Suggestions re lending rehab funds as a 2nd mortgage.

[Sheri Lowrance]

I'm wanting to learn about flipping in my local area. I met someone through Linked In that has a company that has been successfully doing fix and flips in Denver for about 1 year. He is offering me 10% interest for me to fund about $80K for the rehab portion of a property they just put under contract. My concern is I would only have a second mortgage position. They've got relatively low rates previously working with a hard money lender. Normally I would not consider a 2nd position, but am really wanting to work with someone willing to teach me threw this flipping deal. What suggestions or feedback do you have for me regarding this?

[Jeff S.]

“My concern is I would only have a second mortgage position.”

This shouldn't be your only concern, @Sheri Lowrance. You don’t loan money to a stranger you met on LinkedIn. This is not how you build relationships, protect yourself, or determine a borrower’s capability. Exactly how many homes have they “successfully” rehabbed in one whole year? Not many, I bet.

It’s just too easy to find more experienced rehabbers who need construction money. Why get involved with a relative beginner to learn on your dime? Start attending some of the local real estate clubs where you can meet experienced flippers face-to-face. Your profile indicates you’ve done some lending, but it’s not clear how much.

As you understand of course, second position loans are extremely risky. Do you know the background and experience of the first position lender? Have you spoken to them? Are they knowledgeable and practical, willing to accommodate the issues that frequently occur with flips, or are they quick to foreclose?

I’m sure you know that a foreclosure would likely wipe out your lien. Are you willing to accept that for a 10% return? Do you know the prevailing rates for second position construction loans in your area, especially to relative newcomers to flipping? Of course, if you received even 30% but got wiped out, would it matter? That is, better know to whom you are lending.

Who would properly originate this loan for you, provide you with legal advice, and a complete set of loan documents? (Don’t even suggest your borrower. Much too much of that on this board.)

You are not going to hand an $80k check to a borrower. How will you handle construction draws?

Last, and probably most importantly, if you want to be protected as a lender you must act like a lender. This all but eliminates any interaction with the borrower in terms of their day-to-day dealings. The last thing you need is for a borrower to come back and say they would have made money if it weren’t for the paint color you insisted on. The flipping & lending businesses have been great these last 10 years or so, but there are now clouds on the horizon. When loses start to mount, like in 2008, borrowers and their lawyers will become much more aggressive to protect themselves.

If you want to learn how to flip, you might instead partner with an experienced flipper in your area, if they will take you on. Instead of lending, offer to pay all the costs, purchase and rehab, in return for a 50/50 profit split and interaction with the decisions. Perhaps find the property yourself.  That adds value and is at least half the battle when flipping. This will be much safer for you and seemingly better aligned with your goals, Sheri.

It’s interesting that almost every rehabber we know says they eventually want to become a lender. I know of no lenders who aspire to flipping homes.

Good luck, Sheri.

Jeff S. – Private Lender in Los Angeles