SKIN IN THE GAME- WHAT SKIN?

[Toyin Dawodu]

As the number of investors swell, so do the number of "so called hard money lenders" Since the recession, a lot of hard money lenders, or as I will call them, "pretend hard money lenders" ask you this question. How much skin do you have in the game? WTF?

This is the most irritating question I get from these so called hard money lenders. The reason I go to a hard money lender is because I do not want to personally qualify or put my money in the deal. My first question to the hard money lender that asks the question is what do you mean? "Skin in the game?" I found the deal, didn't I? Don't you think my cost of finding a deal that is worth $190,000 ARV and I am buying it for $106,000 is enough skin in the game?

Usually the so called hard money lender will respond, “But I still want you to put some of your money in the deal. At this point, I just hang up on the lender, "gently"

The reason we are investors is to find good deals and have others come to the party and share in our fortunes. So if I am giving a hard money lender some business that makes sense, it is irritating for the hard money lender to be harassing me with "skin in the game baloney." After all, that is why you are a hard money lender. If I wanted to put more skin in the game, I would have gone to my bank.

Please chime in, fellow investors. Do you think these hard money lenders have a right to call themselves hard money lenders when they behave like traditional banks?

I have done over 400 deals, and rarely do I put any skin in the game besides finding the deal. I consider that my skin.

By the way, I found a lender who financed the above recently closed deal by loaning me $120,000. With an after repair value of $190,000, his LTV is 63%. After paying loan costs and other escrow fees, I walked away with $7,545 in my pocket for buying the property. When I exit in 90 days, there's at least another $40,000-$50,000 waiting for me. So why would a reasonable lender ask me to put money down loan to me money on a 63% LTV property? That is my question to you fellow investors. Are these hard money lenders for real or are they just pretenders? Let me have your thoughts.

[Al Wilson]

We are for real. We always require the borrower to be invested in the property. Human nature dictates that folks are more likely to do the right thing if they have something tangible at stake.

[Bill P.]

@Toyin Dawodu You make perfect sense in a perfect world, but most HML still like to wrap themselves in the security that you have real money in the deal. Of course, using historic metrics since the housing crisis doesn't really make sense when you can find deeply discounted properties using true ARV (not hopeful ARV). But human nature being what it is, people are hard to change their processes, but if necessary, remind Chase, Wells Fargo, BoA and the others how well their metrics protected them in 2008 - 2011. If things were different, like properties having assumable loans, investors would have scooped up more properties and the recession would not have been so deep. Hopefully, one day, common sense will pervade in the world of banking.

[Rod Desinord]

Originally posted by @Toyin Dawodu:

Who are your lenders that don't require skin in the game? I am interested :)

[Charlie Fitzgerald]

It's really pretty simple...it's called principles of sound financial practices.  Those lenders that have these principles, tend to remain in business a lot longer than those that do not.  Finding the deals as you say, is not a worry for most of us.  Anymore than finding any other thing to buy is.  Your service to a lender is in the repayment within the terms offered, of the money they are willing to loan to you.  The faster you can do that, and the more times that you can repeat that process, the more valuable you become as a borrower.  The vast majority of credible hard money direct lenders are also in the asset acquisition business, just like you.  Some of us buy these assets in auctions and off-market transactions by the 100's in pools from other lenders, acquisition company's and investors.  Other not so credible hard money lenders acquire them from investors like you that are under capitalized going into their deal, borrow too much money from the lender at terms that they find themselves unable to repay timely, and the lender forecloses on the property and the investor loses it.

The beauty of the capitalist environment we all enjoy in the USA is that there are an abundance of different service providers in this hard money space, with a vast number of  different programs and terms available.  So, most everyone can find the service provider they want to have, on the terms that they feel best suit them.  Lenders, can do the same thing when it comes to borrowers...and we do.

Hope this helps.

[Cal C.]

Any lender who doesn't require some of your money in a project is playing a dangerous game with the odds heavily stacked against them.  That is especially true for small lenders because unlike the banks they will not have the luxury of a taxpayer bailout.  

No matter what your intentions are or how excellent a track record you have stuff happens.  

