In the private lending market, I am seeing several newbie private lenders doing some imprudent actions when making private loans. Meaning frankly, these credit cowboys are going to lose money by extending certain credit terms. Ask me how I know this…because I extended those loan terms once upon a time and found myself in a ringer. Let me tell you about two loans I recently declined, but may have funded in years prior.
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Loan #1 : The Loooong Term Flip
This 3 bedroom 2 bath home needed about $12,000 in remodel costs – mainly cosmetic. Borrower wanted another $15,000 for construction rehab for an additional outside and upstairs exterior entrance. This was to be given back to the borrower upon his completion of the construction. Property has new plumbing and electrical installed by the prior owner who lost the property to foreclosure. Borrower requested 2 years term. Loan amount of $82K. Estimated market value of $127,000 gave the deal a loan to value of 65%.
I could not give the borrower 2 years to complete the project and pay me off because invariably, the borrower could move a tenant into the property and thereby risk destroying my collateral as tenants sometimes do. Also, your borrower will thank you for keeping him on a ‘short leash’ regarding term because that keeps the project moving forward.
Secondly, to give the borrower’s cash back before my loan is paid back is unwise in my humble opinion as the borrower now would have NO ‘skin in the game’. The borrower could walk into the lender’s office and through him the collateral’s keys and be gone. Again, ask me how I know this.
Lastly, during the inspection, it is found out there are adequate comparable properties to establish a value, however, the collateral is in a small pocket of run-down homes known, in our area, as Felony Flats. The immediate neighborhood did not support the borrower’s purchase price for a flip. It did not matter the neighborhood is improving, our loan would be short-term in nature. (see my last blog with the Bering Sea analogy and leaving your money at risk too long)
Loan #2: The Small Town Spa
3 bedroom 2 bath home built in 1951 on 2 acres out in the country. Loan amount of $60K. Estimated value was $130K. Borrower as going to convert the property into a relaxing spa in the country. Needed $40K in repairs – collateral was a mess!
Glossing over the fact the borrower did not have the cash on hand for the repairs (this is not a deal breaker, but it is a red flag), the property was not near a major metropolitan city. Meaning, the number of buyers for the take out loan to pay me off were limited. The borrower tried to assure me there were several buyers who would be interested in the completed property.
Secondly, the borrower wanted to convert the property into a spa. What this does is make the property a single use property way out in the middle of nowhere. The number of buyers for this type of property are limited! And again, ask me how I know this. When I first started lending, I did a deal like this and I barely got out with my skin. A man from Alaska happen to be looking for that exact type of property in that exact location and bought my borrower out. The borrower made no money.
The Take Away
Although private lending is how I and my employees make a living and it can be very profitable, if a lender makes a loan based upon imprudent credit factors or wrong assumptions, it may take the lender a long time to recover.
To Your GOOD Wealth….