How to Expand Your Real Estate Portfolio Using Hard (or Private) Money

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As real estate investors, we usually tend to do things on the cheap.

I’m not sure if it was my upbringing or where I came from, but like many of us, on occasion I have to be reminded that sometimes being so cheap can also be just plain stupid. And that’s the way it was for me with hard money.

Before I even really knew what hard money was, I had pretty much been a loner, doing it my way, and somehow I still managed to build up a small portfolio of residential real estate rentals.

But looking back now, one of my biggest regrets is that I didn’t use more hard, or private, money when I was starting out in real estate.

How I Bought, Rehabbed, Rented, Refinanced, and Repeated for 14 Rental Properties

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Are You Making Money on the Draw?

Throughout my real estate and note investing career, there’s one thing I learned: Don’t knock someone’s business model until you at least fully understand what they’re doing.

That’s the way it was for me and my buddy Russ (of “Houses R USS”). I’ll never forget having lunch one day with this super experienced real estate investor/rehabber/wholesaler/buy-and-hold guy with 100+ properties, and after I asked him how he acquired so many houses so quickly (especially since we’re about the same age), he shocked me with his answer — that he used hard money.

Related: 8 Things The Real Estate Experts Won’t Tell You About Hard Money

In fact, he bought his first 39 houses that way. At first I was taken aback, and I’m thinking to myself, this dude’s nuts. (After all, isn’t hard money super expensive with down payment requirements, points, and penalties?) So, Russ proceeded to tell me that the main reason he had done so many hard money deals was because of all the tax-free money he’d make on the draw. His strategy wowed me, as I never really thought about it like that.

When he was new to buying and rehabbing, the hard money guy he used (who also owned a huge portfolio that he had placed a massive line of credit against to do hard money deals with) was a great resource, if for nothing more than to run his deals by him, first and foremost, to be sure it truly was a good deal. Not only that, but as the hard money guy got to know him over time and understood how he actually worked, he trusted him more and more, and eventually he lowered some of his fees and rates.

But the most important value was probably in the draw schedule. Once he closed on a property, after certain stages of work were completed, the hard money guy would release the next draw, or batch of money.

So, for example, if Russ was getting $10,000 from the draw schedule for all the work that was completed by paint and carpet, and if he was able to get his crew to do it for $6,000, he would make the remaining $4,000 off the draw tax-free, because it was a loan. He said he had done this for several years starting out, and it had become like a game to him to try and come in under budget.

How Many Deals Could You Do With an Unlimited Supply of Money?

This was his next point. With almost unlimited capital behind him, the world was his oyster. He could now focus on what he did best — finding deals and running his crew.

This is a great scalability question for real estate investors (or even note buyers): “How many deals could you do if money wasn’t an issue?

Another thing to keep in mind is that after you build a track record, it will be easier to acquire private money for your deals, which is typically still less expensive (less strict draw schedule, lower fees, fewer points, fewer inspections, etc.) than hard money.

Time to Build the Money List

As I think back to when I started out and how long things took me in my own little micromanaged world, where I’d wait until I had my own money or I’d use my own little line of credit, I realize how much time and money I wasted and how foolish I was by being so cheap. (After all, HELOC rates are lower than hard money rates, right?)

Related: BP 009: Using Hard Money Lenders to Grow Your Business with Ann Bellamy

Instead, I wish I had started out more like Russ, putting true deals in my LLC, with the guidance of an experienced hard money lender, making money on the draw, with my tenants paying to build my portfolio that much faster and quicker. If anything, I could have done like Russ did over time and let my private money list eventually replace my hard money guy.

Now, my question for all of you on BiggerPockets is: What are you going to do to accelerate your real estate portfolio?

Leave me a comment below, and let’s talk!

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

25 Comments

    • Dave Van Horn

      Hi Deshan, thanks for the positive feedback. I didn’t really think about it either, until I heard of it from Russ. I guess that’s why the title of that book “Never Eat Alone” by Keith Ferrazzi makes sense.
      Best of luck to you,
      Dave

  1. David Semer

    Great article @Dave Van Horn. I know when I started in real estate and if you needed money you have to talk to a hard money lender. Which was a dirty word at the time. I just did not know what I was getting into. They have become some of my best partners on my team. Since I have started and have done most of my deals with either Private or Hard Money Lender it has allowed me to increase my volume. I especially like your question that if you knew money was not the issue how many deals could you handle? I am working on figuring out that point out as long as the numbers make sense. Thanks for the article.

    • Dave Van Horn

      Hi David,
      Regarding the scalability question, I believe there’s two things to consider. The first consideration is “how many deals can I handle with my current crew, and do I need to run more crews?” The other consideration is “am I doing enough marketing to find the deals?”
      I agree that using hard money can have a bad reputation due to the higher expense, but if you’re finding enough true deals and you’re efficient in your renovation, then it could become a valuable tool.
      I’m glad to hear that it has allowed you to increase your volume. Thanks for sharing!
      Best,
      Dave

  2. Karin DiMauro

    Thanks for the info, Dave! This is probably a simpleton question, but can you expound a bit on what you mean by making money on the draw? How does that work, exactly, to take that “extra” money tax-free as a loan? What do you do with it, and how?

    • Dave Van Horn

      Hi Karin,
      Well, some hard money lenders release the capital to the borrower in stages. For example, they may provide some of the capital to acquire and/or close on the property, then they may release additional capital when you reach certain completion stages of the rehab depending on the scope of the size of the renovation.

      If you’re given a certain amount of money for the next stage of the renovation, and you are able to come in under budget, the surplus is still yours tax-free as it is part of the loan package.
      Say you have a property that’s going to be worth $100K ARV, and the hard money lender agrees to give you $65K total.

