Using Money to Buy/Rent Out or Lend out as Private Lender
Investor · Sugar Land, TX · Member since 2016 · 109 posts · 46 votes
Hi BP members,
I need help analyzing the follow:
In Houston Rental market (suburban), most will follow the 1%...so here is my calculation for getting a rental house that can rent out for $1500/month, at $150K
| Monthly | ||
| Rent | 1,500 | 18,000 |
| 50% rule (tax, insurance, HOA, Maint 10%, Vacancy 8%) | (750) | (9,000) |
| Mortgage | (539) | (6,468) |
| Cash Flow | 211 | 2,532 |
| Price | 150,000 | |
| 20% downpayment | 30,000 | |
| Closing Cost | 4,000 | |
| Total Cash out | 34,000 | |
| Cash on Cash Return | 7.4% | |
| Cap Rate | 2% |
If I get COC return at 7.4%, why should I or any other investors do it? If you lend your money out to as private lender or even on Realtyshare.com; RealtyMogul.com you see that the return can be as high as 13% or as low as 9%.
Am I thinking straight? Why should I buy and hold a rental property for 7% vs lending out cash at higher rate?
Thank you in advance for your help.
I would have to respectfully disagree with @Kami S.
Hardmoney lending:
$34k lent out for 1 year at 12% interest will give you a gain of $4,080k. Lets assume you are in a 35% tax bracket. You will cut a check to the IRS for $1,428k, leaving you with $2,652k or a after tax cash on cash of 7.8%
Rental property investment:
$34k down payment on a $150k building. At an 6% capitalization rate (very achievable) you are left with $9k net operating income. lets assume when you borrowed the $120k from the bank they lent it to you at 3.5% interest over a 30 year term. This means your monthly mortgage payment is $539(given by you) leaving you with $2,532 in annual cash flow or a pre tax cash on cash return of 7.4%. This does not beat your 12% from above but we haven't even started on all the other benefits of investing in real estate.
So you cash flowed $2,532k do you pay tax on $2,532k?? NO! another beauty of real estate and leverage is the depreciation tax benefit. Even though you only put 20% of the $150k in to the property you get ALL of the depreciation. residential real estate is depreciated over 27.5 years which means you get to depreciate $150k/27.5=$5,454. What does this mean? It means you don't pay any tax on that $2,532k you made on the building. You actually have a paper loss of $2,922. This loss can off set other income. Again assuming a 35% tax bracket the paper loss of $2,922 would result in an additional $1,022 in tax savings. This means your after tax return is 10.4% substantially more than after tax return from hard money lending.
Thats all great and will make you a lot of money, but where wealth is built is in the amortization of the debt you put on the property. The $120k in debt you put on the building will have a tenant paying down your mortgage month after month. In our example after 10 years you will only owe $92,644 on the building IF the property never appreciated one cent and it was still worth $150k in 10 years you would have $57,356 in equity. You could then sell it or refinance it (again tax free).
Now lets wrap the amortization into our example. using the loan terms I mentioned the first years of the loan will result in a $2,499k reduction in principle or if the value stays the same that would be seen as a $2,499K increase in equity. If we add that $2,499k into the cashflow and tax benefits we are left with a all inclusive after tax return of 17.8%. How much tax do you pay on that??? NONE.
This is just the basics. You can accelerate depreciation benefits through cost segregation, Structure loans for quicker amortization depending on your goals and many other tricks.
I obviously enjoy talking about this stuff. Feel free to reach out to me whenever and we can talk more.
I would have to respectfully disagree with @Kami S.
Hardmoney lending:
$34k lent out for 1 year at 12% interest will give you a gain of $4,080k. Lets assume you are in a 35% tax bracket. You will cut a check to the IRS for $1,428k, leaving you with $2,652k or a after tax cash on cash of 7.8%
Rental property investment:
$34k down payment on a $150k building. At an 6% capitalization rate (very achievable) you are left with $9k net operating income. lets assume when you borrowed the $120k from the bank they lent it to you at 3.5% interest over a 30 year term. This means your monthly mortgage payment is $539(given by you) leaving you with $2,532 in annual cash flow or a pre tax cash on cash return of 7.4%. This does not beat your 12% from above but we haven't even started on all the other benefits of investing in real estate.
So you cash flowed $2,532k do you pay tax on $2,532k?? NO! another beauty of real estate and leverage is the depreciation tax benefit. Even though you only put 20% of the $150k in to the property you get ALL of the depreciation. residential real estate is depreciated over 27.5 years which means you get to depreciate $150k/27.5=$5,454. What does this mean? It means you don't pay any tax on that $2,532k you made on the building. You actually have a paper loss of $2,922. This loss can off set other income. Again assuming a 35% tax bracket the paper loss of $2,922 would result in an additional $1,022 in tax savings. This means your after tax return is 10.4% substantially more than after tax return from hard money lending.
