Would I Lend to Me???

“No money down” real estate really does happen.  And it isn’t all captured on infomercials at midnight.  If you find a great deal you can get someone else to fund it as either a debt partner or an equity partner (more on the difference between these two types of partners in a bit).  I still suggest that you have some money in the bank when you get started.  This allows you to put some “skin” in the game by contributing to the project.  This helps lenders get over your newness to the business.  When we first started using private loans, as I’ve mentioned before, we didn’t even ask to borrow the whole purchase price.  We borrowed 5k less than the purchase price (which was steeply discounted due to the property condition) and funded the entire renovation from our savings.  The next renovation was funded entirely by this same lender (purchase and renovation).  These relationships allowed us to never need to use true hard money at the more expensive rates.

As we have begun dabbling in some private lending ourselves (from retirement accounts); we see the other side of the story.  As a borrower you might have heard “banks lend money to those people who don’t need it.”  And this is kinda true.  As we have looked at some deals from a lenders perspective, we see that many of those who want to borrow money have no experience and no money but want a loan for purchase and renovation costs.  Do you see why this might seem risky to a lender?  You will appear as having no experience in this business, no skin in the game, and thus nothing to lose if the deal goes badly.  And worse, you have no capital with which to save a deal gone bad.  The HGTV shows generally show a few challenges and then the deal is redeemed and is still profitable.  Here in the real world, deals go bad.  Lenders take back properties.  No one likes to talk about these cases but they are real.  So if lenders measure risk to decide what projects they will lend on, how do we minimize their risk and make them want to lend to us?  We capitalize.  Or we gain experience.  Or we find extremely reduced priced properties.

Let’s start with Capital.  We put some money in our corner.  We may be able to recoup this money eventually but we are showing we have some money to contribute which gives us a reason to fight through any challenges that arise with the project.  This is what is known as “skin in the game”.  So how do we get this capital?  I’m going to list some ideas here.  Savings accounts, piggy banks, loans or early distributions from IRAs or other retirement plans, sell a car, garage sales, home equity line of credit, cash out refinance your home, sell some old collectibles, drive Uber, sell old clothes, charge those scooters that are everywhere (yes, people get paid to do that), start an ebay store, or any other side hustle that you can think of using your unique strengths and skills.  Tighten up your budget and save something from your regular earnings.  These things will add up.  They will put you in a position to have something to contribute to the deal, and thus something to lose, if the deal goes bad.  This is a good thing from a lender’s perspective.

Another way to reduce perceived risk is to gain experience.  Think about these things from the lenders perspective.  Would you rather loan on a first project for a borrower or a 50th successful one?  Conversely, these experienced investors have been able to lower their interest rates by being perceived as a lower risk for the lender.  So newer investors pay more in interest generally.  Now how do you gain experience?  Those darn lenders only lend to those who don’t need it!  You might partner with someone who has some experience and borrow their expertise and give them an equity split on the project.  Maybe they help to get the loan and you do the bulk of the work and you split profits.  By splitting the profits with your partner rather than paying a set rate for their funds, they are what is known as an equity partner.  You are splitting the equity created by doing the project.  Now you each have one more deal under your belt.  And you will want to document this project with pictures and numbers and hold all profits in the bank (remember: ‘capitalizing’).  Now you are becoming more and more appealing to lend to.  Your cost of money is dropping.  One or two more deals and you are well on your way to getting all the funding you need.  

The third way to get people to throw money at you (for a price of course) is to find really, really great deals.  If I asked to borrow 5,000 dollars from you to buy a sweet ’08 Honda CRV like mine, would you lend it to me?  First you’d check Kelly Blue Book and establish what the market value is.  Then you’d choke back your jealousy that I drive such a cool ride.  Once on KBB, you’d see that the market value is 5,100 dollars (I mean it does have a sunroof and gen-u-ine ‘leather’ seats).  This might not be a very safe loan if I don’t have any money to my name.  You would have pretty weak collateral.  What if I ask, instead, for 2000 dollars because I found this steal of a deal on this car for 3000 dollars and I was willing to put 1000 dollars of my own money into the deal? (Combining finding a great deal with skin in the game) Now if I default, you have one pretty awesome car to re-sell after you repossess it (I don’t mean to brag).  See how this makes it less risky to the lender?  Let’s say you approach a lender with your first flip project and ask them to fund a purchase price of 50k but it will be worth 130K after 20K invested-and you are willing to pay the 20K out of your savings.  This makes your deal pretty low risk despite your lack of experience.  

So add to that some experience and some capital and you become a slam dunk borrower who can negotiate down your borrowing costs.  This is how I see borrowing: “how do I become a low risk borrower in the eyes of my lender?”  This is how I see lending: “how do I safely lend to beginner investors and make sure I will get my capital back?”  So often we can find answers to our problems when we look at it from the other side’s perspective (we could probably apply this to a lot of aspects of our lives).  I want to help new investors but I don’t want to lose our capital because before we can have a return ON investment, we need to make sure we will get a return OF our investment.  

I hope these points have given you some food for thought.  There is a ridiculous amount of money out there looking for a place to be invested for a return.  You will likely be surprised where you may find it.  I hope you have a great day and, as always, keep the main thing the main thing!

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