Should I use Hard Money to grow at an early stage?

Question

HI everyone.  This is my first post, and I'm a new Pro Member as of today!  I am currently finishing my first deal (BRRR).  It is a self funded deal all in at 110k.  I will be pulling my cash back out in the next few weeks, and I've began searching for my next deal.

Once I finish the BRRR on my first deal, I will have the funds free again to start another project.  My first deal came to me via networking...a gift to get my feet wet that I knew I could make work.  After educating for the past 8 months I now have an acquisition strategy with direct mail / Adwords that I've just launched.  I didn't set out to wholesale deals, but could end up in a situation that would require that if I can't fund it.

I have set what I think Is a very realistic goal of acquiring 9 more buy and holds by the end of 2020 for a total of 10 roof tops.  Based on currently only having the funds to do 1 deal at a time, and the length of the BRRR process, I don't believe I can achieve my goal without another source of funding.

Other than owner financing (which I am looking for) Is hard money a good option for funding another project while one is already underway, or is there a better alternative that I'm not asking about with my local lenders?  I have a few good lenders that are eager to help when I already own the property and it's time to pull my cash out, but when it comes to a quick purchase I don't have any takers on funding it up front with out the lengthy loan process, and the typical down payment no matter what the LTV is.

I'd appreciate any advice.

Ben

Ronald Isgate · Answer

Hard Money definitely has its place and usefulness - but as @Tom Shallcross pointed out above, all have their pluses and minuses.

It all comes down to the math as to whether the project warrants, and can sustain the cost of hard money.  What I can tell you is once you develop a successful track record with a HML, generally speaking of course, you will get better terms and rate as you do more and more deals.

"Partnering" hard money along with private equity partners who contribute capital is a solid way to go as well to keep your costs down, again provided you have a solid relationship/expectations with the private equity partners re: their expected returns.

The last thing - if using HML - you need to have a solid exit strategy.  I would strongly suggest speaking with a conventional bank to again get a relationship if possible, but find out what they need to see in order to do a refi.  You dont want to get trapped in the hard money loan, default interest will kill the deal.  Having a solid strategy in place for an exit is just as important, if not more so, than the strategy to get the loan in the first place.

Best of luck with your business and your future purchases

Tom Shallcross · Answer

@Ben Wernert - I use a combo of HML, private lenders and cash and each has it's own pro/con.

It's def possible to make HML work, but there are risks.  Below is a quick walk through - details will vary slightly with each lender - and you can judge if this is something you can handle:

Let's say you buy a home for 100k, it needs 50k of work and you think it'll appraise for 190-200k.  You find a HML to do 85% of the purchase and 90% of the work.  So that's .85% of 100 and .90% of 50 for a total of $130,000 plus fees and 1-2 points.

You'll need that 15% down of the purchase (they are doing 85%) and you'll close with the 45k in escrow held for draws. You need to work with your contractor on the pay schedule, but you may end up in a situation where you pay him while you wait for your draws. So he finishes 10k of work, wants to get paid, you put in the request and have to float that 10k for a few days. There are many ways around this, but important to factor of and openly communicate beforehand.

Also, if rehab goes over by 10k, do you have funds to cover?  Remember you've already paid the 15k down payment and 5k of the total 50k out of pocket.

Besides potentially having to float money, you will also have to pay the monthly 1,000-1,200 HML pmnt depending on the rate you get.  So if your rehab is 10 weeks, and takes you another 2 weeks to get a tenant to get the long-term refi done and you're out the 3,000-3,600 total plus the closing fees and 1-2% points.  This is all on top of the fees the long-term lender pays.

Adding up the holding fees and the closing costs of the two loans, you can be 6-8k in to make it happen.  Again, if numbers still work, that's great, just be aware you need to account for it.  Like in this example, you'd be in 100 + 50 + 8 for a total of 158k.  If it's truly worth 200k, you can make this work with a large cushion.

Lastly, what if your appraisal only comes back at 165k because you missed the comp or the market turns?  Your long-term lender gives you 75% of 165k = 123k - fees.  Your HML is for 130k so you not only don't get the down payment back, but now have to come out of pocket to get out of HML (this is where things can get very scary).

All that said, HML can be a nice tool to scale, you just need to understand it and have contingency plans for potential risks/scenarios.

Cliff's Notes:

• Account for all fees/holding costs in your numbers
• Overshoot holding time and undershoot ARV
• Have reserves to cover potential higher construction # and/or draw delays
• Have an exit strategy if appraisal comes in lower than expected 
• Communicate with the long-term lender early and often to minimize turn time and any blockers (don't get caught naked with a HML and no option to refi out)
•

George Despotopoulos · Answer

@Ben Wernert you've got a lot of great responses here. One thing to add is that some hard money lenders also offer a 30 yr refi option so that way you have an exit should you want to hold the property.

Fred Shatzoff · Answer

@Ben Wernert  As they say use other peoples money.  You can get a loan to buy and rehab.  Potentially you could do 2 properties at the same time.

Should I use Hard Money to grow at an early stage?

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