Thats all great and will make you a lot of money, but where wealth is built is in the amortization of the debt you put on the property. The $120k in debt you put on the building will have a tenant paying down your mortgage month after month. In our example after 10 years you will only owe $92,644 on the building IF the property never appreciated one cent and it was still worth $150k in 10 years you would have $57,356 in equity. You could then sell it or refinance it (again tax free).
Now lets wrap the amortization into our example. using the loan terms I mentioned the first years of the loan will result in a $2,499k reduction in principle or if the value stays the same that would be seen as a $2,499K increase in equity. If we add that $2,499k into the cashflow and tax benefits we are left with a all inclusive after tax return of 17.8%. How much tax do you pay on that??? NONE.
This is just the basics. You can accelerate depreciation benefits through cost segregation, Structure loans for quicker amortization depending on your goals and many other tricks.
I obviously enjoy talking about this stuff. Feel free to reach out to me whenever and we can talk more.
@
Thank you much for your answer. You are absolutely correct! I am not seeing the full picture and the long term of building wealth through rental properties. Time to buy more rentals for retirement..:)@Jered Sturm WOW, that was an AWESOME explanation. I learned a couple of things from your post. I always thought that my COC of 7 or 8% wasn't much of anything considering you can make this in the stock market without hassles of tenants or law suits. As you said, I never considered the tax portion with depreciation and equity in the property.
Here's a another question for you since you really enjoy this. I paid cash for 3 properties and want to refi to pull the cash out to purchase other homes. The COC on this is a lot lower since I'm not paying taxes on the property since they are all paid off correct (leverage)? And two, should I get a portfolio loan and do all 3 together or should I do them separately?
Thanks in advance and also thanks for the post.
Miguel
@THU NGUYEN Awesome, Happy to help. Real estate is a very useful tool when used right to grow wealth. Everyone has their own strategy, and risk tolerance, but from my own experience the returns I listed above are very achievable with minimal risk. Always buy right and it makes the life of the investment a great journey.
@Miguel Dormany Thanks! Glad I could help. Yeah, returns are only mediocre when looking at real estate as an investment with out the power of leverage and taxes. Our government has incentivized real estate investment through the tax code more than any other form of investing and using/understanding that is key.
I'm not sure if Im understanding your question correctly, but Ill take a crack at it. Let me know if Im not answering what you asked. If I understand, you bought three properties cash, you want to do a cash out refinance on those properties to pull the equity out to buy more property. This has been a great strategy I have used many times.
Typically your COC is much lower in a free and clear property. This is because you have more cash into the deal. for example if you buy a $100k house cash and you have $10k cashflow on that property you have a 10% COC return ($10k/$100k). If you buy that same house with a $20k down payment and a $80k mortgage it is likely your cashflow will drop because you have to pay a mortgage. If the mortgage payment is $500 a month thats $6k a year that eats into your cashflow. So your cashflow is only $4k. BUT your COC would be 20% ($4k/$20k). So you doubled your COC with leverage.
Any income your properties produce will be subject to tax. Even if the properties are free and clear, or leveraged. In the example above the property paid for in cash will have $10k of income and the leveraged property has $4k of income. Regardless if you have debt on the property you as the owner get to depreciate the whole $100k purchase price. Residential property is depreciated over 27.5 years. This means on a $100k property you have depreciation of $3,636. That $3,636 will reduce the taxable income the property generated. this means on the free and clear property you have to pay tax on $6,364 where the leveraged property you only pay tax on $364
2) Wrapping 2 or more properties into one loan is commonly know as a blanket loan. If you search that term on BP you will find a bunch on that. My opinion is that it depends on each specific situation if that would be a good fit. it can change by portfolio, by borrower, and lender. Whats most important is understand pros and cons of a blanket loan before agreeing to one.
I hope I answered your question!
Just to add a little info to what @Jered Sturm mentioned about depreciation. You will not depreciate the full purchase cost. You subtract the land value from the purchase price, then you divide that by 27.5. Otherwise, he's right on target. RE absolutely rocks, particularly when it is smartly leveraged.
I'd say there are a few errors in your assumptions.
1) Don't ASSUME 50% for taxes, insurance, HOA, maintenance and vacancy. Yes you need to make an assumption for maintenance and vacancy but you know the HOA fee, you know past taxes (though rising in Houston) and you can call insurance agents for quotes. You can tighten up your major expense by getting exact numbers.
2) The second error is buying at retail or at least my interpretation of your example is buying at retail. You can easily get deals at 80% of current market value and that is not a super deal at all.
