Hard money lending leverage.

[Juan Martinez]

I'm looking for a deal for my first flip, my lender tells me, won't give the loan unless he makes sure the deal I'm getting in to is good, also saids once we buy the property he will provide funding as the project is being completed, using a schedule of values. This sounds great! since recognizing a good deal is one of my biggest worries, also offers me General Contractor they usually work with. But the whole thing sounds a little too good. I would like to know if this is a common practice in the Hard Money lending world. Any experience, advice o recommendation would help.

[Dan DiFilippo]

Originally posted by @Juan Martinez:

Interest rate would be 10-12%

Yeah, so you're borrowing hard money.  Not necessarily a bad thing, but take an accounting of your deal.  Remember that financing is extrinsic to the fundamentals of the deal.  You might have a homerun deal that you just can't do because you don't have the ability to finance it at a low enough cost.  Here's an example of flip using somewhat simplified numbers to help illustrate the point.

$100,000 Purchase Price
$50,000 Renovations Budget (including, we will suppose, six months of carrying costs from close to close)
$200,000 ARV

So we've got $50,000 in equity to build.  But then we account for the disposition.  I advise investors to just underwrite for 10%.  You might end up under, but 10% would be prudent.  After you consider brokerage fees and closing costs that you may have to pay as a part of your deal, plus maybe even a couple of small repairs and maybe throw in a home warranty, 10% is probably a good number to work with.  So your $200,000 sale will already only be worth $180,000.  Now so far, these figures are true no matter how you finance it.  These numbers still only pertain directly to the deal itself.  This is your starting point for when you go to analyze it in terms of your ability to undertake it.  If you are buying cash, then your deal will pretty closely resemble these numbers.  If you're financing in some way, we will need to account for the ways in which this will impact your costs.  If you're borrowing hard money, then we need to look at the expense profile associated with that form of financing.  We can typically presume something along the lines of a $2,000 fee associated with the loan origination, as well as 2 points as a fee, and the interest will be, suppose 12%.

Let us suppose that your lender is willing to finance 80% of the total project cost.  That means that your loan amount will be $120,000.  This is the basis upon which your points and interest will be determined.  Given this, we can determine your financing costs to be $2,000 from the fixed fee, $2,400 from the points, and if you are in and out of your project in 6 months, then you will pay 6%, or $7,200, (12% annual rate means each month is 1%) in interest.  Thereby, total financing costs come to $11,600.  So the project may net you $30,000, but your cost of capital is $11,600.  So really you stand to make $18,400 in this deal.

Again, these are rough numbers, so yours may be completely different.  This deal as I've wrote it is actually not that bad.  The Capital Share Of Productivity (meaning the $11,600 versus the $30,000) is 38.66%.  That's essentially the lender's cut of your project.  It seems like a lot, but remember it gives you the ability to make $18,400.  You might consider that the deal may be worth it even if the Capital Share is 80% and you were only left with 20% of the net profit.  Because it's still enabling you to play with someone else's money in order to make money.  You just have to weigh the risks associated with the project overall against the return that is in it for you at the very end of the day.  It's all a decision that you have to make based on your risk tolerance and your opportunity costs.  Just make sure you are applying the right formulations in your analyses.