[Toyin Dawodu]

@Cal C. I thought the price of charging investors high interest is assuming the risk that stuff happens. At LTV of 63%, the lender has enough protective equity to make more should the borrower default.

[Toyin Dawodu]

@Charlie Fitzgerald, @Rod Desinord,@Bill P., As an investor, if you spend $5,000 locating a deal that has almost $80,000 equity, and the lender has the first priority to that equity in a default situation, should that not constitute a skin in the game? 

Traditional lenders should require skin in the game in case of default. because their skin in the game is the equity the borrower puts down as downpayment, which is meant to protect the lender, since the property is now leveraged to the tune of 80% and the 20% put down by the buyer.

As an investor, I came in with equity by finding and buying the property way below market and only asking for a loan that is 40% less that the market is worth. what other skin do I need? So a hard money lender who knows what he is doing should have no problem loaning at 60% LTV with zero down payment or any other "skin" from the investor.

[Charlie Fitzgerald]

Future potential value, that may or may not be gained at some point, is not equity.  It's speculation of potential gain, and like any speculation, can go either way, positive or negative, given the timeline and market conditions. 

[Cal C.]

What rate are you paying compared to what HML who required skin in the game were offering? Isn't it pretty similar. I mean you are not paying 5% higher or anything like that where the risk of no skin in the game is covered over and above the normal hard money loan? That would mitigate to some degree the increased risk.

But here is my real issue-Somehow more stuff happens when someone is not invested in the project.  Face it, most people are much more willing to walk away from something when they have zero into it than when they put their own hard earned money into it.   It is human nature.  

You are looking at the reward not the consequences.  A smart lender will factor in human nature into the equation and realize that skin in the game increases the borrowers incentive to get things done and to overcome obstacles.  

One thing mentioned by @Charlie Fitzgerald some HML are actually hoping that the borrower will fail in order to pick up a property and thus will be more willing to lend to someone with no skin in the game. However, in your case, since you walked away with cash I doubt that is the HML's intention, unless of course the HML is stupider than I think they are. :)

Bottomline- lending is a calculated risk, anything the HML does to lessen their risk (requiring skin in the game certainly does that IMHO) will increase their chances of success.

[Account Closed]

As a HML in Arkansas before I will do a deal I ask for the Credit score. If the credit score is above 700 the negotiating continues. I am willing to loan the purchase price but not the repair costs or any transaction costs. I personally vet the property in it's current condition and evaluate the estimate to repair. If I agree with the numbers it is a deal.

However, if lending to a homeowner who is having some temporary hard times I insist on a 3/1 income to expense ratio in addition to evaluating the property. I never lend 100% of the home value.

[Toyin Dawodu]

@Charlie Fitzgerald , As an investor, I don't buy based on future potential. The day I buy, I have build in equity. For example, the property I just bought for $106,000. I had investors willing to give me $139,000 which is 92.66% of its current market value of $150K. That is still $33,000 profit to me. To my hard money lender who loan $120,000 , its 80% of the as is value and 63% of ARV. So there's no speculation on my park.

As investors, we make our money on the day we buy, and take the profit when we sell. My position is my ability to generate money for the lender in form of loan fees, interest and other junk fees. As the investor, I am still the source of their income. 

[Toyin Dawodu]

@Account Closed,  Your analysis of each deal makes some sense, but what does FICO score have to do with the deal if you have enough protective equity. What hard money lenders fail to understand is that they are loaning against the asset, only the asset should be required to qualify not the operator or the so called "skin in the game"  

[John C S.]

I love this conversation guys keep it up.  

[Toyin Dawodu]

@Cal C., Since I did not put any money down, the interest rate does not matter, as long as I come out whole at the exit. My return is infinite. Just to show you that we should be glad we live in the land of opportunity and choices. The loan I got on this deal is structured as follows, here's the term sheet from the lender. I pitched this deal to several of them, but one smart HML took the deal because it made a lot of sense. .

TERM SHEET FROM LENDER   

(I blanked out some information for privacy purposes)

Toyin

We are good to do the following on 5XXX J**A****M St.  

1.Loan amount $120,000.00

2.10.5% interest only, payment $1,050.00 per month $34.52 per day

3.No Prepayment penalty

4.Lender origination fee 2pts or $2,400.00

5.Loan Documents and disclosures $450.00 + $75 wire funding fee

6.  2 years.

