The Pros and Cons of Hard Money for Investors

Hard Money

We’re not talking about coins versus soft paper money.  Hard money in the real estate investment business refers to money from private lenders using collateral rather than a credit rating as the basis for granting the loan.

Hard money loans are quite popular with investors, particularly those who are doing fix & flip projects.  Hard money lenders can be indviduals, small partnerships, or major bank lenders.  Their interest is in higher returns than they can get from normal real estate lending, and with faster turnover.

Who needs hard money loans?

I’ve already mentioned fix & flip investors.  However, developers and anyone doing shorter term real estate projects can have reason to use a hard money lender.  Many of the most successful real estate investors are stretched when it comes to funding for the many projects they’re working at any given time.

Often these investors either do not want to use their personal credit to back a loan for liability reasons, or perhaps they’re already carrying a lot of debt and getting more the conventional way is difficult.  It’s also time-consuming.  Their interest is in having money available quickly when an opportunity presents itself.

Pros of hard money loans.

For the active investor, relationships with several hard money lenders can be a valuable asset.  Many of these lenders will issue fund guarantee letters that investors can present with offers to prove the ability to finance a deal.

You also cut through a lot of red tape with hard money loans.  The time from application to money in your hand can be as short as a couple of days.  When an investor finds that perfect deep discount bargain fix & flip that requires fast cash, this is the way to go.

Often appraisals aren’t necessary, and a deep enough discount to current market value can get you 100% funding of the purchase price.  For a fix & flip, financing the property is just one facet.  The funds to carry through with the rehab must be borrowed as well.  With the average fix & flip lasting only a few weeks to a few months from purchase to sale, hard money lenders are happy to provide financing for a quick profitable deal.

Cons of hard money loans.

Really, for an experienced investor, there aren’t any really prickly issues other than the cost of these loans.  Many of these lenders will get right up close and cozy to the state’s usury limit with interest, with 12% to 18% interest very common.

But that’s just the interest.  The loan origination and other fees can vary between one percent and as much as five percent of the amount borrowed.  If you need $100,000 for four months, you could end up with interest and fees totaling more than $7,500 to $10,000.

Of course, if you’re rehabbing a property that takes a total of $100k plus these costs to finish the project, it’s still a great deal if you’re selling it for close to $200,000.  The key is to know your market, know your costs, know your buyer and selling price, and stay within your budget and time frame for project completion.

Before committing to a hard money loan, take a hard look at your numbers from end-to-end.  If the numbers work, it’s a fast and profitable way to go.

Should You be Buying New or Existing Homes for Rental Properties

Should you buy new or existing homes for rental properties?  The rental property investor is seeking cash flow and value appreciation over the long term.  For years since the crash that began in 2007, rental investors who do not do their own fix & flip have for the most part been buying existing homes.  Many times they’re buying from fix & flip investors, or they’ve purchased ready-to-live-in foreclosure homes.

However, the foreclosures coming onto the market now are often “zombies,” homes in poor condition that have been abandoned through a long foreclosure process.  The fix & flip investors are enjoying a great market, as they can buy these at deep discounts and rehab for sale at retail or to rental investors.

There is a lot of competition for fewer foreclosures, so prices are rising.  This of course increases the amount the rental investor will have to pay.  Zombie homes cost more to rehab as well.  This evolving market brings the question of whether prices have risen to a point that buying a newly constructed home could be a viable rental property deal.

Builders are cautious.  They’re not flooding the market with spec homes, but they are beginning to become active again.  Let’s compare and contrast new versus existing homes for a rental property purchase:

New Delivers Desired Features

Renters want what buyers want; the newest popular home features.  The fix & flip property can be outfitted with some of them, but things like great rooms with dining, living and kitchen together aren’t as easy.  The new home hits all of the tenant’s hot buttons.  Usually they will pay higher rent for these features.

The Right Neighborhoods

Home builders are building in the popular areas of town.  Where buyers want to live, tenants want to live.  Your market research has been done for you, and buying in these growing areas can also be a good equity-growth strategy.

What about the Cost?

The first concern is usually whether a new home price will cut cash flow at competitive rent levels.  Obviously, you’ll want to compare what’s available to you for pricing.  However, sometimes you may be able to help a builder with a win-win deal.  They need to turn homes to roll funding for new building.  This keeps their sub-contractors happy as well.

