Why Do Some Real Estate Investors Become Hard Money Lenders?

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First of all, there are many reasons that a real estate investor might shift from utilizing traditional bank financing to using a hard money lender. Many real estate investors start out with a regular bank when acquiring their first few doors. Especially for those moving from property to property while they’re still young, before settling down to raise a family, it makes sense to keep buying properties as an owner occupant. Doing so allows you to take advantage of the more favorable terms (i.e. low down payment and lower interest rates).

Once you hit a certain number of doors, where the mortgage originator can no longer sell off that loan (due to Fannie May or Freddie Mac guidelines), most banks will begin to cut you off from the traditional, residential financing. So, at that point, what’s an investor to do?

Turning to Commercial Financing

With commercial financing, a deal really needs to be a deal in the truest sense of the word. By that, I mean the investor usually needs private or hard money to make the acquisition, then they do the fix-up, oftentimes with skin in the game, only to turn around and refinance with a commercial loan just hoping to get their capital back (acquisition and fix-up costs).

Related: 4 Ways to Use Hard Money & Private Financing for Your Rental Business

If for some reason you can’t sell the flip, or it was your intention to build your buy-and-hold portfolio, the end game of the commercial loan or adding one more property to your commercial blanket may leave you with a deal where all your profit is tied up in the equity of the deal that’s backing the commercial lender. Other than the long term cash flow play, it’s like working for nothing.

Commercial plays, financing wise, for larger real estate deals, such as apartment complexes, mobile home parks, storage centers and new construction developments, tend to make much more sense, especially since real estate values are based more on an NOI (Net Operating Income), instead of nearby residential comps.

If commercial financing doesn’t look appealing to you, there is another option, which is to start lending hard money loans to fellow rehabbers.

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Why Become a Hard Money Lender?

Let’s say you’ve been down the path of building your residential portfolio, and you’ve utilized the traditional bank, the commercial banker and even the local REIA hard money lender, learning a lot along the way.

Take my buddy who locally has over 250 rental properties. When is it time to say enough is enough?

Advantages

Obviously, it takes a certain skill set to be a hard money lender, but most of that skill comes from years of experience. Anyone who’s used hard money knows intimately how it works.

For most experienced long-term investors, with large portfolios of rentals, it’s possible to get a large commercial line of credit at a favorable interest rate.

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

Now, it’s just a matter of “what’s the worst that could happen?” You’ll access the line, lend a secured, short-term, first mortgage, rehab loan in an area you’re familiar with, possibly to a rehabber you know. Even in the event that they default, you could end up with a property at $.60-$.65 on the dollar and just send your own crew over to complete the rehab. But trust me, this rarely happens. Plus, you are the one collecting the high, hard money interest rate, along with some points.

So, whether you plan to graduate to lending hard money by tapping into your own line of credit, or better yet by hitting up your self-directed IRA, it may start to make more sense being the bank.

My buddy said he’d had enough after owning 250 doors, and he’s not likely to own 500. He’d just rather be the bank. Many of us real estate investors don’t think of our hard money lender as being the bank or as being in the note business, but they are.

So, as you accumulate more and more properties, would you ever consider becoming a hard money lender?

Let me know with a comment!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.