I need:

1.Escrow estimated costs (GFE)

2.Title company and escrow company contact info and order numbers

3.Vesting information and Tax Id for corporate vesting

I can do loan docs and disclosures right away with this info above.

Prior to funding:

1.Property Insurance naming XXXX  Lending XXXX. as loss payee for loan amount

2.Corporate Resolution naming you as member with rights to bind corp to real

estate purchase and loan.

I hope this answers your question, If you need the name of the HML, please contact me directly.

This is the second loan the HML has done for me in the last 30 days.

[Chris Martin]

Regarding "I have done over 400 deals, and rarely do I put any skin in the game besides finding the deal." Good for you.

I assume your 400 deals were largely profitable. Why are you messing with HML, who you clearly don't like dealing with, when (apparently for the principal of the matter) you don't like their rules? It's starting to sound like you can't put money in a deal. That's a real red flag for most lenders.

What you fail to see is the risk a lender faces. Say, god forbid, you get hit by a bus as you are focused on counting your $7,545 that you took out of your pocket and started counting as you crossed the street. Will the lender be able to sell the property for $190,000? I think not. I'm sure you have a life insurance policy, with the lender named as beneficiary, in case you don't "perform"... right?

[Toyin Dawodu]

@Chris Martin, The point I am trying to make is that HML should not pretend to be HML when they have regular bank requirements. This conversation is for investors who may find themselves with little or no money and drops out of the game because some HML says to them, "what is your skin in the game" Major Wall street investors never use their own money. Yes, I have my own money, and I sometimes pay cash when I need to tie up a good deal. It's not really about my money, its about choices. Thank God we live in America where we have several lending options.

HERE'S MY ANALYSIS OF THE DEAL-- So you can see there's little or no risk to the HML

As an investor, I don't buy based on future potential. The day I buy, I have built in equity. For example, the property I just bought for $106,000. I had investors willing to give me $139,000 which is 92.66% of its current market value of $150K. That is still $33,000 profit to me. To my hard money lender who loaned $120,000 , its 80% of the as is value and 63% of ARV. So there's no speculation on my part.

As investors, we make our money on the day we buy, and take the profit when we sell. My position is my ability to generate money for the lender in form of loan fees, interest and other junk fees should be the main factor. As the investor, I am still the source of their income. 

[Chris Martin]

There is no question that you create value. But until you execute by finding a buyer for your property, the current market value for your $106,000 purchase is $106,000. Saying that it is worth $150,000 now is like saying my FB (Facebook common stock) purchase today at $106/share is worth $150 now.  It isn't. Maybe later... but not now.

In your 400 deals, have you ever lost money? Got a "bad deal?" I have. And I would suggest that the argument you make is a turnoff to lenders. You didn't answer the question about your life insurance policy. You are short changing your lenders if you were unable to perform... IMO.

If it is worth $150,000, why not just sell it today for $150,000 and be done. Then I would agree that the value today is $150,000, because that is the value to your buyer.

[Mike Arias]

You can't blame a lender for not wanting to lend to you against their guidelines. They are not "pretend lenders" that's just the way they choose to run their business.  You want to do business with no money in, then find someone that's willing to do that. 

[Al Wilson]

We are VERY far from bank requirements. You are talking about apples and oranges. Good luck.

[Toyin Dawodu]

@Mike Arias, I am not really blaming the lenders, I just want them to let the world know that they don't qualify as HML. Hard money lending is asset based. Period. Not Credit or skin in the game driven.

[Chris Martin]

I hear what you are saying, but I still contend your "asset" is at today's value. I've been down this path on a property we (my company) purchased that was 58% of the value of a current appraisal. We chose to buy w/o any lender (private or otherwise) in our case because of some property impairments. Not that you will answer my question, but did you provide a current appraisal that identifies your property value as $150,000?

I'd contend that asset based lenders have always been based on liquid or near-liquid asset valuations. Accounts receivables haven't even been covered by asset lenders... that's where A/R factor lending/borrowing comes in. 

What we (my company) do/did is add capital as additional collateral. You could put up an apartment or some other (liquid or not) collateral to get the results you are looking for.
My 2 cents.

