9% interest as a private leander
Flipper/ Wholesaler · Roswell, GA · Member since 2013 · 89 posts · 61 votes
I'm a new real estate investor and have been spending some time over the last few months to learn and build up my network. I met an investor in my local REI club that needs some additional private funds to grow his business. Right now, he is only looking for an additional 50k which would seem to be a perfect starting off point. My question is around the terms he is offering an wondering if there is anything else I should be asking for.
50k, 9% interest amoritized over 15 years with a ballon payment due in 5 years. The loan would be secured by a property that he plans to buy, rehabbing and holding.
Does this sound like a good opportunity? Should I also be asking for any points up front? I was also thinking of reducing the balloon payment to 3 years so I can get out quicker if I decide I need the money for my own business. In doing my due diligence on this type of loan, I'm assuming I would treat this as if I were the bank and ask for the paperwork to see his track record and assumptions on the investment opportunity?
Regards,
Kyle
"… I'm assuming I would treat this as if I were the bank and ask for the paperwork to see his track record and assumptions on the investment opportunity?"
Don't treat this as if you were the bank and ask for paperwork, @Kyle Kufeldt Treat this as if you were loaning money to a stranger, which it sound's like you might be. Anonymous paperwork might satisfy a bank. They base their loans, in part, on LTV, appraisals, and credit reports, and can spread their losses over many loans. You can't.
Get in a car and drive around with your borrower, looking at his current and previous properties. No experience, no loan. You don't want anyone learning on your dime. Go to lunch and get to know him a little. Are you comfortable loaning him your money for several years? Do you have a sense he cares about paying you back? Has he borrowed from others? Who? Call them.
Have you discussed your borrower's exit strategy with him? If he doesn't have the cash now, how will he have it in 5 years? Will he sell his property? Refinance? Pay you sooner from another sale? Don't assume he knows. Blank stares and raised shoulders are not exit strategies.
9% interest amortized over 15 years and due in 5 sounds like a great deal for your borrower. Do you understand how much the monthly payments will be to you and how much he will owe in 5 years? If you are comfortable with that, then fine. What if he's late or defaults? Where are you getting your loan documents?
Since you've never done this before, you'll want to either use an experienced broker to help you or, preferably, a lawyer experienced in lending. A local hard money lender might be able to originate this for you as well, and perhaps recommend a good lending attorney. Don't rely that your borrower's paperwork will serve your interests.
If you are happy with a 9% return, I suggest you make it interest only for as long as you are comfortable. Interest and points are regional and I don't know what your market, or this borrower, would bear. Most concerning is your comment,"…he is only looking for an additional 50k…." Additional?? Does this mean he already has a lender in front of you? Under no circumstances, with your experience level, do you want to loan in second position.
After you've checked out your borrower, the property, and the paperwork, make sure this is a first position loan only, secured by a specific property, with a lenders title policy, and adequate hazard insurance. The process is remarkably simple. Just be careful and get good advice from local professionals.
Good luck, Kyle.
Jeff
From the perspective of a person who borrows a fair amount of money, this is a good deal for the borrower. 9% will get you customers all day long, even if you add a few points at the front of the loan.
To protect yourself you would want to hold the first position mortgage on any property you fund. If your borrower is using a conventional mortgage, you'll have to sit 2nd position. Not a great place to be, but better than an unsecured loan.
Ask for any piece of paperwork that you think will help with the due diligence. Your goal is to make money and help his business grow enough to cover your loan and balloon. Bank statements probably tell the best story. Cash (in your account, not waiting to be collected) is king.
I view any relationship as the ability to get a win/win situation for all parties. If you are comfortable with 9% as a return, plus points, this should be a solid deal for you.
As Aaron indicated, 9% will ensure your money is lent out.
My experience has mostly been as a consumer of loans, but I have made a small number and am no gearing-up to be able to write mortgages from my RRSP (like an IRA).
The five year term is a bit long {this coming from someone in a country where 5-yr is the most common mortgage term}. I tend to prefer shorter terms (1-3 years) with the option of renewal / extension ... especially with an unproven borrower.
If you are to be in second position, I would suggest looking for an interest rate that is a little higher (12-14%) and a term <= 2-years and never more than 3.
Also, determine all your costs upfront (legal to draw up the mortgage, third-party servicing fees, trustee fees {if lending from a registered plan}, etc.) and build them into the mortgage. viz. say your costs to create, register, and service the mortgage over its term are $2500.00. The borrow would draw 50,000.00, but the amount on the note would be 52500.00. Do this separately from any points you charge.
Thank you @Aaron Montague and @Roy N. for your feedback. Those are exactly the type of things I was looking for.
"… I'm assuming I would treat this as if I were the bank and ask for the paperwork to see his track record and assumptions on the investment opportunity?"
Don't treat this as if you were the bank and ask for paperwork, @Kyle Kufeldt Treat this as if you were loaning money to a stranger, which it sound's like you might be. Anonymous paperwork might satisfy a bank. They base their loans, in part, on LTV, appraisals, and credit reports, and can spread their losses over many loans. You can't.