3) If you are really trying to save money with a rental and you have cash (like I think you do from other posts), you should buy under market value with cash AND getting a loan from a friend (such as giving YOUR money to friend to loan to you) closing and THEN refinancing. WHY? You will never get more than 75-80% loan to value on a conventional loan on a purchase as the lender lends the lesser of purchase price or appraised value. When you refinance (WITH A LOAN ALREADY IN PLACE) they loan 75-80% of appraised value so if you bought below market, you'll get most of your money back out of the deal. The ONLY way you'll do this quickly, however, is with the "friendly loan" (which may have even been your own money) as most banks will not do a cash out loan until you have owned the house for 6 months. This reduces costs and gives you control of a property with the absolute lease money left in the deal, giving you the opportunity to do more deals with the cash you have.
4) You've mentioned the idea of getting away from your full time job so whether your analysis for a rental is correct or not, rentals may NOT be what you need to generate sufficient income to live. That is a calculation you need to make before you quit your job. Understand you will NOT be able to get conventional loans after you quit your job, at least until you have a 2 year track record in your new real estate business. That may not be true if you have a working spouse who could still qualify for loans.
@Aquila Oliveira read the second reply on this thread
Hi Matt Huber,
Rental CF is for retirement income which I have another 20 yrs to go before I can count on rental CF to replace my income...:)
Thank you for the feedbacks. I am curious on the this point: "you should buy under market value with cash AND getting a loan from a friend (such as giving YOUR money to friend to loan to you) closing and THEN refinancing". Is there a reason why I should give my money to my friend, then my friend loans me back the money? I read on another post that someone actually does it...what's the benefit? Why don't I just use my own to pay cash and refinance 6 months later to get my cash out via cash out refinance?
@Jered Sturm has done an excellent job detailing the benefits of owning over handing your money over to a(n) REIT(insert entity). I LOVE the tax benefits and BRRR benefits of owning.
Hi Thu,
You mentioned the hope of leaving your job in one of your posts. If that is the case you may REQUIRE your investing to match your current income. Meeting your monthly income needs through rentals usually will NOT solve that problem quickly. That is one reason you would NOT want rentals, unless you can cash out quickly to have sufficient cash to fix and flip other houses. Cash is king in real estate so you want to tie up as little as makes sense. Leaving your job is likely to retard making money via rentals as the only way to do that successfully is via loans and your ability to get loans for rental properties will drastically decrease when you leave your job.
Age is not required to retire, income is, so there is no set rule you need to wait 20 years to retire. I stopped working for someone else at age 42 and went into real estate full time with zero residual cash flow coming in monthly, though I did have cash and access to cash. I believe there are faster, more assured ways of developing long term cash flow than through owning rentals. I know many neighborhoods in Houston that never appreciated for decades. Admittedly even most crappy neighborhoods are starting to appreciate but appreciation is NEVER guaranteed. I also know many landlords whose cash flow never improved due to ever increasing taxes, not to mention vacancy and maintenance and perhaps the all too frequent floods. Being a landlord can create wealth, but it can also be a very long and unpleasant struggle. Good tenants, good management and avoiding flood plains can certainly can make the rental business much more pleasant, profitable and with very little effort on your part so renting certainly does have significant benefits. Long term you are also likely to get appreciation and in the meantime you get depreciation, so yes, renting done right can bring long term wealth. Renting rarely brings wealth quickly without the benefit of the luck of rapid appreciation.
As to your other question of loaning yourself money via a friend to buy a house, I do that every time I buy a house. It gives me more rapid exit strategies and some side benefits. The most useful is I can (essentially) cash out immediately via a refinance loan. I don't have to wait 6 months to refinance as is the current custom of conventional lenders in today's market. You lose 6 months time of cash availability (perhaps 4.5 months since it does take time to get the refinance) where you may have been able to buy 2 or 3 more properties in that same 6 month time frame using my method rather than buying with cash.
With my method I pay no lending costs with my first purchase since I use loan documents already created by an attorney for another loan for which I participated. (Even if the docs aren't perfect it doesn't really matter since the money is essentially being lent to myself via a friend.) When I refinance the refinance is always at appraised value, not the lesser of appraised value or purchase price so I can pull out ALL of my money if I bought right (under 80% of value). Loan costs are minimized since I only have 1 conventional loan, not 2 (if I had initially purchased with a loan). I avoid the cost of private mortgage insurance at all points of the transaction. My speed of getting my money out and available to do another deal is at least 4 times faster than refinancing a cash purchase if you assume it takes me 45 days to refinance versus the 6 month wait before you can get a cash out refinance. My title costs when I refinance are also less since I purchased with a loan and get a discount mandated by Texas (about 40%). Lastly leaving less money in each positive cash flowing rental allows you to buy more rentals (cash to buy, down payment, closing costs, loan costs and required reserves).