      He might give you $45K to acquire the property, and maybe closing the property costs you between $45 and $50K. And, you have $20K in renovations that will be released to you in two draw schedules of $10K each.

      In the first half of the renovation, let’s say you got the work done for $8K, the remaining $2K is still yours tax-free because it’s part of the $65K loan, which you’re going to pay off with a refinance if you intent to keep the property or your new buyer is going to pay off when you sell the place. It’s the same way with the next phase, if you come in under budget, you can keep the remaining capital and put it in your pocket tax-free.

      I hope this info helps,
      Dave

  3. Cydni Anderson

    I actually did this exact strategy for several years, and did quite well. It does become somewhat of a game, trying to see how well you can do. For me it provided a nice condo in an expensive area (Santa Monica), all tax-free.

    The only reason I stopped was due to health issues. Now that I’m stable, I look forward to building this sort of business again. 🙂

  4. Tom Waddell

    Dave — thanks for the article. Hard money for buy & hold, notes, and even flipping still requires a large down payment, correct? Which would keep it out of reach of those with limited capital. But maybe this article is not meant for people in my current financial situation (which is fine). Just curious if maybe I’m missing something here.

    • Dave Van Horn

      Hi Tom,
      Thanks for your question.
      A hard money lender may require some type of down payment or escrow (may depend on your relationship and your track record, as well as the quality of the deal), and that’s one of the reasons that some people move towards private money. Depending on the deal, you may get that money back when you refinance or sell the place.
      Best,
      Dave

    • Jonathan Green

      Andy,

      If I understand correctly, you will in fact be making the money tax-free. The chosen investment strategy will dictate how the loan is paid off, but this (theoretically) would not come out of your personal finances. For instance, if you employ a buy-hold strategy, refinancing under a conventional loan using the sweat equity from the rehab as down payment will pay off the hard money loan, in this case $65k, and the investor would keep the residual rehab budget from the draws tax-free. The result is effectively the same under a ‘fix-flip’ strategy where the new buyer would ideally purchase the property at the ARV, thus paying off the $65k hard money loan, generating profit from the sale, and pocketing residual draw money. Now, to be frank, this scenario excludes other costs (e.g., origination points, closing fees) so the numbers won’t be exact, but this is only to demonstrate the concept. Hope this helps! If I’m confused on your question, please correct me 🙂

      • Andy Gross

        Jonathan,

        I doubt there is such thing as “tax free” money. Let’s say you have a $60k HML and you take a $5k draw to pay your flooring contractor. He comes in under budget and only charges you $4k, so you pocket the $1k. By the time it’s all said and done, you have a house that sells for $100k, for a nice $40k profit. Had you not taken a cut of the draw, you’d have a $41k profit. Either way, it’s part of the profit or it’s part of earned income as some sort of fee. The flooring contractor has to pay taxes on the profit he makes on the flooring job. This is something I would run by a CPA first before trying. Last thing you need is an audit.

      • Cydni Anderson

        Exactly. You don’t pay taxes on borrowed money, which is why many long term investors choose to refinance and pull out cash instead of selling. Borrowed money is not earned income.

        Some of the follow up books to Rich Dad Poor Dad cover this in detail. If I remember right, Cash Flow Quadrant and Increase Your Financial IQ give pretty detailed examples. Every now and then I pick the whole series up from the library and go through them again, to refresh my memory. Just re-read Rich Dad a few weeks ago; helps me to refocus!

        Cheers!
        Cydni

    • Dave Van Horn

      Hi Andy,
      Thanks for your comment.
      You are correct that once you liquidate the property, you would have a taxable gain, but a future gain and untaxed financing are two separate things.
      For example, what if you didn’t sell the property for 5-10 years? In that period, you would still have 5-10 years tax-free use of the money you made on the draw. Personally, I would rather have the extra draw money sooner with no tax when I take it, instead of that money included in a taxable gain later.
      If it takes me awhile to sell the property, I could use the money to pay my hard money lender. It may allow you more time to market the property, or it may allow you to take a lower price.
      Plus, for some people, when they borrow more money, they have more write-offs, offsetting earned income.
      Best,
      Dave

  5. Steven J.

    Dave this is really a great article! I’m looking at acquiring private money in the near future for my investments. Correct me if I’m wrong but this strategy works the same with private money, correct? For example, I buy a 50k property and rehab it for 20k. I’m 70k in of the 85k raised through private money so I do get the 15k tax free? Or is this different since I’m using private money?

    • Dave Van Horn

      Hi Steven,
      Thanks for the positive feedback. It’s certainly possible to employ a similar strategy with private money, where you borrow enough capital to pay your investor until you refinance or liquidate the property. One of my buddies uses this strategy with student housing.
      Best,
      Dave

  6. Michael Hickmott

    most of the hard money in my area is no more than 65 per cent LTV or ARV,i HAVE RECENTLY tried to to cash out some of my free and clear properties but they won’tgive me any more than 65 per cent. after about 3 deals I’m out of cash again-unless someone out there knows something I don” know. The killer is they want an apprasal and some of the places I buy are in pretty bad shape. Am I missing something here?

  7. Whit Bowersox

    I found this fascinating. Are there IRS requirements for the loan itself? Ive never done a HM loan with draws. So for a fix and flip the “draws” would be considered the expense right? and your proof to the IRS would be the draw schedule, correct? Also, if you obtain a HM loan to acquire the property, can you make a private money loan to your LLC to cover the rehab and essentially do the same thing? or am I starting to split hairs?

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