Offering private money loans using LOC on commercial property

4 Replies

I recently purchased a 12 unit building which came with a very high appraisal value at $95k over the purchase price (which I put 20% down on). I found a local lender that is willing to do a LOC at 80% LTV on the property at the appraised value, and I am interested in finding creative ways to use that equity.

I was contemplating using that line of credit to offer private money loans to a local flipper/developer and start out in the note business. I was wondering if anyone has gone this route of using a LOC for private lending and what expertise is needed and legal ramifications there are for using borrowed money to make loans?

there are 12 states you need to be licensed in to lend money.. check that first.. not sure about WI...

but usually if you google HML in your state and if they have a NMLS number then its probably required if not probably not.

@Michael Andrews Reading your post gave me some negative flashbacks because of errors I've made in the past. I'm sensitive to over leveraging because I have done it in the past and it's not a fun experience when things don't go the way you've planned. If you borrow at 80% LTV, is the income from the 12 unit building enough to cover your entire P&I payments, property taxes, insurance, utilities, maintenance, and cap ex? What happens if you have several unexpected vacancies and your hard money loan goes non performing at the same time? Do you have enough reserves to tide you over in case this happens? That's not a worse case scenario even, they happen from time to time. I don't want to rain on your parade but just want to make sure you're thinking about these things just in case. Maybe 20% equity is enough to do what you're planning, I don't know. Leverage can let you expand like crazy but it can also crush you. Be careful....

@Andreas Mirza Thank you for this comment, this is exactly the type of feedback I am looking for.  I am very, very concerned about over-leveraging, and being brand new to investing in real estate I have no real experience in determining what is an appropriate amount of debt.  I feel like it's the one subject that most people ignore on BP when contemplating growth and risk, and I have had a very difficult time determining what my risk potential should look like.  

I really want to grow within a moderate risk tolerance, where debts are covered and there is still positive cashflow even at the worst of times.  I am not planning on retiring from my career as a software engineer to live off of this real estate investment business until I have grown the cashflow up to $100k+ per year with leveraged properties.  By my estimation that means I would need to acquire between 8-10 more properties like this 12 unit, so the timer in my brain is ticking and I want to make intelligent choices on my journey to that goal.  

So the question becomes how do you people manage leverage?  What is your tolerance for risk and reward?  Is there a moderately safe method for pushing the accelerator and growing with equity, or do you just leave it alone?  

I love rain on my parade, please make it downpour so I can learn something!

@Michael Andrews Haha, love the downpour comment!

It really comes down to your individual risk tolerance. Will you be able to sleep at night or will these deals that you get yourself involved in keep you up at night? If you're married, consider your spouse's risk tolerance for what you're doing. A difference in risk tolerance can cause a lot of stress. (Ask me how I know.) Some investors want to own their properties free and clear and don't want any leverage. I used to think that was a waste of equity but not anymore.

So, you already realize the relationship between risk and growth. The higher the risk, the higher the potential growth or loss. The lower the risk, the greater the stability but the less growth.

My opinion:

For income property, I like 50%-80% LTV loans per property with an average of 60-65% across the portfolio. I get some cash flow and there's a big enough cushion in case I need it. I might go higher on the LTV in the short term, if I have a solid plan to reduce the LTV and there's a good reason for it.

(I got crushed one time by financing a flip with 100% financing, combination of hard and private money. One lesson I learned was to take on equity partners when possible instead of debt partners; much better to make a smaller profit than expose yourself to huge downside risk.)

Personal Residence: We started with 10% down and intend to keep paying down until the end. If we upgrade to a different home, we will take the equity from the current home and effectively transfer it to the new home with a bigger down payment. The idea is to have our personal home owned free and clear. There is something very comforting to me to know that if we faced an unexpected financial setback, we'd still have the house and be able to hold on to it.

For our Funds: 100% equity. Leverage will be used sparingly, maybe in the form of hard money loans when we have to rehab an NPN that goes REO.

You and your needs might be completely different but that's how I look at it. When I was young and single, my risk tolerance was high. If I lost everything, I could go crash on my friend's couch. When you've got a wife and three kids, you've got different priorities, needs, and overhead. Plus, I like to sleep at night and not worry about my investments. It really sucks when you can't :)

I just looked at one of your last questions again about "pushing the accelerator." For me, I've always been willing to go too fast, even when I've had doubts, and my desire to grow fast would win out. If I listened to my gut feeling I would have been better off. Over the years, I've learned to balance my first instincts with my experiences, especially the ones that didn't turn out so well. This has helped a lot. Focusing on what I do best, saying no to everything else, and growing at what I feel is a moderate pace has been the best thing for me. I also threw out my personally imposed deadline on when I needed to "make it." As long as I'm progressing towards my goal, I'm content knowing that I'll get there one day. (The hyper motivation to make my deadline led me to make some bad decisions regarding the above mentioned flip.) This is the best I can do to answer your question. I hope it helps!