Frankly I don't often refinance with a conventional long term loan. What is more important is that I have the ability to refinance quickly if that is what the market tells me I must do to make the property productive at a faster pace. It is more critical to you when you are buying rentals because you already have a long term hold strategy so you want to refinance as soon as possible to make funds available for another house (flip or rental). I do NOT have a long term hold strategy, that is only my least best option of multiple exit strategies. Additionally you are more "secured" from lawsuits when you have liens on property you own. When you own rentals free and clear the value in your rental house is easier to access from losing a lawsuit so you are less of a target if your properties have liens. Admittedly this is low on the list of importance but it is a side benefit.
I hope that helps.
Matt
Matt, it helps a lot. Thank you much for the advice. BP members are great. I am learning everyday!
@
You mentioned that I can easily get rental at 80% value...can you please let me know how and where? Besides the New Western Acquisitions, what other companies in Houston that constantly have regular deals/projects? Some deals at NWA are gone so fast, as soon as they send out an email, within 12 hrs they already it contracted. With working full time, I was not able to view/make decision within a few hrs.Frankly 80% is getting harder and harder to get from wholesalers in Houston and that is 10% above historical norms (70% minus repairs or 65% minus repairs is the historical standard). I think it is because: 1) we are in the middle of retail buying season and; 2) I've heard through the grapevine that New Western Acquisitions and Net Worth Realty (both realtor based firms) have institutional buyers paying 84%. If that is true that explains why deals disappear so fast and for such a high price. The other reason "deals" are overpriced is due to the super low interest rate environment. If interest were to go up, prices would have to go down.
Also you have tons of wholesalers and gurus training newbie wholesalers who don't have a clue about value and the cost of repairs and misrepresent both the value and repair costs, to their own benefit. Frankly I've seen the same price misrepresentation going on by wholesale firms using licensed realtors in the Houston area. You also have tons of new buyers who have money and/or credit who do not have full MLS access or do not get a reliable third party realtor to verify comps from these wholesalers are NOT cherry picked and do not misrepresent the values. Lately I have seen licensed realtor generated comps that must purposely ignore all recent sales in 2016 and only include 2015 sales, when 2016 sales prices have dropped. This is especially true in the over $200,000 market which is soft due to all the oil layoffs.
Houston also seems to be the "in" place to be for investors from all over the country. I know one wholesaler who learned from wholesalers in others areas (perhaps from Bigger Pockets), specifically New York City, that in Houston the acquisition cost per house is multiple times more expensive in Houston due to the immense competition.
I think you need to communicate often with wholesalers on Bigger Pockets and network with local wholesalers and let them know you have money and are buying. Hopefully one will turn you something that closer resembles a real deal rather than the crap that is being peddled now by nearly all wholesalers in Houston. I've seen some "wholesale" deals ABOVE the highest retail comparable. Worse yet, I've seen some above the highest retail comparables that needed a lot of rehab when you could buy something directly from MLS at full price that was pristine. I'm getting sick of these overpriced deals but I have seen crappy wholesale deals reblasted at lower prices a lot more lately. The only way this trend will continue is for buyers to properly do their own due diligence and stop overpaying for properties that are NOT deals.
Wholesalers are making more than rehabbers and have ZERO risk and ZERO money in the deal.
Another "trend" I've seen are stumbling onto discussions on Bigger Pockets about Houston not being that great of a market for deals any longer. Hopefully those discussions continue to spread, reduces the buying pool in Houston, which result in prices getting closer to the range of reason. A good crash would also be helpful to shake out newbies and institutional investors alike, who have paid too much for properties.
I do hope and expect that prices will be better once school starts. That ends buying season and sellers will become more desperate with houses sitting longer and longer, though it may take a few months for the desperation to sink in.
@Matt Huber I think some of what you're seeing has to do with some different factors. I've worked for New Western in two, kind of three major markets from San Antonio to Austin and now Tampa. The 70% of ARV adage that has been popular for the last two decades has really become outdated for a number of different reasons I've talked about on my blog before.
I remember when my dad was a real estate broker in San Antonio back in the early 90's. There was no such thing as MLS. Every morning he'd get a fax in with all of the updates to listings and then have to go into this gigantic binder to physically take out the old property sheet and put in the new one. I really don't understand how anything got done back in those days. With the introduction of MLS systems the market inherently became more efficient. In the 2000's when sites such as Zillow and Trulia popped up it then gave the power of information to the hands of the every day consumer. Before that in non-disclosure states such as Texas, one essentially had to use a real estate broker in order to gain access to data not readily available to the public. The introduction of these two sites made the market even more efficient. As economists will point out, when you give buyers and sellers access to critical information about pricing that was not available beforehand the wide margins at which savvy buyers were able to take advantage of less educated sellers begin to tighten up. That being said, there are still those type of deals available but just much fewer and farther between.
