By: Skyler Moore
Now more than ever cash is king. Investors with cash have always had an advantage, but more now than ever self reliant investors can capitalize on the blood in streets. Although Americans hear everyday on TV that banks are lending, small business loans have increased, the truth is that it is very difficult to obtain a loan, especially when the business model is structured around real estate and profits depend on the sale of a property.
At best once a track record is established, an investor may be able to leverage their cash position with a bank, if they have a banking relationship in tact. The reality of the matter, is that investors who do not have millions liquid will need and should use leverage. That option is using a hard money lender, which may charge 12%-17% plus a few percentage points on the front or back of the loan.
I personally have been fixing and flipping Denver Investment Property during the housing downturn. The profit is made when the property is bought, but a lot of work goes into a property after it is successfully purchased. There is often a lot of paper work to ensure clean title, taking bids from contractors to remodel the home, supervising the work and listing the property are just some of the obstacles to over come. What about having a nice Saturday night dinner, only to get a phone call for an 8am showing tomorrow. Since you wanted to save 5% profit, you decide to show the home yourself instead of hiring a Realtor only to not have the buyer show up, or worse realize they couldn’t buy the home if they wanted to.
Flipping homes can be a profitable business, but if it were easy everyone would do it. In my opinion, investors with cash, even a few hundred thousand dollars are better to lend their money to other companies with an established track record and be an arm chair investor.
Lets look at an example.
If a home is purchased for $150,000 with the ARV (after repair value) of $250,000 that leaves a $100,000 potential profit. Of course, the profit will not be anywhere near that, because there are rehab and fixed costs associated with fixing the property. In fact, the estimates for all costs is $50,000.
Instead of tying up $200,000 in cash, the investor is better off to leverage their purchase. A typical hard money lender in this scenario would lend 70% of the $150,000. That is (150,000*.7) $105,000. The owner of the property now has 30% of their cash (150,000*.3) $45,000 into the deal with an additional $50,000 in costs. In some cases hard money lenders will loan on the ARV, but for this example we will assume that is not true.
With an expected hold time of 4 months, the total expected interest paid to the lender is (at 12%) $6,000. The lender also has 2 points or, 2% on the exit, which is an additional $2,100. That is a total amount of $8,100 or a (8,100/105,000) 7.7% annual return in only 4 months.
There are other ways to structure deals like these, such as 7% annual interest rate, with a 10% net profit kicker upon exit, but the key is that the money lender made $8,100 dollars over a 4 month period without any of the heavy lifting, anxiety or stress. I believe this is a much better position to be in, plus money lenders are protected unlike many people believe.
Before a deal is funded, the proper agreements are signed that put the money lender in the “first position” or gives them the first deed of trust. This protects the lender in case of failure. If the company borrowing the money is unable to perform according to the contract, or make payments, the property becomes the lenders. Not an ideal situation for the lender, except they own a property for 70% of the distressed value, plus in most cases thousands if not tens of thousands of dollars has been used to improve the property. It may take more time than expected, but a handsome profit is likely waiting at the sale of the property for the lender.
There are a lot of angles a cash investor can pursue in a distressed market like we are currently in. The big factor to consider is how much time, knowledge and work does a cash investor want to spend in order to make their desired return.
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