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.

The Importance of Due Diligence

The wall art was the most interesting thing about the house. Other than the artwork, the interior of the hose was a disaster.

Even well-done pretty graffiti scares off retail buyers and drives down the price of an investment property. You can paint over it. It may take several coats of Killz, but you can.

This post originally appeared on the Hermit Haus Redevelopment website on 2015-12-18.

I got an email from a wholesaler today offering a property in Round Rock for $90-thousand. I performed the desktop analysis quickly and became very excited. While I couldn’t find anything that had sold on the street in the last year, two houses on the next street over had sold for just north of $200-thousand. That left a lot of room in the deal to cover whatever redevelopment the house might need.

I told the wholesaler I wanted to make an offer contingent on a walkthrough of the property. The wholesaler said we had to close by Christmas, and I agreed to the stipulation. He mentioned that he had a bid for $7,000 to cover foundation repair. Other than that, he said, all the house needed was paint.Even allowing another $5,000 to cover accidental damage to the plumbing during the foundation repair, I was still happy with the deal.

The house looked pretty good from the outside. The schools across the street made it feel welcoming.

Boots Are Made for Walkin’

Russell and I met at the house during his lunch hour. The first red flag went up as I drove to the house. The comps on the next street turned out to be at least 20 years newer, and all of the houses on that street were much more appealing than any of the houses on the subject property’s street. My comps were not really comparable, but I couldn’t tell that without seeing where the main street had been extended for the newer development. Even the pictures on Google Maps made the houses look comparable.

Location, Location, ... Or Not!

On the other hand, the subject property was across the street from two schools. Location and location.

We walked the property and found that the exterior would need more than just paint. A dog had trashed the back door. Some of the eves and facia were rotten. No big problems but enough to start adding up.

Inside the house was in really bad condition, but the demo had already been started. All the carpets had been removed when a water pipe broken and flooded the house. A note on the kitchen cabinet said that repair was in process.

I won’t go into all the details, but the repair estimate came in at between $35- and $40-thousand.

The final analysis showed that we were likely to lose money on this deal. So we walked away.

To Buy or Not to Buy

When I got back to the office, Carol had run a much more accurate CMA than what I had pulled for the desktop analysis. She estimated the ARV of the house at between $140- $160-thousand. We determined that the deal was just too risky, even if we could get the house for $80-thousand. One of our mentors, Shenoah Grove, agreed. So we walked away from another property.

But the wholesaler said he had two other investors willing to take the property at full price. I wish them good luck. There are plenty of people with money to chase these deals—many of them are too willing to take on a project without fully understanding the numbers. No matter what you see on shows like Flip or Flop, those people are professionals. They almost always know what they are getting into before they buy the house, and they walk away from 20 or more deals for every project they take on.

Here is what I want you to take away from this article:

While I won’t accuse any wholesaler for outright lying, their numbers are almost always overly optimistic. This business is risky enough without walking into a deal without doing your own due diligence. Always include a contingency for unknown factors. Every project has them, but you can’t know what they are before it’s too late.

I’m going to keep my eye on this property to see what happens to it.