The concept of wholesaling has been around since the introduction of a market economy. Buy something and sell it for slightly more than you paid for it. If I knew more about boats or cars I'm sure I could buy and sell those too. The popularity of Guru's and the notoriety via television that rehabbing and investing in real estate has gained in the last decade has increased the amount of buyers in the pool, as you suggested. Decreasing supply therefore increases pricing. Additionally right now we're seeing historic availability in the credit markets with the Fed funds rate being virtually zero. This access to cheap capital has increased the potential buyers in the pool as well.
Finally to address some of the blame you think we may have. Wholesaling has traditionally been a very disorganized market. Being able to trust a valuation or a rehab estimate from dozens of different independent entities who may have varying degrees of experience and who may or may not be licensed was difficult. The investment brokerages that have sprung up have become so popular because of the organization and consistency that we bring to consumers. Having worked here for over five years and been doing this my whole life I can tell you that I don't remember a time when the market was ever truly selling at 70%. It's kind of like I remember getting gas for under a dollar a gallon when I first got my drivers license. I know it happened, it's just kind of been a while and I don't think it's going to go back in that direction. San Antonio was seeing about a 72% market in the middle of the recession (like 2011). Tampa consistently sells at 79-81%, Dallas and Ft Worth operate at somewhere around the same margins, and Austin as far as I can tell has ARV's that are almost entirely based on appreciation. While large companies like us are fairly visible to investors in the market we make up less than 5% of all investment transactions that take place. I track hundreds of houses in my market that I consistently get beat on by investors willing to pay more than me for the same property.
I do agree that another adjustment in the market will weed out some of the inexperienced investors who are evaluating their deals too highly. I also see a shift among the institutional buyers right now that entered the market building massive rental portfolios now beginning to liquidate some of their assets. I think by about this time next year we'll start to see some fundamental changes in the way major markets function nationally.
@Ryan Harthan has much said that is valid however 70% of ARV less repairs for a wholesale rehab flip to make money will NEVER change (to any degree of significance), especially using hard money. If one uses realtors to sell, pays closing costs of all parties to buy, has hard money costs, and holding costs they typically make 10% profit on the sale.
There is and can not be a new model of 80% for a rehab flip when the economics simply dictate there is no profit left for the actual party that takes possession, risks money, risks loss, risks vandalism, pays for insurance, has holding costs and actually adds value to the property through repairs. Yes, that might be possible for a relatively clean house, but is absolutely impossible for a larger rehab project as holding costs due to the additional time to do the work.
The zero interest rate environment is a major factor in the price increase as wholesalers have used this to their advantage to show non real estate investors what good cash flows they can get with little investment providing they can qualify for low interest conventional loans. The low rates of borrowing are only one cause of the flood of purchasers, the flip side of the same coin is the other reason. That reason is that investors with cash can not get safe reasonable returns like they used to in this low interest environment. That's why I am able to get loans on houses from a couple insurance companies which allow me to sell to someone else AND keep their loan in place on a house with their knowledge and consent. I have two sources to do this, one at 7.25% interest and one at 8% interest. This low interest environment is killing savers, especially the retired generation who could formerly make safe 4-5% returns but now can not. When insurance companies struggle to find safe reasonable returns you know the system is contorting.
I'm not sure I'd agree it is an "efficient market' by selling at higher wholesale prices when the wholesalers are taking larger and larger and larger cuts of the pie with no risk except marketing costs. I disagree that the information age is informing consumers to sell at higher prices. Sure there is some affect but that doesn't change a motivated seller's motivation. Death, divorce, loss of job, transfer, etc. are and will always be sources of motivation that cause sellers distress which motivates them to sell at below market levels. I believe the prices wholesalers are buying at is slightly increasing due to the mass competition, but even that affects a minority of deals since the relationship with the seller is more important than price in most cases. Sellers usually go with the first buyer they trust so speed and giving the seller a sense of confidence you can do what you say are much more important than the actual dollars offered.
Mass wholesalers sell their own book, promoting rentals for "long term wealth", but like all promoters gloss over the bad sides of landlording and, in my opinion, misrepresent vacancy and maintenance - frankly by never even mentioning them and showing "cash flow" as if those realities don't even exist. A friend who owns at least 130 rental houses and has done over 1200 deals in Houston freely admits that being a landlord is a pain in the ***. He is very, very well known in Houston. He is a professional with more knowledge, experience, financial backing, connections, etc. etc. than 99.99% of all landlords. There is no way the casual investor is going to attain the average rental yields he does, nor have the ability to call up a contractor and get a first rate, immediate response at wholesale contract prices so if it is a pain for him, it is worse for everyone else.
