Figures Don’t Lie

Selfie by Suna Last year, Paul Esajian invited Sue Ann and me (and some other investors) to watch the San Diego Chargers from the Fortunebuilders skybox. Paul has given us some great advice in the time we’ve known him.

This post originally appeared on the Hermit Haus blog on 2016-09-24.

Hanging on every word

Believing the things I heard

Being a fool

—Russ Ballard

One of my mentors, Paul Esajian, says, “Always trust the numbers.” By that he means your numbers. Phill Grove, another mentor, emphasizes this concept. He says, “Always do your own due diligence. Run your own CMA. Do your own repair estimate.” In other words, buying real estate is a perfect opportunity to follow the advice of the old Russian adage, “Doveryai no proveryai”—trust but verify.

Trust but verify. Especially when dealing with wholesalers.

We expect homeowners to lie through acts of commission, omission, and ignorance. They, after all, are in dire straits. They really need to get out of a problem house, and they often know what they need to accomplish that goal down to the penny. We expect them to over-emphasize their house’s strong points and ignore or hide its deficits. Further, they may not even know about a termite infestation, a leak in a wall pipe, or countless other problems that can drive a renovation over budget and into red ink. And, to be fair, homeowners expect investors to lie to them, too.

But wholesalers are a different animal. They speak Investor, so it’s easy for investors to let their guard down too much. For example, wholesalers know how to get our attention with numbers. They know the secret formula we use to make sure we have some cushion for the unforeseen issues that arise in every project: .7ARV – R = O. Our Offer should be in the neighborhood of 70% of the After Repair Value of the property less the cost of Repairs.

The Perfect Deal

Asking Price	$100,000
Repairs	$40,000
ARV	$200,000

So when we see an opportunity like the one shown to the right, our immediate tendency is to short-circuit our processes and jump to the conclusion, “That’s a good deal!” Why? Because .7 of $200,000 is $140,000. Subtract $40,000 in repairs and we should be comfortable paying $100,000 for the house. I mean, what could go wrong? Well, there are only three possible reasons why the numbers match our formula so well:

• The deal is a perfect fit to our expectation, and we stand to make about $25,000 after holding and marketing costs. 
• The ARV has been overstated, intentionally or not, which could reduce or eliminate our potential profit. 
• The repairs have been understated, intentionally or not, which (again) could reduce or eliminate our profit margin.

We don’t need to talk much about what happens in the first outcome, where the numbers are correct. Everybody is happy. Everybody wins. But I reckon each of the other two outcomes deserves its own post. As I write them, you can find them gathered here.

Most wholesalers are hard-working, honest people. But especially with the growth of HGTV, DIY, and similar networks, vast numbers of newbies are coming into this profession, and wholesaling is the logical starting point. (We can discuss why in another post some other time.) People in our profession follow the distribution of the general population with roughly 2% falling somewhere along the psychopathy scale.

It’s like one of my favorite bosses (she hired me three times in the corporate world) once said, “Figures don’t lie, but liars figure.”

Other People’s Money

Photo by UfaBizPhoto / Shutterstock The first time you loan a substantial portion of your wealth to a rehabber, you may worry about this being your new home—no matter what your relationship with your borrower. When you stop worrying, it’s probably time to stop lending.

Photo by Ardfern / CC BY-SA If you’re putting your money in Any bank, you might as well be putting it in The Bank, an Irish pub. You’d get more pleasure out of it, anyway.

Being a PML can earn you a Lot More Money than a bank CD. I think the rewards are worth the risk.

This post originally appeared on the Hermit Haus blog on 2016-09-08.

In a previous post, I talked about the advantages to Hermit Haus of using other people’s money (OPM). I mentioned that I prefer using private money to every other source. I prefer private money because I really do believe in the big Win-Win and spreading the wealth around a bit. This post deals with why becoming a private money lender (PML) is good for you as the lender.

Let me start out by saying I am a PML. I have helped fund several other people’s projects. I don’t like lazy money. I want my money working all the time—even when I don’t have a deal in progress. (Yes, that does happen sometimes. It seems like this business is always going from one extreme to another. Either you don't have any deals at all or someone accuses you of being a "house hoarder.")

