Wannabe HML

[Account Closed]

about to get out of the service and at a crossroads. I have saved up a pretty nice chunk of cash that I want to put to work. I'm trying to decide between buying my own rental properties and being a landlord, or giving out private loans. I feel being a hard money lender is going to make me more cash quicker which would be my goal. Anybody have any experience lending and have you had any success?

[Kevin Bellavance]

@Account Closed

When it comes to which strategy makes cash quicker, it really depends.

Just look at it this way :

Hard money lenders average 10-15% interest rates, sometime below this. Here's some numbers crunching with a 10 000$ loan at 10% for 5 years:

1) Borrower pays Capital + Interest : 
Payment you get monthly - 211.38$
Over 5 years, 60 x 211.38 = 12 689 $ 
So you now have 12 689$ from a 10 000$ investment, on a 5 years period.
Your annual ROI is 4.88%.

2) Borrower pays Interest only + Balloon payment at the end (full capital amount)

Payment you get monthly - 83.33$ (10% / 12 x 10 000$)
Over 5 years, 60 x 83.33 = 5000$ + 10 000$ = 15 000$
So you now have 15 000$ from a 10 000$ investment, on a 5 years period.
Your ROI is 8.45%.

3) Now what happens if you buy a rental property, let's say a SFH at 100 000$ that rent for about 1200$ a month and assuming 50% of the rent goes to maintenance, capex, taxes, etc which is the average cost of ownership (most of the time expenses are less than that). For the example, you put 20 000$ down.

Tenant pays rent

Payment you get monthly - 1200$

Expenses - 600$

Payment of the Mortgage (bank loan) of 80 000$ at 5% interest (which is higher than the market nowdays)  over 25 years - 465.28$

Net rent : 1200 - 600 - 465.28 = 135$

Over 5 years, 60 x 135 = 8100$
So you got 8100$ from rents, your mortgage went from 80 000$ to 71 000$ (+ 9000 in equity) and your asset appreciated for 1% per year (which is a low general market inflation) and is now worth around 105 000$ (+5000 equity). 
You have 8100 + 9000 + 5000 = 22100 in gain over 5 years on a 20 000$ investment.

So you now have 42100 from a 20 000$ investment on a 5 years period.

Your ROI is 16.05%. And THAT, is with poor market condition such as 50% of rent going in expenses which could easily be only 30-40%, 5% interest rate which is almost twice as high as what you can get nowdays and appreciation of 1% which could be 2%-5% in some markets.

You see, and that is my opinion (I'm only a business student with not much experience in Real Estate but a lot of theorycrafting), buying a rental property might be a smarter and ''get rich quicker'' choice here.

From a financial analysis point, you get more money per dollar invested by buying it yourself instead of loaning your money. You have the leverage effect with the property which you don't have with a loan. For that same 20K invested, you can have an asset worth 100K and therefore, the appreciation is based on 100K, not 20K. Also, with a loan where the borrower pays capital + interest, the capital payment make you lose interest money since it applies to a lesser amount than the 10 000$ used in the example.

Also, if you refer to flip123.com (which is the website of a previous BP's podcast guest), he was able to maintain ROI over 300% while flipping houses over several years (and also made a million in profit over 50 flips).

If I were you, it would be a no brainer. Rental or flip or both. Personally, I believe HML is for retired people, perhaps former RE investors that still want cashflow but don't want the RE management that comes with it. Maybe RE investing is more work than HML, but the payday is bigger too (from what I think). Also, maybe you can diversify, and have some rentals, do some flips and do some HML but here's one final quote taken from Grant Cardone (he owns 350 millions worth of real estate....and a private jet ah ah ah)
''I don't believe in diversification. Find the right investment vehicle and go ALL-IN.''

Well, hope this helped you!

Regards,
Kevin