July 17, 2020

The Hard-Money Mindset That Is Weakening Your Portfolio

By Charles Sells

The real estate industry stigmatizes hard money and private money lenders, and it is preventing thousands of investors from generating the wealth and returns they are fully capable of creating. Although private money was once (justifiably) considered expensive and sometimes predatory, those days are long gone. Before you lose one more cent, isn’t it time to change your mindset?

What if I told you that it is you preventing yourself from really experiencing growth in your real estate portfolio and business? You would probably be annoyed and shocked. However, the odds are good that some long-held misconceptions about private money are creating barriers between you and the success that today’s real estate market holds.

I’ve listed three mindsets about hard money that are just plain wrong in today’s lending environment. If you believe any of these, take a minute to adjust your thinking and get ready for some serious growth in your portfolio.

Misconception #1: “Using hard money means giving up returns.”

I meet so many investors who tell me they think about hard money this way: “Why give up 8-10 points (or more) if I have my own capital?” I answer them simply, “Why wouldn’t you do that?”

Consider this example: Investor Bob took $500,000 and invested it into five different opportunities at $100,000 each. Each deal was worth far more than $100,000, but Bob was able to spread his money out and dramatically multiply his returns by using leverage to make up the difference on each deal. Investor Bailey, on the other hand, took $500,000 and invested it in just one deal equivalent to any one of the five Bob invested in. Both investors made money, but Bob’s buying power and returns were nearly five times greater even after he paid back the loans.

Misconception #2: “Private lenders want me to fail.”

Probably one of the biggest hurdles you will face in terms of accessing hard money is experience. If you don’t have it, you may have trouble getting a loan. But that is precisely because your private lender does not want you to fail. Furthermore, if it appears likely you will fail, a private lender probably will not want to be part of that process.

When you work with legitimate private lenders, they will likely know even more about your investment area than you do. They will request appraisals (which they will expect you to provide at your expense). They will demand plenty of equity remain in the deal after financing, and they will require you to prove real estate is not just some new hobby you picked up last week. In fact, if your private money lender pitches you on taking out a loan using verbiage resembling this familiar refrain, “Invest today, using other people’s money, in your spare time,” then run!

With an experienced, reputable hard-money lender, your loan rate will often depend on your ability to prove you have experience in successful investing and liquidating in the past. In most cases, three successful deals will get you in the door with a pretty good rate. Does this mean less experienced investors are out of luck? Not necessarily, but usually you will need to partner up with a more experienced party or work with a third-party servicer who has already established relationships with hard-money lenders.

Misconception #3: “My market’s hard-money lenders are too picky. I’ve tried to finance dozens of wholesale deals and they won’t bite.”

One thing that will stop an investor in their tracks is trying to finance wholesale deals. If you have been finding yourself against a brick wall as you attempt to finance one wholesale deal after another that you found in your meetup, then the problem is likely that you are trying to convince your lender to fund a deal that isn’t worth doing. The heart of your problem is likely your source of inventory: wholesalers.

Now, novice investors in particular, pay close attention: There is a type of investor called a wholesaler, but you will probably never meet a truly legitimate one. In the past two years, the concept has invaded our industry that absolutely anyone can be a wholesaler and make a fortune at double-closings. In reality, most wholesalers have no legal right to offer, list, sell, or negotiate on behalf of the legal owner of the deals they are trying to do. I do not mean they need a license, either. I mean the contracts on these deals are so convoluted and have been assigned so many times that often neither the wholesaler nor the seller has any idea which way is up anymore. Good news: A private lender is not going to want any part of that “ghost inventory.” Private-money lenders seldom loan on wholesale deals, but that does not mean those lenders are unreasonable. They could be saving your skin.

Where Viable Deals are Located and How to Acquire Them

So, now that we have exposed some of the barriers to hard-money financing, let’s talk a little bit about how to find the volume and quality of deals that can turbo-charge your investing power.

Inventory is a hot topic these days because it is very tight in many markets.