What’s the Worst That Can Happen?

A few years ago, I was at one of those massive networking events with vendor booths all along one wall. I got to chatting with a hard money lender who was willing to fund 70% of the after repair value (ARV). At that time, I had been doing one deal at a time, mostly with my own money. I asked him about the risk of lending money on an undone house. "What's the worst that can happen?" he asked.

“I don't know. I guess I default on the note,” I said, somewhat naively.

“No,” he said. “that’s my best case scenario. Then I get a $200,000 house for $140,000, and somebody else has done the renovation, or most of it." He let that sink in. "The worst that can happen is you pay off the contract as written. Then don'tI only make 14% on my money.”

That was an eye-opening conversation for me. The worst that could happen was for the borrower to honor the contract. Wow!

Why Lazy Money Is Bad

Even though my hard money friend said the worst that could happen was that I paid back his loan, he was wrong. The worst that could happen was that I left my money in the bank. I want my money to work for me, not laze around in a bank. Here’s why:

Banks are pay ridiculously low interest rates. They can get away with these low rates because your money is “safe,” protected by government insurance. Even if the bank fails, you get your original deposits paid back. But that’s not really safe, is it? If you only get back what you put in you have really lost money. In fact, even at the interest rates banks pay today, you are losing money every day you let your lazy money vacation in a bank. Assuming the federal government’s core inflation rate of about 2.2% (January 2016), your money is worth 0.183% less every month. If you put $100,000 in a CD in January, it would be April before the interest rate you earned would overcome inflation. Think about that. It would be three full months before your money—including interest would buy as much as it would if you spent it all in January! And that’s with the highest paying CD I could find on the market today!

At the end of the year, your $100,000 would have grown to $101,124, but it would only be worth $100,939 compared to January. that’s still $939 more than you had to begin with, and compounding would continue to make it grow faster each year. But if you needed to have a million dollars to retire and maintain your current lifestyle, how long would it take you to get there? Would you even still be alive?

Why You Should Be a Private Money Lender

The only way to beat the bank is to BE the bank. Become a PML.

Let’s say you invested that same $100,000 with a reputable rehabber at 10% with one point paid at funding. You would earn $1,000 just for making the loan.

Think about that. You’d make almost as much money just for making a loan that could possibly be repaid the next day as you would for leaving your money in a CD for a full year. Then you would earn $833 in interest every month until the loan was repaid when the house was sold. that’s a lot more than the $183 the highest paying CD would give you.

Now as a PML, you could let your money compound, just as you would with a CD. But you could also take that interest payment every month and do with it what ever you want. Put it back for taxes. Make a car payment. Anything. What would it be like to drive a $100,000 car and have someone else make the payment for you every month? At the end of the day, you have the car and the $100,000.

The graphic at the right compares the money you'd earn as a PML to the money you’d earn in a CD. Even if one project finished and it took two months to find another project to fund, you’d still make $9,552 during the year. that’s $8,428 more than a CD. You’d make an additional $360 by letting the interest compound. Or you could drive an essentially free car.

The Bottom Line

The bottom line is simple. Find a local rehabber to work with. Fund their projects and let them do the work. Just make sure you have a good contract and a first position lien on the house. I would also recommend that you not loan more than 75% of ARV and stay involved with your rehabber. That way, if the loan goes south, you still have a $133,000 house for $100,000.

For more information about being a PML, sign up for our free booklet.

How To Finance Your Projects

Photo source: Amazon “Other People’s Money” didn’t originally have the connotation we think it does today. Based on what happened in 2008, Brandeis’s thesis is a lesson lost. I highly recommend this book to anyone who has money or wants to have money some day.

This post originally appeared on the Hermit Haus blog on 2016-08-30.

If you watch HGTV’s Flip Or Flop—and who hasn’t?—you’ve heard Tarek El Moussa say, “We buy houses for cash.” If you watch regularly you may have also heard him say that they don’t always use their own cash. Not using your own cash is a consistent bit of advice from everyone from Than Merrill to Phill Grove.

