these arent't new strategies. My fiancé and I met with a hard money lender this afternoon and two things came out of it that I have not been exposed to.

1. The lender is essentially guaranteeing a refinance before the rehab even begins. Based on our credit scores, income, cash, arv, etc. they'll be able to lock us in at an estimated 4.25 interest rate before we even get to the point of signing any contracts. 

2. As it relates to funding the rehab process, I've only heard of getting these funds through draw requests throughout the rehab process. This lender, like others, rolls the rehab costs into the loan like everyone else does but makes you pay out of pocket for the repairs and then submit the invoice for it before getting paid back. 

I guess my questions are 1, are either of these standard practice? 2, what is the risk/reward in doing either of these?

Bonus questions, what's everyone's opinion on using your own cash to fund as much of the purchase and rehab versus using hard money? Especially for a first time investment? In our short time learning about investing, you hear a lot about trying to fund deals with as little of your own money as possible but there's this thing called debt and we're kind of afraid of it.

Thank you!

David,

Lets start here: The HML is guaranteeing a refi for you, so they are guaranteeing their exit strategy (i.e. they will get paid). Do you need to use them, or will a pre-qualification or pre-approval letter from another lending institution work? If you go with their exit financing, what do the fees look like, and how is the HML getting paid for the referral? What is the Down Payment for the HML, and what are the HML prepayment fees. The only reason for the HML to do this is either A) they guarantee that they will be made whole, or B) they are making some cash somewhere in the refinance. Or both (most likely).

The hazard of you paying and then getting reimbursed is that you need to be the draw funding closer and make sure that title is good (title date-downs), no mechanics liens, the budget is in order etc. It's not that hard, but it is time consuming and the HML doesn't have the staff to do it. The second hazard is that the HML doesn't reimburse you in a timely manner, and thus you are on the hook for the rehab funds until they do (you could run out of money). Make sure that you get their requirements for giving you money IN WRITING. If they are loosy-goosey about this, I'd look for another HML lender.

It is always cleaner and cheaper to use your own funds for the rehab, but it limits the number and size of the deals you can do. HML money is expensive and short term, so you need to be on your game to make it work. The motto of most HML lenders is "loan to own". They aren't being predatory, or nasty, or even want your property. What they want is their money back. They are going to try to loan in such a way that if you default, they come out financially whole or ahead. With them, the more money you have in a deal, the more likely you are to try to do anything you can to save the property, and the less risk they have.

If you are worried about the debt load, there are a few things you can do. The first is make sure your rehab numbers are ROCK SOLID and you included the cost of your HML for the ENTIRE TERM OF THE LOAN, plus any fees. Make sure you have contingencies built in to your bids (10% +/-). Preserving cash in your bank account will make it easier to pay the HML should the need arise, so you should have enough reserves to fund them for 6 to 12 months, or better for the entire term. You could either acquire the property with your cash or fund the rehab and avoid the bigger debt load. Having your exit numbers (loan amount/payment etc.) along with the potential rent will allow you to develop a proforma that will tell you where you need to be. Follow the "the day you get into it is the day you get out of it" model.

Standard practice with an HML doesn't really exist. They will do and write whatever they can to make sure that they are protected.

Hope that helps.

Good Luck,

Jim

as it relates to number 2 

That is very common you do the work in phases and once a phase is done an inspector comes out to make sure the work has been completed then funds are released. 

As far as #1 i am sure they can look at the details and set you up for a refi as well. I wouldn't be as certain that they can lock you in at a specific rate just yet. too much can change between now and the end of the project but if they say they can.... who am i to shoot that down

@James C. It does help A LOT! Basically I need to ensure that I've got everything nailed down to a T. I've acquired a few more pieces of the puzzle and have created a new post for the deal I'm looking at if you are interested in taking a look. Thank you!  https://www.biggerpockets.com/forums/88-real-estate-deal-analysis-and-advice/topics/501791-interesting-subject-property-suffering-from-analysis-paralysis?page=1#p3078116

David,

Your numbers look tight, especially if the units need everything inside, kitchens, walls, bathrooms etc. 40K seems a bit low to me for doing 2 units completely new inside.

If you were going to fix/flip there is no margin in this to make it go. If you are going to OO, then it's a different story. Again, your margins are VERY, VERY Slim. Most investors I know would pass on this deal and look for something with a bit less head damage.

I'd still be looking at my ARV more closely, you could be in for a nasty surprise if your ARV dips much more than 187K. Make sure you are doing your ARV on other two units that have sold, and not on per square foot estimates. They are ok for ballpark, but you need to sharpen your pencil on this one. You are correct in saying you have no equity to start with. What this means is that you are putting in a whole bunch of your time and effort into getting this property up to standard, and you are not getting paid for it. Ideally, if you are doing all the rehab/build out (paying for it) you SHOULD BE expecting a profit on your work. Also, why with MFR being so desirable at this point in time hasn't this one been done? (My guess, it's overpriced for the market)

Also, your monthly estimates for cashflow don't include management, and they should. You need to get compensated for your time. Take off your homeowner cap, and put on the business one. You are looking at 2000/moi income is that for one unit or two? By my calculations at 1400/mo out go, your 2000 per month income doesn't meet the 50% rule by a wide margin. If you rent both sides you are going to be putting in $500 ish per month. If you OO, then your nut will be about 1500 (1000 rent + 500 shortfall). This assumes a 1400 payment, 2000 income, 5% vacancy, 5% capex, 5% repairs, 10% management fee, 1200 yearly insurance, 3000 taxes. This all adds up to some -300 per month.

I am guessing that your 1400/mo is for the HML, so, if you were to do a 150,000 refinance, (80% LTARV, no PMI), at say 4.5%, 30 yr fixed, now you are looking at a payment of 760 ish, and the numbers make much more sense., and you have some equity.

Bottom line, get your homeowner cap off, your business cap on (i.e. expect to make a profit on your work), make the rehab as inexpensive and quick as you can, get your pencil sharpened and get your numbers nailed down.

Good Luck!

Jim

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