Hard Money to Purchase Distressed Property

Hard Money to Purchase Distressed Property

     In San Antonio I have found that far fewer investors focus on ROI - Return on Investment- as opposed to investors in Dallas or Houston.  It is crucial when first starting out to remember that investing your money is like recommending a career path for your son.  It's great that he's 18 and finally ready to get a job and move out of the house but you want him to be as successful as possible so he doesn't wind up moving back in with mom and dad.  A lot of investors tell me, "My investment strategy is to make $200 a month cash flow from a rental" or, "I want to make $15,000 to $25,000 on a flip".  While it is excellent to have a goal, it doesn't give the individual any concept of what to look for or how to go about the investment process.  It is similar to your son asking you if he should spend four years in college and spend $60,000 to enter the job market at a job paying $70,000 a year, or to start straight out of high school making $30,000 a year.

    Leverage is an easy way to lower the amount of cash needed for a transaction. This minimizes your risk exposure and increases the amount of properties you are capable of investing in at any given time.  Hard money is a construction loan that allows you to not only purchase a property, but to also do the necessary rehab on the house to get it to either resale or rentable condition.  Asset based lenders are hard money lenders that focus less on the credit of the individual and more on the parameters of the project.  Credit based lenders are going to offer more competitive products, but are focused on the qualifications of the buyer.  For instance, let's take the following scenario where an individual is buying a house for $50,000 that needs approximately $20,000 in work and is worth $100,000.  For this example I will be using Sherman Bridge Lending.  The lender will lend out up to 70% of the after repaired value of the property or $70,000 in this example.  As this covers the entire purchase price AND rehab amount, one can deduce that this amount will be less as every lender is going to require you to bring some money to the table.  This lender is going to require

• 50% of the projected amount of repairs
• $6,000
• Enough to bring the LTV of the ARV to 70%

    As per our example the borrower would be looking at bringing $10,000 to the table the day of closing.  This amount is going to cover the purchase and set up the escrow for the $20,000 in repairs.  Let's take a look at what this looks like in excel.

Loan Terms:	12 Month Term, Interest Only
Interest Rate	13.99%
Points	4.0%
Max Loan:	70%	of ARV
Price	$50,000	Monthly Interest Payment	$816.08
Estimated Repairs	$20,000	Monthly tax Escrow	$250.00
ARV	$100,000	Total Monthly Payment	$1,066.08
Max Loan	$70,000	Estimated DOM	90
		Realtor Fee (Back-end)	6%
		Annual Taxes, County Data	$3,000.00
$50,000.00	Price	Projected Down Payment
$20,000.00	Repairs
$6,818.04	Closing Costs	$10,000.00
$76,818.04	Total Deal Cost
$66,818.04	Loan Amount

Now let's compare cash vs. hard money 

.

Cash		Hard-Money
$73,090.00	Cash + Costs	$76,818.04	Hard money + Costs
$2,000.00	Sale Closing Costs	$2,000.00	Sale Closing Costs
$739.73	Property Taxes	$3,154.44	Carry Costs / Taxes
$6,000.00	Realtor Fees	$6,000.00	Realtor Fees
$100,000.00	Sell or Refinance	$100,000.00	Sell or Refinance
$81,829.73	Total Cost (Cash)	$87,972.48	Total Cost (HM Loan)
$18,170.27	Profit from Sale	$12,027.52	Profit from Sale
$26,170.27	Equity as Rental	$20,027.52	Equity as Rental
Risk:	$81,829.73	Risk:	$13,154.44
Reward:	$18,170.27	Reward:	$12,027.52
Return on Money (ROI)	22.20%	Return on Money (ROI)	91.43%

      It is easy to see that with a buy fix sell strategy, the ROI increases dramatically by using hard money despite the fact of lower return in dollar amount.  This involves a risk of only $13,154 as opposed to an $81,170 risk for doing it in cash.  If you had identical opportunities, you could do six times as many properties at the same time.  This would jump your dollar amount return up to $70,000 for the same initial investment.  

     The biggest concern I hear from investors when talking to them about hard money is about the fees associated with opening the loan and the high interest rate.  If by using hard money you increase your profit potential by more than 350% AND diversify your risk with the only negative aspect being that you have to pay some nominal fees, I say do it.  Also, think of diversifying your investment.  This spreadsheet is an example of a perfect transaction.  If this same deal was done six times you would find that on one you would make ten thousand, on the next five, the next twenty, the next zero, the next ten, the next twenty and so forth.  If you were doing a single deal at a time in cash and had some catastrophic mishap that cost you ten thousand dollars, you would blow out your profit potential for the entire four month duration of the project.

Hard Money is Smart Money.  ROI is your goal at the end of the day.