Get in a car and drive around with your borrower, looking at his current and previous properties. No experience, no loan. You don't want anyone learning on your dime. Go to lunch and get to know him a little. Are you comfortable loaning him your money for several years? Do you have a sense he cares about paying you back? Has he borrowed from others? Who? Call them.
Have you discussed your borrower's exit strategy with him? If he doesn't have the cash now, how will he have it in 5 years? Will he sell his property? Refinance? Pay you sooner from another sale? Don't assume he knows. Blank stares and raised shoulders are not exit strategies.
9% interest amortized over 15 years and due in 5 sounds like a great deal for your borrower. Do you understand how much the monthly payments will be to you and how much he will owe in 5 years? If you are comfortable with that, then fine. What if he's late or defaults? Where are you getting your loan documents?
Since you've never done this before, you'll want to either use an experienced broker to help you or, preferably, a lawyer experienced in lending. A local hard money lender might be able to originate this for you as well, and perhaps recommend a good lending attorney. Don't rely that your borrower's paperwork will serve your interests.
If you are happy with a 9% return, I suggest you make it interest only for as long as you are comfortable. Interest and points are regional and I don't know what your market, or this borrower, would bear. Most concerning is your comment,"…he is only looking for an additional 50k…." Additional?? Does this mean he already has a lender in front of you? Under no circumstances, with your experience level, do you want to loan in second position.
After you've checked out your borrower, the property, and the paperwork, make sure this is a first position loan only, secured by a specific property, with a lenders title policy, and adequate hazard insurance. The process is remarkably simple. Just be careful and get good advice from local professionals.
Good luck, Kyle.
Jeff
You should also consider your position as a new Investor who needs to get himself educated. If you just lend money like this, you're not going to learn much. It might be a better investment for you to take a piece of a flip and play the role of financing partner, visiting the site and have everything explained to you as it rolls out. This way you will "live" the deal, the only way to truly learn the business.
This will serve several purposes simultaneously;
1. Educate and inform you about investing.
2. Get you a higher premium for your money 7 -10% for the duration of the flip with a couple of points upfront.
3. Network with real investors.
There's not much other than trash for around $50k in Roswell, but you will find a good deal elsewhere in S. Atlanta for your investment. The median for entry level home purchase in Atlanta is around $130k, so funding per project ideally comes in around $90 -100k
Don't even consider working with another newbie, one truly is enough for any deal. Find an experienced Investor who has a reputation to protect. You can do this by going one of the many REI meetings which are strong in Atlanta and there are several every month in Roswell.
Finally, just to be sure you're on the right track, post the financials and terms of your deal on BP (no address necessary) and we'll be happy to point out any potential pitfalls, we're very good at that here.
You're in a great spot with the choices you have and best of luck with it.
Speaking form my experience when I'm borrowing funds I pay for all upfront cost. This allows my private lenders to make the points as stated in the agreement.
Stick with the first position with new investors. But if you do take second I would be asking for more % on the loan.
Also 3 year balloon is what I find works well.
@Jeff S. Thank you for your comments. They are much appreciated. You gave me many things to consider and will definitely be bringing these points up with the borrower.
@David T. The property is in Atlanta, near Grant Park but a bit outside of where most of the investors are putting there money today. The borrow believes that the trend will continue and this property will appreciate nicely in 3-5 years. He is normally a flipper but wants to buy and hold on this deal and hence the reason he needs additional funding.
I am interested in proposing a partnership on this deal instead of a straight loan to cut my teeth. If he is mainly looking for funding, what kind of proposal would be a good alternative to a straight loan? Would something like a 70% - 30% split of the initial investment and then a 50% split of expenses/profits after that make sense?
There are many people here who know a lot more about the Grant Park area than I do, but I will tell you that appreciation or whatever you like to call it is not a reason for investing in any property, even though it seems to be a way of life in California.
The only way I would invest in anything is based on what I get back over the immediate term. In other words, focus on current rate of return and any upswing in value is a bonus.
As for how you structure your deal; don't be getting yourself into anything you can't get out of.
My company borrows money in first position at 9% interest only all the time. Its a number we can make cashflow in our market of Kansas City and is also a very solid return for the investor.
We always put our investors in 1st position and give them a guarantee against the rest of our company and make them an additional insurer in case there is an insurance claim. 9% return is a legitimate number for an investor to make work in a cashflow market, but the big thing to consider is if they will be able to make a margin on top of your return and what you will get if things go wrong.
Having some extra equity on top of your loan is very helpful, but having a guarantee against other assets in my opinion is more important. My reasoning is that if a tenant trashes the unit so much that the property is worth less than your loan, or something else hurts the value it's tempting for the owner to just stop making payments and let you foreclose. Hopefully the person your working with would want to protect the relationship but it sets up a bad incentive in that type of situation without the extra guarentee which is why we always guarantee our loans against all our companies assets.
As others have said, 9% is a good deal for the borrow but I'm not so sure about the investor. I haven't looked at hard money in awhile but not too long ago, hard money, even short term was more than 9%. I have to think that you can get a higher return on a 5 year note.