[Jay Hinrichs]

@Toyin Dawodu I echo the same sentiment if your that experienced which I have no reason to think your not.. why on earth are you talking to a HML you should be ONE. !!

with that kind of success rate and cash earnings you would easily qualify at a local commercial bank... I would think...

I think its disingenuous to lead the beginners here on BP thinking that HML should be NO money down loans..

Granted pre 08 that was the norm.. I was a fairly decent size HML I had a 50 million dollar company. and we not only did no money down we paid profits at the close of the loan.. Now it seemed ok at the time but as we came to find out it was STUPID... But for the 2000 + loans I did from 2000 to 2008 it seemed like the thing to do and it would never stop.

So fast forward to today any lender that lived through that knows that folks with none of their own cash in the deal gives you another level of risk. and the lender is not an asset manager they don't want the asset no matter the equity protection..

So for the BP beginner which is the vast majority of the audience here.. they are going to be looking long and hard to find that no money down HML and if they do I will bet dollars to donuts that lender was not lending pre 08... and has only known good times.

Can experienced flippers with extensive track record like you get no money down HML absolutely they can... but not first timers and generally not your first few with the particular lender.. I know HML that will do no money down but those are with very well established clients. Who also have some reserves and wherewithal.

That's my take on it, and I think that pretty well sums up the industry today form my vantage point.

Last little tidbit lending is regionalized so a prime CA flip deal may be OK for no money down  just like a prime Portland Oregon deal... But in other areas of the country were RE is not as liquid and the markets not as robust.. Cash into the deal is a must

[Mary B.]

Interesting topic, good points made on all sides of the fence - Bump.

Kudos,

Mary

[Boyd McClean]

Hard money lending can be whatever a borrower and lender decide on. This can be credit or asset based or a combination of both as well as a provision for SAM.

As a HML I find out what the borrower is trying to achieve and design a loan program around his needs, not my needs. I always give him/her 2 choices. Borrowers tend to look at the interest rate rather than the YIELD.

I eliminate a lot of borrowers when I tell them they get money only after a phase is completed, inspected and approved not before. Interest rate charged should be a reflection of risk. Does not a subprime borrower pay more for a loan than someone going conventionally.

[J Scott]

Originally posted by :

HERE'S MY ANALYSIS OF THE DEAL-- So you can see there's little or no risk to the HML

As an investor, I don't buy based on future potential. The day I buy, I have built in equity. For example, the property I just bought for $106,000. I had investors willing to give me $139,000 which is 92.66% of its current market value of $150K. That is still $33,000 profit to me. To my hard money lender who loaned $120,000 , its 80% of the as is value and 63% of ARV. So there's no speculation on my part.

Wait, you haven't factored in the EXTRA costs to the lender should you not perform:

- Legal fees for foreclosure proceedings

- Extra holding costs during foreclosure process

- Risk of property deteriorating during foreclosure process

- Risk of pissed off borrowers (because he's being foreclosed upon) doing more damage to the property before the foreclosure

- Risk of market decline in the time period during which the borrower has defaulted and the lender is trying to gain ownership or recoup costs

By the time the foreclosure is completed, that "80% of the as is value" could actually mean the lender has more than 100% of the as-is value invested into the property.

In addition, the lender has now invested a lot of time and effort into the property, meaning his total investment could be MUCH MORE than the as-is value...and potentially even more than the ARV.

There's a reason that banks require a downpayment -- they are smart when it comes to their investments. While you think that the higher interest rate covers the extra risk to the hard money lender, that extra 5-10% you're paying hardly covers all the risk (presumably, if you're going to an HML, it's because you or your business is higher risk than what the traditional banks are interested in exposing themselves to). For that reason, the HML, wants the borrower to share in the risk.

Not only does it seem perfectly reasonable to me, every successful HML I know has this requirement.

Like @Chris Martin mentioned, if you've done 400+ deals without having to put money in, but now you're in need of an HML, that would be a red flag for me. Even if you've only averaged $10K per deal, that means you're business has grossed over $4M...even if you only have a portion of that left, you should be able to use it to collateralize a good bit of money from non-traditional lending sources.