There is absolutely no question the casual real estate investor can buy at full market value in Houston, in the decent low valued neighborhoods, and get cash flow and yes, long term wealth as long as they can get the low interest conventional loans. I expect a great many landlords drop that idea after being a landlord for some time when yields are reduced by vacancy, bad tenants, increased taxes (which is happening big time in Houston), flooding (several this year alone), etc. My last tenant paid for 1 month before they stopped paying. It took 6 weeks to evict then follow up with a writ of possession to throw them out, and they caused $3,000 of damage on purpose. Yes, I screwed up and didn't screen. Perhaps screening would have raised flags, but not always, though there is no excuse to fail to do it. Casual investors are going to make the same mistakes and worse. They will not be on site to fix for thousands less with little effort, they will incur extra costs due to the requirement to hire management since they are out of state owners. Many will learn their cash flow never increases despite rising rents due to dramatic increases in taxes (at least in Texas). A large percent of those will drop out because they become expectant of better cash flow and it never transpires. They learn "long term" is really, really, really long and don't have the patience to wait it out for 20 to 30 years for the loan to be paid off.
In 13 years heavily involved in the investment community in Houston I have never heard a landlord brag about his rentals, the income they generate, and the lifestyle they create unless they owned a minimum of 15 to 20 doors. There will be damn few of your buyers that ever attain that volume. The birth/death model is a huge friend to wholesalers as it brings in new dreamers, most of which don't comprehend what is truly needed effort and consistency wise, nor do they have the will power or financial resources to get where it makes a big difference in their life.
As to the efficient market, I believe it is a distorted market, not an efficient market. Distorted by unrealistic interest rates and marketing specialists who sell to buyers with no risk. Rehabbers and even landlords need to be better disciplined and insist on better prices. More importantly they don't even do proper due diligence and swallow the numbers fed to them as if they were true. If they collectively would not be so foolish in overpaying, the lower prices are available right now. If that never corrects, and I see that as an extremely difficult correction to occur unless and until money becomes more expensive and difficult to attain, rehabbers and flippers will be forced to vertically integrate and market to find their own deals unless they can team with wholesalers that sell with pricing using a long term view knowing they can not have repeat customers unless they leave enough meat on the bone for the rehabber/flipper to make a profit commensurate with the risk and financial investment involved. Most people want to get what they can, while they can, so I expect few wholesalers to sell at reasonable prices which will force flippers to find their own deals. It wouldn't surprise me to find hard money lenders begin sourcing and selling their own deals so they have deals on which they can lend, at least in this environment.
@THU NGUYEN What criteria are you looking for in rentals (area, bedrooms, price, % ARV, etc)? I might be able to help you find them. I'm new to marketing in Houston, but I'm not new to real estate.
As to my comments regarding 70% ARV (or any percentage for that matter), directly above, I realized any percentage is inherently based on a price range. I am focusing on houses with a value in the $100K-$150K range so profit can definitely be made with higher percentage purchases for houses with significantly higher prices as is true in most of the rest of the United States as compared to Texas. Buying at higher percentages result in a MUCH HIGHER RISK however, because the profit percentage actually made is much smaller even if the dollars are larger. If the market is weaker or the value less than expected, the end result is even worse for the investor because their hoped for small profit (percentage wise) can more easily turn into an absolute loss. That is exactly why the higher dollar markets have bigger crashes when money dries up as owners have no cash flow coupled with losses in value, even below their purchase price, which causes investors to flee the market.
Rentals outside of Texas, especially the high dollar states like the east and west coasts (with the southern coasts excepted) typically have significantly less cash flow or even negative cash flow for rentals so all profit is expected from buying below market, principle pay down AND (mostly) appreciation. If one does not do proper due diligence to verify correct values they may not be purchasing below market. Appreciation, in my opinion, is mostly luck. Certainly one can see trends in good neighborhoods, watch development of schools, roads, infrastructure and growth so appreciation can be more likely than not, but appreciation is mostly based on timing and economic success in an area and market crashes can and do wipe out all gains even when everything else was done correctly.
Can someone ( @Matt Huber ?) elaborate on the ""friendly loan" (which may have even been your own money)"? I am unfamiliar with this approach and its benefits/drawbacks.
Thanks very much
@Fred Weiller OK Fred, I wrote up the details of my "friendly loan". Here they are:
Benefits of a “friendly loan”
1)You can refinance rate and term loans immediately.If you buy with cash the current industry standard requires a 6 month hold before lenders will allow you to refinance.This may not be true for all lenders so ask your lender prior to your purchase if they require 6 months seasoning before a cash out loan can be obtained.Lending requirements change all the time so what is true today can change tomorrow.
If you it takes 45 days to get the refinance loan, you can refinance potentially 4 times faster than getting a cash out loan if you have to wait for 6 months.Naturally you don’t want to refinance until repairs are complete to get full loan value so reality has a time delay to make repairs, but will still be much faster.
