Hard Money or Equity partner?

Question

Those that have made the choice between funding deals as an HML, equity partner, or private lender, how did you choose your entry point?  Are the risk profiles or recourses different for each?  What happens if a deal goes sideways--costs go over or takes too long--in each case?  I'm brand new, and I'd love to get some feedback from the veterans.

Don Konipol · Answer

Debt is always riskier than equity - debt is always potentially more profitable than equity.  The actual numbers are deal specific.

Ann Bellamy · Answer

Don is right.  However, a few caveats.

Not all hard money is 6 points, so you have to run the numbers to see what makes sense.  Be sure you calculate worst case scenario.

Taking an equity partner can cost more than hard money in some deals.  Again, calculate worst case.

The key to using hard money is to get out quickly.  Underprice your property so it sells quickly, and be as sure as you can in this market that the end buyer qualifies for the financing.  Be prepared for the end lender to need 2 or even 3 appraisals if you've done a rehab.

Underpricing can actually make you more money at the end if you didn't have to pay the hard money for very long.

I've seen more deals go sideways because the seller decided he could get more money, and spend a month or two at the higher price, only to end up taking the same or less than if he had underpriced to the market.

Don Konipol · Answer

I would like to expand upon the private money vs. hard money point.  I have been a commercial hard money lender for 11 years.  My opinion is that hard money should only be utilized as a last resort.  Pay whatever interest rate you need to get private money, as long as you pay few or no points.  It is the points on hard money loans that kill you in the short term.

If you have a loan for only 2 months, paying an annual rate of 18% won't kill you; however paying 6 points will eat deep into any profits.

Mark Anderson · Answer

Assuming we are talking about a flip, I personally would do private money first.  The terms should be better than hard money and you get to keep all the profits after paying off the private lender.  Sometimes, if a deal takes a little longer than expected, you can extend the loan with the private lender.

If private money is not available, I would look to hard money IF I was confident with being able to sell the property after the rehab.  Otherwise, I would look to for an equity partner who will share in the risk (but also any reward).

Paul B. · Answer

Don, unless you have mistakenly switched debt and equity in this post, I am going to need mega clarification to understand your point of view, which I respect and appreciate.

Thanks!

Edit: Never mind. I think I get it now. You're looking at it from the point of view of the person needing the money, not providing it. Got it!

Michael B. · Answer

Though I'll admit I'm more conservative than most here ... I'd choose door number 4, Monte.

Spend the next year working an extra job. Save enough cash to either purchase the place you want outright or at least enough for a large down payment. In that time spend time looking at likely properties in your area and talking with people who do what you want to do. After a year of education with cash in hand, then you're ready.

Being new, your first deal is likely to go at least somewhat sideways. But it's likely to go a whole lot better if you're neither paying exorbitant interest rates or dealing with partnership issues when the unexpected happens.

And even in the end if you don't have quite enough cash for what you want to do, you'll be able to drive a much better bargain if you have most of the needed cash and are knowledgeable about the business in the area.

Take your time. The deals will still be there when you're ready.

Bill Gulley · Answer

Have no idea how this happened, .......commercialfinanceBill Gulley, and I received a mention, but it should be fixed.  :)

Keith Schneider · Answer

Private Equity money is a manner of raising funds on a limited or nonrecourse basis, limiting the contractual liability to the particular project. It can be done so as to contractually protect the general cashflow and debt to assets ratio of the balance sheet. The way the deal is structured between debt and equity can also perhaps lend greater flexibility to the company to do business if there are previous lending restrictions in place limiting the taking on of additional debt. 
The use of private equity capital is also a good way to share risk between principal and equity partner, risk being contractually limited to the undertaking at hand, rather than commercial bank loans requiring recourse to collateral assets. Private Equity funding is also great when transmitting proprietary information generally to investors could lead to security leaks, since all interested parties sign a nondisclosure agreement and have a vested interest in keeping matters private due to commercial competition. Of course these factors need to be discussed with an accountant, as there are footnoting requirements for such transactions required, but in structuring equity may provide less restrictions for the principal.
Keith Schneider 
k.schneider.commercialfinanceBill Gulley

Greg Turnquist · Answer

Don Konipol mentioned 18% lending rate. I have heard it mentioned in other topics involving note buying to check state usury laws to make sure you aren't buying/selling an illegal note. Do those laws apply to hard money and private lending too?

Jimmy Oldrich · Answer

Hi all.  Just getting back to this.  Thanks for the feedback.  I understood better what you were getting at when I thought more about it, Mark.  Thanks again.

Hard Money or Equity partner?

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