When other investors and colleagues ask me how I manage to achieve such consistently high margins on our investments, I tell them, “Stay off the beaten path.” Keeping clear of the latest, greatest investing fad will give you the best odds of finding good deals and gaining high returns.

In my company, we have three “Inventory Truths” we use to make sure we are spending our time looking for leads in markets that will work for us and our investors. Here they are:

Inventory Truth #1: Being the big fish in a small fund is better than the alternative.

You will hear a lot of investors say they like to operate in really big, hot markets because there is just more success in the market and they feel that increases their odds of being successful, too. The idea is not without merit; you’ve probably heard the saying, “A rising tide lifts all boats.” However, we’re not in a maritime business. In fact, we’re landlocked. We have different rules in real estate.

For nearly all investors, the best option if you want to be in the business of flipping is to get out of your own backyard. Pick your market based on metrics rather than geography. When I choose a market, I never make a move until I know:

  • My realistic margins
  • How long it will take to establish a good network
  • The duration of time I can reasonably expect to dominate the inventory in that market

Knowing these things gives me a degree of control over my investment capital I will not have in a market where I am a small player with no influence over market trends.

Inventory Truth #2: Fact-checking “conventional wisdom” will open many doors for you.

Many investors have never seriously considered using private money because they get their deals at auction. They believe you cannot buy auction properties using private money. That is false. Depending on your state, you might even be able to use private money at the county auction! Find out the truth for yourself before writing off this incredible resource.

Don’t believe me? Here are two examples as evidence:

Example 1:

My wife and I bid at auction and won a beach house on Hubzu.com last August. We were literally binge-watching something on Netflix one night and placing online bids! Our highest bid won around 10:30 p.m. on a Sunday night. We put $15,000 down in earnest money (on a credit card), reached out to a private lender to obtain financing, put a $400,000 deposit down and funded that deal in less than two weeks at 8 percent. The private lender funded us $1.95 million (including repairs).

On Aug. 26, 2019, we sold that investment for $3.55 million, giving us a net profit of $1,292,369.06. We used private money on that deal and generated a huge windfall.

Example 2:

In my home state of South Carolina, you do have to bring cashier’s checks to the county REO auctions. Investors often believe this means using private money is not an option here. However, if you are the winning bidder, you only have to provide them with a 5 percent deposit. That meant that last month, for example, my wife and I bought a home at the county auction for $403,000. The as-is value of that home is about $575,000, meaning there is already plenty of equity in it from the start. We knew we would be able to get the deal funded. The day of the auction, we only had to provide them with about $20,000 in cashier’s check. We then had 30 days to fund the balance, which was ample time to get a private lender involved to fund the deal.

Now that the deal is funded, we have two options: flip the property for about $795,000 (based on its after-repair value) or rehab it ourselves and hold it as a short-term vacation rental. In our market, it would likely generate about $80,000 a year as a short-term rental, making it a very valuable property. Our lender realized this, and that is why we were able to finance the deal.

An Important Note: It is important for readers to realize that when you buy at auction, you commit to the purchase before you have the financing. You must be very sure of your numbers and that the appraisal will come in right or you may find yourself on the hook for a deal you cannot finance. In this circumstance, you would need cash reserves to handle the rest of the acquisition yourself.

Inventory Truth #3: You do not need to rely on wholesalers.

That’s right: I am giving you all this information to drive home the fact that you can stop relying on wholesalers and start using private money in your real estate business! They are one of the biggest reasons you had those misconceptions about private money and, as a result, have been leaving money on the table for years.

In closing, don’t be scared of private money. You would be surprised at how easy it is to qualify and how competitive the rates actually are. Private money is a powerful tool to leverage more deals and bigger long-term profits. If you have been considering private lenders and haven’t yet tried, dip your toes into the shallow end of the pool and give it a try. These lenders don’t bite, and you will be shocked at how well they work to help you be successful and more profitable.

Charles Sells is Founder and CEO of The PIP Group. Sells has been investing in distressed real estate for himself and on behalf of more than 700 investors worldwide for more than 20 years.

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