What costs more, a money partner or hard money lender?

Question

I'm curious what people think.  I'm sure it depends on the money partner split, HML costs, etc.  I think, generally speaking, you are going to end up putting less money in your pocket with a money partner than if you used hard money on your rehabe deal.  Any thoughts?

Scott Hubbard · Answer

Let's apply a real world scenario to help us address your question.  For the sake of argument, I am going to assume the investor in this scenario does not have a money partner willing to accept a 8% or even 10% return on investment. Additionally, the investor has only $60K capital to invest.

Here is the scenario; the investor's lead is a property with a $150K ARV and a purchase price of $90K.  Renovation estimate is $25K.  We will budget a 6 month hold. Closing costs are $2K each side total with commissions at 6% on the B to C sale only.

We have two choices, borrow the money from an HML or partner up using a joint venture agreement.

HML terms:

10% down @ 12% I/O with a 12 month Stop and a 2% origination fee due at closing.

Total cash out of pocket for the hard money loan:

$9K downpayment
$2K Closing costs
$1.6K  Origination
$25K for the renovations
$.4K for utilities
$1K for insurance and Property Taxes
$5K for 6 months of debt service
= $44K out of pocket

Note:  That we now only have $16K remaining of our original $60K.  This probably would not be enough to get another project going, so we will be forced to wait for this one to sell.

Money Partner terms:

A joint venture agreement where the proceeds from the sale are split 50/50.  The money partner acquires the property paying for all acquisition costs including purchase costs, insurance, taxes, closing costs .  The investor partner pays for the rehab costs, utilities, manages the project, and markets the property.

Total cash out of pocket for the joint venture:

$25K for the rehab
$.4K for utilities
= $25.4K out of pocket

Note:  The investor still has $34K capital in this scenario.

Profit Margins:

Assuming the property sells at $150K on the 6 month with no seller concessions and 6% commissions with $2K closing costs.

Profit under the HML scenario is $150K - $2k (closing costs)- $44K (out of pocket) - $9K (6% commish)- $81K (HML) =  $14K

Profit under JV scenario is $150K - $2k (closing costs)- $25.4K (out of pocket) - $9K (6% commish)- $93K (To Money Partner purchase price + closing costs, plus insurance) =  $20.6K / 2 = $10.6K

Upon first glance, the HML scenario realizes a $3.4K higher net profit.  But, on a cash on cash basis, the JV scenario has a higher return.  Thus, your risk reward is also substantially lower with a JV scenario. [b]However, the biggest advantage for the JV scenario is the investor has $34K in capital and is poised to take advantage of another deal.  Essentially, this investor could do two deals under the JV scenario compared to one with a HML.

To answer your question, I believe with the HML, your likely going to have a higher margin.  However, you need to account for opportunity costs in your scenario which many of us investor's sometimes forget to do. In the scenario above, this investor would be able to to do more than one deal at a time, thus the opportunity costs would be higher using an HML.  I feel one should utilize a money partner because ultimately your going to be able to do more deals.

Mike Jakobczak · Answer

Some money partners will be happy with a 8-10% return on their money.  This type of deal will definitely be cheaper then HML.  All depends on the type of partner you are working with.  This is what you should be thinking of when you are planning to raise funds.  What you are willing to give money partners comes down to what you can afford in the deal.  Giving a higher return will create a bigger buzz for yours investors.

Aaron Mazzrillo · Answer

There is an advantage to using a HML. At least if you have a good one to go to. A HML will require an appraisal. Your private lender probably will not. A HML should analyze the deal and determine if there is actually a profit to be made. A private lender will hand you the money and just expects to get paid back with interest.

A HML may be more expensive when it comes to fees & interest, but if you are just starting out or have only done a few deals and don't have a lot of experience, especially with unique property, a HML can save you and your private lender from a big mistake.

Scott Hubbard · Answer

I think an 8% return is inappropriate when an MP is bringing all the capital and consequently taking on all the capital risk.   My MP's get substantially higher returns for rehab investments. However, it is possible for an MP to get excited about an 8% return when it is being compared to a low yielding investment vehicle like a money market, a bond fund, or CD.

Account Closed · Answer

Good analysis Scott.  I would assume at 50/50 profit split with the money partner (MP), as you did, but that the MP brings all the money to the table, not just acquisition costs.  The Rehaber brings the deal and project management.  This would strengthen your conclusion, that the HML scenario brings a better return, and the MP scenario brings less risk, better cash-on-cash, less lost opportunity.
I guess a good companion question would be what the MP/HML assumptions should be.  The answer to that would probably be all over the board.  I would think it rare (and unfair)that a MP would be satisfied with a 8% return when coming up with all the cash.

Ned Carey · Answer

It depends, how good of a negotiator are you?

Scott's numbers above could be VERY different if your private lender is giving you money @ 8% simple interest and the Hard Money lender wants 15% and 3 points (common here in Baltimore). You have to run the numbers as Scott has done above.

What costs more, a money partner or hard money lender?

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