2)You have as little money left in the deal as possible, potentially nothing after refinancing if you buy at or under 80% of value if you refinance the loan at 80% of appraised value.Compare this to buying with a conventional investor loan which requires 20% down payment and the loan amount is always the lesser of purchase price or appraised value. In this case you always have money left in the deal.
3)You never pay PMI (private mortgage insurance) if you refinance at 80% of appraisal or less.
4)In Texas (and perhaps other states) if you refinance within a short period there is a discount (40% I believe in Texas) on the title insurance for the refinance.This actually saves more than the cost of the additional lender’s title ($100 in TX) when purchased.In my case I didn’t even purchase lender’s title when I bought the house with the friendly loan and still got the discount when I refinanced.
My friendly loans are with my own money, lent to a friend with a personal loan, who relends to me with a mortgage loan.Our terms are mirror image for the personal loan and the mortgage loan.Ideally the loan includes all costs, including future repair as I want to be able to get all money back when I refinance.The ultimate refinance means you have no more than 80% or less of market value total into the property so when you refinance you have no private mortgage insurance to pay.That also matches with conventional loan standards of 80% LTV for investor purchases.There is no industry norm requiring you to wait any period of time for a "rate and term" refinance so you refinance as soon as the rehab is complete.
There is no law about getting a “cash out” loan immediately.That is simply the current lending standard for most lenders.A “cash out” loan is one where you paid cash for the deal and now want to refinance to pull your cash out of the deal, hence the name “cash out loan”.Unfortunately industry norms currently require you to wait for 6 months before they will give you the cash out loan which is the reason I use my “friendly loan”.In Texas, once a cash out loan, every refinance by the same owner is also a cash out loan.In Texas, cash out loans are more restrictive than refinance loans and cash out loans do not qualify under some government sponsored finance programs available to rate/term refinance loans – another reason I prefer rate/term refinancing.
I recycle legal docs (promissory note, deed, and deed of trust/mortgage) that I got from an attorney that I alter for each purchase. You may want to pay an attorney once, but really it gets you nothing to pay for each additional transaction.You can get free mortgages/deeds of trust by downloading from county clerks websites, but then you have to type them up.Since the promissory note is private, you’ll never get that from a public filing.It is legal for you be your own attorney and "alter" the docs by removing or altering the names, address and parts of the legal description of the former note, deed and deed of trust.Perhaps the most crucial thing to get correct is the deed to make sure you have a good legal description.That is easily obtained by getting a copy of the deed that was filed for the current owner, just change names.Since the loan is a friendly loan, in my case essentially from myself, if there are minor items that are not perfect in the note or deed of trust it really is not important since I am essentially lending to myself. Another reason to get a FULL SET of docs from an attorney for the first time is for “lender instructions” to the title company.Lender instructions make everything look official as that is standard practice in the industry.[You won’t get lien release instructions in the “buying documents” but you can write those up for your friend to send to the title company when you refinance.]
To truly protect yourself if you give money to a friend to loan back to you, your friend should agree in writing they are getting a personal loan from you in the amount they are lending to you for the house and that they agree to release the lien simply by you asking, or more importantly do as you direct them to release. Make the personal loan to your friend and real estate loan to you have mirror payment requirements. To ensure your friend is trustworthy get a signed, notarized lien release dated the day you get the friendly loan. I call it an “insurance lien release” as it insures my friend’s honesty.Hopefully this first “release” of the friendly loan will be torn up and never used, this is simply to protect yourself.To get the rate/term refinance loan, you can’t release the friendly loan until you refinance.The actual recorded lease is given by your friend to the title company only at time of payoff of the friendly loan.
An even safer way for the friendly loan is to never put the money into your friend’s hands.You wire funds directly to the title company and just provide the loan paperwork to the title company.Verify with the title company first to see if they are OK with that scenario – some may not like the idea.Investor friendly title companies have been OK with it for me.In this instance you can get the notarized lien release from your “friendly lender” dated the same day as the loan as your insurance and the money never touches their hands. The insurance lien release you hope to never use.Ideally the insurance lien release is torn up after you refinance because you get a correctly dated lien release and lien release instructions from your friend to the title company at the time of refinancing. The second lien release used at the time of refinance is the one recorded.If you record the “insurance” lien release you kill the rate/term refinance as nothing is being refinanced.Pay attention and don’t undo everything.
When you get the refinance loan, you will need to have your friendly lender paid off by the title company from the refinance proceeds, then your friend pays the money back to you. [This is the weak point where your friend could take your money.]Do NOT receive the refinance loan proceeds from the title company (except proceeds in excess of your friendly loan, if any and normally not).Refinance loan proceeds must be sent to your friendly lender otherwise two things occur: 1) the refinance lender and/or the title company gets suspicious this is not really a refinance, which may kill the refinance loan and; 2) you don't get the discount on the title insurance due to buying title insurance again within a short period due to refinancing (in Texas) because you’ve tipped them off that you’re not really refinancing. Even in the case of my friendly title company I had to have loan proceeds from the refinance loan paid directly to my friendly lender.If you don't know the title company well, you may not want to tell them about the friendly loan. Let them think it is a private third party who, while cooperative with you, calls their own shots.This is not strange in this day and age as they are a lot of private loans.
