|The author Gordon Catts is a long time member of real estate groups. He was evolved in the formation of several Local Associations. Gordon was a founding member of what ultimately became National Real Investors Association.
Gordon’s website GordonCatts.com has several articles relevant to Real Estate Investors and he writes and teaches in this arena.
Recently a friend called to ask a very specific question. He wanted to know how well I knew a woman real estate agent. My response was that I had spoken with this agent several times and had just recently met her at a networking event. My friend was surprised that I was not better acquainted with this agent. In conversation with her, he was led to believe that we were great friends. I subsequently found out that she had told several new investors that we were “good friends”, and that I routinely called her for professional advice in investment matters. This agent appears to be a nice person but is not a bosom buddy, an advisor nor a confidant of mine. My friend did just what you should do when contemplating a business relationship with an individual. Check them out. Check references.
Ask people you know about the individual’s reputation. Talk to more than one reference. I seldom run into someone who gives bad references. I like to check with someone who is not on the reference list.
Some professional trade organizations have lists of members available to the public. You might check there. Attorneys subscribe to a service called Martindale Hubble which rates attorneys. They are rated by specialty and rated by their peers (other attorneys). All attorneys are not rated but established practitioners generally are.
As a real estate professional you are expected to do your own due diligence. I run into investors, usually beginners, who have purchased properties based on someone else’s numbers, only to find out that those numbers did not work for them. The seller may have flat out lied, may have a different idea of the degree of fix up, or may have a vastly different level of expertise. Get your own comparable sales data. Don’t be lazy-pull your own comps! If you plan to do any business as an investor you should know how to pull comps.
Develop relationships with realtors, appraisers, tax assessors, and other investors. In many markets you can subscribe to commercial data sources, or access the Board of Realtor’s sales data or the appraiser’s shared database. You should be familiar with repair costs and should learn to estimate what repairs are necessary. Develop relationships with people who will discuss a deal with you. Remember that people who do this for a living are generally busy, so respect their time constraints.
We are seeing the consequences of the hot market of the early to mid 2000′s we are operating in. We saw flip the flip, the flip, the flip, yes, 4 levels of wholesalers. Either the bottom guy was getting incredible deals or the last guy was paying too much. This reminds me of the land boom of the early 70′s where it didn’t matter what you paid because you could sell to the next person for more. This scenario is known as THE GREATER FOOL theory. What happened at the end of the 70′s land boom was a complete market collapse. Some of the acreage tracts did not sell again at boom prices for over 10 years. Even worse, some of those properties were highly leveraged and the speculators lost the property and had the IRS declare those transactions as sales. Because the speculators were writing off substantial interest deductions, there were significant negative tax consequences. We are again seeing the consequences of a super hot market. Properties are selling for a fraction of the top of the market prices we saw in the mid 70′s. With the glut of foreclosures and type credit there will be downward pressure for some time to come.
What’s the point in all of this rambling? Simply this, real estate is a great business, but you are expected to do your homework and check what people tell you. Remember the Latin phrase mot caveat emptor: let the buyer beware. Make it a habit to not take someone else’s opinion for gospel. Form your own opinions based on your own research. I recently met a young man who was mentored out of twenty thousand dollars by someone who was going to teach him the business. I think they gave him the business! There are good, honest mentors/consultants out there. If you are new it is good to have someone you can bounce things off of. The young man I spoke with had not done his homework. The individual who helped him sold him an overpriced property with substantial deferred maintenance and assured him that the necessary repairs could be done for several thousand dollars. It turned out to be closer to twenty thousand dollars. this sheep did not check out the individual or the deal. Don’t let this happen to you. GAREIA has comp services available to the members. (No, they will not pull your comps, that’s not their function.) You can and should learn all of the data systems available to members.
This article was written several years ago and has been published in investor newsletters in other markets. I chose to rerun this article because of a recent troubling event. A business acquaintance of mine hired a super salesman to join his organization. The individual told a compelling story about his production with his former employer. The individual appeared quite knowledgeable about the business and was very personable. After this individual came aboard, things didn’t ring true. His production was good, but nowhere near the super salesman level. The individual told amazing tales of his college athletic endeavors and even claimed to have played professional sports. In time his stories became questionable to the point that the employer did some checking. The stories did not check out. The individual claimed friendships and relationships that were either untrue or grossly exaggerated. By the time the individual left, he had created problems with several customers as well as taking proprietary information and computer software. He even tried to erase the personnel files. It was a tragedy. The individual was bright and personable. The exaggerated stories were not necessary.
