Cash vs Hard Money Lender

[Ben C.]

Hello, What is everyone's thoughts on using cash vs HML (9-12% with 2-3 points)? Much easier to make cash deals work (from acquiring properties easier to having a lot more room for margin). Seems like you are doing the same work for much less $ profit with HML. Also, if you go with HML how does it work? Once you find property you send it to them and they very quickly let you know if you can fund and then can make offer? Look forward to a productive and educational conversation.

[Jeff S.]

This is the classic debt or equity question, @Ben C. , best answered by an example.

You have $100k in the bank earning a 0% return. You find a property that will cost $100k. This property can be fixed up and sold, earning you a $10k profit when you sell it in exactly one year. Your annualized return on investment is Profit/Amount Invested = $10k/$100k or a 10% ROI.

The risk here is that if you fall on your face, you will lose $100k.

Leveraging the same deal:

You put $25k down and borrow the remaining $75k. You make the same $10k on the property but your return is now $10k/$25k or a 40% ROI. Notice that putting 25% down is 4 to one leverage. That is, 1/25% is four. Four times the unleveraged 10% return is 40%. The dollar return on this one deal didn't change.

If you can invest your remaining $75k cash in three identical deals that return $10k each, you will make a total of $40k with your $100k investment, or a 40% ROI. Again, the return in dollars per deal didn't change but leverage allows you to do more deals for more total dollars.

The risk here is if you fall on your face, you will lose your $100k plus the additional $300k you borrowed, or $400k. Leverage not only multiplies your return, but your risk.

Notice that if you have only one deal with no other prospects, and enough cash to pay for it yourself, then you might as well fund it yourself since you avoid the loan expenses. (Cleverly, to keep things simple, these were not addressed above. That is, your real ROI above will be less than 40%. You must always do a detailed cash flow analysis and consider the loan costs.)

Obviously, if you don't have enough cash for at least one deal, but enough for a down payment and other costs, then you'll have to borrow the remaining cash if you want in. All the active flippers we know use leverage to be able to buy many properties at once to make more dollars.

"Once you find property you send it to them and they very quickly let you know if you can fund and then can make offer?"

No. You should be looking for money as hard as you are looking for properties. You'll soon learn that buying properties and finding money are both businesses based on relationships. Find your money locally, face-to-face, and stay off the Web. (Too many scams.)

Discuss your plans with many lenders of all shapes and sizes to understand their terms, processes, and lending criteria. These will all be different. Some will work with newbies, some won't, etc. When you find a viable deal, you'll have an idea who will loan on what, how much cash down you'll need, and even whether you qualify. This will add to the confidence you need to make viable offers. Good luck, Ben.

Jeff