I transact often with one particular title company, have a good relationship with one senior closing officer and tell him everything.He knows me, trusts me, understands what I'm doing, and even guides me on what to do. A title company where I have never business may get worried or bring up issues which may concern your refinance lender.It is best to let sleeping dogs lie so don’t tell an unknown title company the friendly loan proceeds initially came from you.It’s none of their business your terms with your lender and how you acquired the funds.
My loans from a friend are not truly free, though he would do so for free. I wire him $150 more than I need to send the title company. $25 is for his incoming wire costs, $25 for his outgoing wire costs, and I let him keep $100 for the hassle of going to the bank to wire the money and when refinancing signing the lien release and lien release instructions. It doesn't hurt to put a $100 bill in his pocket for very little effort on his part and keeps him happy.I save $400 in title fees when refinancing with the friendly loan (in Texas) so I prefer to pay those that help me so they are happy to do it again the next time I need help.
One bit of advice on the loan terms from your friend. You can make the first payment not due for 90 days or more, so no payment is due by the time you refinance. If a payment is due before refinancing, you need to write a check to your friendly lender so the paper trail matches the terms of the private loan. Your refinance lender may request the proof of loan and proof of payment so you need to treat the friendly loan exactly as if it were a stranger lending the money and follow its terms exactly. Do not pay cash as you have no 3rd party proof of payment.If you structure your note where no payment is due for 90 days, you will owe MORE on the refinancing than the original loan balance as interest accrued during with no payment. One "down side" of this strategy is you may have to come up with a little more money out of pocket at closing if the appraisal doesn't come in high enough to cover your friendly loan, loan costs and closing costs. That makes it important to know your values and have sufficient additional funds on hand to use this technique to do a rate/term refinance immediately.
One thing to pay attention to is the title commitment. Make sure you get a title commitment in advance so you can use the exact same legal description in your note and deed of trust that they use in the title commitment as that is most likely the wording they will use on the deed. As stated earlier you can also get the legal description from a previous deed, which should match the title commitment.My deed references a vendor’s lien so that’s what I use.I don't believe referencing a vendor’s lien in the deed is crucial, especially on a "friendly" loan, but for a third party loan from a traditional lender it is a separate safety precaution to clearly show on the deed. Filing the deed of trust shows the lien/loan exists.Showing the vendor’s lien on the deed is additional safety for the lender as the lien is recorded in the deed itself.
@Jered Sturm I do not think I have ever seen a more beautiful post then that one. Your clients are very happy to have you.
WOW! Thanks for sharing and explaining in such details. Great concept.
Very much appreciated.
@Matt Huber one quick follow up question: could this friendly loan approach work with a family member (same last name) or should it be done with a non family member (different last name)?
Thanks very much,
Fred
@Fred Weiller The answer to your question depends on the lender and broker. My friend who has done this three times uses her brother as trustee on the deed of trust (mortgage) and her cousin as the lender. In this case they all have the same last name. I really didn't like that idea of everyone having the same last name, but it worked without a problem.
Without going into detail, it is far better to get the short term loan directly from your family member or friend than to provide the money yourself. Providing the money yourself has issues of disclosure (which I recommend disclosing to the broker) plus may raise questions when the lender looks at your bank statement and wants to know why a large amount of money moved out of your account around the time of the purchase. It may further make your qualifications look much worse if you send the money to the trusted party to loan back to you.
The first time my friend did this she gave a regular check to her cousin and it hadn't cleared when the wire was needed for the purchase, luckily her cousin had enough in her account to cover the loan before the deposited funds were available.
I understand my friend is disclosing everything to her broker. It's my guess the broker and lender have no problem with it because it follows the rules as it is a refinance. Brokers and lenders all want to make the loan but if you buy with cash their hands are tied because the current convention doesn't allow it for 6 months. I recommend talking to the lender (broker) with whom you plan to refinance prior to the purchase and make sure they're OK with it. If they aren't OK, then find another broker/lender. The idea is not to misrepresent anything as that could and may be loan fraud (depending if you over represent or under represent your qualifications). You are simply using the current lending guidelines in a way that benefits you. The broker/lender that agrees you are following the rules will make the loan, presuming you qualify with regards to other loan qualifications. Different brokers/lenders may have different interpretations of the same thing, just like attorneys and accountants. Find a broker that interprets their lending guidelines that works with the friendly loan, in fact you can ask them for guidance to make sure you do things they way they want to see it done. They all have their guidelines, sharing them with you is not a secret.