Watching the market for new homes that aren’t moving as quickly as others could yield opportunities.  A builder has holding costs just like investors.  Helping them to turn a house that is sucking up interest and marketing money could help you to negotiate a great deal.

Factor in Warranty Savings

Buying a new home carries a warranty, and some builders even have extended warranties available.  Your budgeting to determine cost and potential rents should factor in lower maintenance and repair costs for the warranty period.  Over the long haul holding period, your repair costs should be lower due to the all new major appliances, plumbing and electrical.

It is Still all in the Numbers

Considering the pros and cons, it still boils down to the numbers and going out into your market and working deals.  Talk to builders and particularly check new home listings with longer than average days on market.  There could be a deal out there that will cash flow.  Of course, if you can buy existing homes at double-digit discounts to new home prices, then the numbers rule.

Real Estate Investor Competition Heating Up – Sharpen Your Deal Pencil

Real estate investors have had a great ride for a half dozen years now.  The glut of foreclosures after the crash that began in 2007 provided over a million bargain basement deals, most ending up in the portfolios of rental property investors large and small.  Fix & flip and wholesale investors filled the supply line with rental properties, and rental demand is still quite high nationally.

When the big players like Blackstone Group jumped into the fray, thousands of properties went in block purchases and were converted to rental units.  All of this investment prosperity and activity has created a bit of a bubble in prices for the properties investors most desire.  Competition is heated in many markets, and this means higher prices.  Higher prices make it more difficult to make the rental cash flow work.  Today’s real estate investor, whether a wholesaler, fix & flip, or rental property investor, will need to sharpen their deal pencil and their negotiation skills as well.

Market Research

Knowing your market inside and out is a must.  Since markets are constantly evolving, market research is an ongoing activity.  Even real estate wholesalers and fix & flip investors need this information, because most of their customers will be rental property real estate investors.  Survey the rental market, call like a tenant prospect, and compare properties you’re considering to the current rental inventory.  Keep abreast of the local economy, major changes in business or industry, and the demographics of the average tenant who is a prospect for your unit.  Keep track of incentives being offered, as giving away a month’s free rent definitely takes down the annual cash flow.

Drive a Harder Bargain or Get There First

This is an “if you can” statement.  Competition is in the mix, so better marketing for distressed sellers could give you an early edge over competitors.  Working pre-foreclosures can help with a timing edge, but they’re well-covered at websites and in publications.  Getting the absolute best upfront price will help not only with cash flow but also with overall ROI when you sell.  One way to help in negotiations with distressed sellers is to have a firm handle on your financing so you can offer a fast close without hassles for a homeowner who is seeking escape from their situation.

Be Careful of Condition & Future Repair Budget

Many of the opportunities available in current local markets are older homes in well-established and popular neighborhoods close to city centers.  This is fertile ground for the real estate investor, but older homes require more maintenance and major improvements may need to be in the planning budget.  One sure way to get to the end of a rental property’s investment life and be disappointed in the overall ROI is to have spent more for repairs and rehab than anticipated through the live of the investment.

Build Rent Increases into Leases

Inflation never ends, though it can ease a bit for short periods.  Sure, you can just surprise your tenants with a coming rent increase, but that can backfire on you with move-outs and vacancy cost increases.  If you put a rent increase percentage into your lease, your tenants will expect it, which yields two advantages.  1) You can let it stand and offset inflation in your costs, or 2) To keep a good tenant you can offer to decrease or eliminate it for a renewal of their lease.  The key here is to have a good handle on your costs to rehab a unit between tenants and a good idea of how long it will be empty and not generating rent.

Expect Property Tax Increases

Rental property owners hold their investments for years, and governments over-spend every year.  Local government deficits will eventually lead to increases in property taxes, so a wise real estate investor will consider them in their budgeting and future need for increases in rent.

Don’t Be Discouraged

Rental demand is higher than at any time in recent history, and it’s still rising.  If you offer tenants good location, nice amenities, and competitive rent, you’ll enjoy near full-time occupancy and nice cash flow.  It’s just best to plan for cost increases and possible rent incentives you may not need now.  The rental property real estate investor enjoys tax advantages and generally lower risk than investors in other asset classes, so just get out there and make it happen!

MainStreet Realty Services is here to help both the experienced and the entry level real estate investor.