But if you have enough money, why not use your own? Honestly, if you have enough money to complete a purchase and remodel on your own, you probably should do your first one or two deals with your own money. But you really don’t want to continue that practice for several reasons:

• It limits the number of deals you can do at one time.
• It lowers your return on the money you invest.
• It ties up resources you might be able to use for bigger deals or personal emergencies.

But, to me the most important reason to use other people’s money (OPM) is that doing so enables you to spread the rewards of this business as well as the risk.

I seldom fund a project completely with my own money. Why tie up $100k on one project that returns $30k when you can tie up $40k on two projects that return $25k each in the same amount of time and still have a reserve? (All numbers in this post are provided to illustrate points and do not necessarily reflect any given project.)

So where do you get OPM?

Here are some sources:

Hard money

Hard money lenders are bricks and mortar businesses, like banks. But they play by different rules than banks. They generally charge the most points and highest interest rates of any source.

Private money

Private money lenders are people like you and me. They loan you their money to complete your projects in return for the guarantee you’ll pay them back.

Banks

You’ve probably heard the myth that banks won’t loan money on distressed houses. What that means is you can’t get a traditional mortgage on a house that isn’t up to code. But you can get a one or two year construction loan. In many cases, these loans are interest-only until due, and they are at a much lower interest rate than hard or private money. The catch is that you must already have a proven track record and assets to get a bank to finance your project.

Owner financing

Owners are the least likely source of capital. If they had the money to fix up their house and sell it on the open market, they probably would. But you can offer to fix up their house for them and split the proceeds.

My favorite source is private money. Even when a bank finances the purchase, private money often finances the renovation. Why? That’s the topic of my next post.

What Is Reverse Wholesaling?

Reciprocity is the psychological word for fair play. When we do something for someone, they usually feel obligated to do something for us. It works both ways.

You can find blank assignment contracts on the Web. I recommend paying the money to have a good lawyer in your area draw one up.

This post originally appeared on the Hermit Haus blog on 2016-08-27.

I’ve talked about the benefits of wholesaling real estate on a couple of posts. In short, wholesaling is the process of getting a property under contract and selling that contract to another investor. (For a more in depth explanation, see “What Is Real Estate Wholesaling?” In “Marketing Pays Off!” Sue Ann discusses a double-close wholesale deal that brought us a needed cash infusion.

Today, I want to talk about a specific variety of wholesaling called “Reverse Wholesaling.” Now Reverse Wholesaling technically isn’t a different type of wholesaling. It’s really more of a wholesaling strategy. Simply put, it’s all about knowing who is going to want to purchase the rights to your contract before you make the offer.

Here’s how it works:

Let’s say you’re out Driving for Dollars (driving around looking for off-market properties you might want to buy). You find someone loading a U-Haul trailer, moving out of a house. So you stop to chat. You find out that they are going to walk away from the house for personal reasons (that matter a lot to them but not to this discussion). You walk through the house with them and realize that you can help salvage their credit score by buying the house. You make the offer and they accept. You now have a marketable interest in the contract to purchase the house.

So far, this scenario fits the wholesaling model perfectly. But what about Reverse Wholesaling?

You know this house is a good investment at the price you now have it under contract—just not for you. But your friend Samantha is looking for exactly this type of deal. You call Samantha and she’s thrilled you found the house for her. You assign the contract to her and collect your assignment fee.

How is that any different from traditional wholesaling?

It’s different because you never had to market the contract. You had a list of buyers, and you knew what they were looking for. You simply called one of the investors you already knew wanted to buy a house like this one.

I was involved in a transaction very similar to this one just last month. Eugene, a wholesaler, blasted a property to an investor group’s email list. I went to see the property and knew immediately that the deal was too thin for the Hermit Haus model, but I knew someone whose model it fit perfectly. I put my friend Larry in touch with the wholesaler, and Larry bought the house. I did not collect a fee because I had no equitable interest; I never owned the contract. But I earned goodwill points from both Larry and Eugene, who has since given me first dibs on several of his wholesale deals.

There are numerous tactics for building your buyers list, but that is the topic of a future post.