The point: check references. People are not always who they appear to be.
Hard Money is called that for a reason. It may be easy to borrow, but it is hard to pay back. I hear “speakers” talk about borrowing Private or Hard Money to finance a deal and not to worry because “the property stands for the debt”. What the speaker is implying is that there is no personal liability associated with the loan. This is a DANGEROUS MISCONCEPTION.
I recently hosted a panel of Hard Money Lenders for my local investment group. One Panelist (they were all Private Lenders using their own and/or partners money) indicated that the borrower must agree to be personally liable for the loan. A member of the audience asked if they would take a Deed in Lieu of Foreclosure in the event the borrower was unable to complete the rehab on a property financed with Hard Money. The response was a resounding “NO”. The lenders said that they did not want to OWN the property, they just wanted to be PAID. They might agree to some type of workout but they were looking for people who could perform.
When an individual borrows on real estate property he signs a Note (which is basically a type of IOU) and a Deed to Secure Debt, or Mortgage (a collateral agreement which gives the lender the right to take the property if the borrower defaults on payment). The lender may seize the Collateral through Foreclosure, or he may go after other assets of the borrower, i.e. “Sue on the Note”. A lender who “Sues on the Note” may get a Judgment, which allows him to garnishee wages, take money out of a bank account, or seize other assets. There are legal processes that must be followed, but the bottom line is the lender has a very big stick.
Lenders are not generally inclined to have the borrower surrender the property. There may be Liens and Judgments against the property and/or the borrower as well as Materialman’s or Mechanic’s Liens against the property. There may be IRS Liens etc affecting the property. Some of these may not show up in a title search and could come back to haunt the lender if he voluntarily accepts the property. A Foreclosure on the other hand will “clean out” most of the potential title issues.
In general, the Hard Money/Private Lenders on the panel all said they were looking for borrowers who could PERFORM. They were looking to establish relationships for repeat business. These folks loan the funds to acquire and rehab or build new primarily single-family houses in their own market areas. Some have more stringent geographic restrictions than others.
In general, lenders base the interest rate and loan amount to the Value Ratio on the particulars of the individual deal, with interest rates currently in the 12-14% range and 3 to 5 discount points for seasoned borrowers.
Inexperienced borrowers will possibly pay more. The lenders generally will expect at minimum, monthly payments of “Interest Only” and will expect the loan to be repaid in 3 months to 2 years. Generally, a lender will allow several Extensions of 1 to 2 months and will charge 1 to 2% for each month’s Extension. At some point there will be no more Extensions and the loan will be called due. It is better to negotiate Extensions up front when you are applying for the loan. Loan-to-Value Ratios are generally in the 50 to 65 % range with ratios going as high as 70% on better properties in better neighborhoods. The lender will factor the experience level and the size of the project into the equation. Several panelists indicated that if the property and the deal were good enough they would be more lenient on the borrowers qualifications. Some lenders do their own appraisals and inspections and others use outside inspectors and inspectors. The Lender will generally have established relationships with these folks and may require the borrower to pay for these services up front.
This panelist, as with other hard moneylenders, does not loan to homeowners and they all are making what are called “Short Term Bridge Loans.” These are in the category of “Commercial Loans”, and are not regulated in the same manner as Residential Mortgages. These loans are not intended to be used for consumer purposes.
Experienced investors use Hard Money/Private Lenders to fund acquisition and rehab projects because the process is quick. Generally the lender can close within 1 to 2 weeks assuming that the title is OK and the appraisal can be done quickly. Private/Hard Money Lenders may also make very Short Term Loans in the following situations: where an investor is Closing on a property and then Reselling, or where the property is Under Contract to sell and a “Simultaneous Closing” or “Assignment of Contract” is not feasible.
These loans are generally made to experienced borrowers who have an established relationship with the lender. By using borrowed funds, investors preserve their own funds to keep sufficient Reserves on hand. It is much more difficult and expensive to obtain funds when you are part way through a project and have run out of money. By utilizing borrowed funds it is possible to do more expensive projects or to do a larger volume.
An experienced Hard Money Lender is a good “deal barometer” in that the good ones are in the streets daily and can quickly analyze a deal. If the lender doesn’t like the deal you should look more closely. Ask him why. He may be currently short of funds to loan, or he may simply not like the deal.
Hard Money is a tool. It has its place in the investment world. It is like a sharp ax. Used properly it can be efficient. Used improperly it can cause serious and/or fatal consequences