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.