Ultimate Guide To Funding
We’re talking about funding!
Whether you’re a seasoned investor or you’re looking for your first deal, understanding your private money loads is fundamental for to your success. We don’t want you to do anything that would jeopardize your deals when you are flipping houses for profit, and understanding your funding will give you more stability in your investing business.
When you pull the right numbers, structure deals well, get houses under contract, and create proper exit strategies, we believe nothing should stand in your way of funding.
(If you’re just joining us, you can read Part 1 HERE)
In Private Money, there is a certain amount of trust that goes into the deal. Unlike banks, private money lenders provide their personal cash to a known or unknown buyer.
Because of this, most lenders prefer “skin in the game,” or a cash contribution to the transaction.
You will not need to bring all of these elements to the table, but most likely you’ll need one:
- Cross Collateral
- Experienced and Cash Partner
- Seller Carry-Back
What are you putting up for collateral? Are you putting up cash, a house, or are you putting up rentals? Skin in the game means the price goes down because the risk-to-reward ratio is reduced for the lender.
“Skin in the game” reduces the lender’s risk or involvement in the situation. If you need to borrow $100,000 to purchase a piece of property, you’re not going to have any trouble getting 65%.
Most lenders want to see a level of participation. They want to make sure they’re covered should you need to default on the loan.
They don’t want to make it too easy for you to walk away and leave the lender and seller (who carried back the second note) hanging. They only want to lend money on good investments where they’re going to get a return on their money.
If someone is reluctant about putting in their own cash, the lender, in turn, will be skeptical about putting in their cash. If the deal’s not good enough for the borrower to risk his/her money, why should the lender risk theirs?
The Carry-Back, Subordinate Second:
If you have a deal that needs immediate funding, you need to structure the deal, so it’s immediately attractive to the lender. This doesn’t mean you have to pull out your checkbook and write a big check for 35% of the deal. It means that somehow within the deal, you need to structure “equity play.”
Let’s say you find this property that after repairs is worth $200,000 and you have it under contract for $100,000. Many people would say, “Look, I have a property that already has $100,000 in equity and a 50% loan-to-value!”
Unfortunately, this isn’t the case in today’s economy. In this market, a house that is bought for $100,000 is worth $100,000. Comps mean nothing, or very little and therefore, what you pay for a property is what the property is ultimately worth. Very few lenders are lending on the after-repair value rate because, as I said before, money is attracted to the tangible, real property, not the dream. It will take into consideration the dream and future cash flow potential, but it will only lend on the purchase price.
So, back to the example: If the lender requires 20% skin in the game and you’re paying $100,000, the lender will give you $80,000 and somewhere, somehow you need to come up with $20,000. The easiest way to do this without any of your own money is to get the seller to do a “carry-back, subordinate second” for $20,000. If you need $20,000 cash back for fix-ups and repairs, then you can see if the seller is willing to carry-back for $40,000 instead.
This is just one creative solution; there are many more ways to structure a deal without requiring the cash. So, if the lack of liquid is keeping you from entering the game, call your Business Development Consultant today for help understanding what your options are. (800) 473-6051.
The Motivated Seller Makes Borrowing Private Money Easier:
Why would a seller even consider a “carry-back, subordinate second?”
This economy and market are creating a surplus of what real estate investors call the “key to success”—the motivated seller. A motivated seller is someone who desperately wants and needs to get out from under his/her property. There are lots of reasons why this happens: job relocation, divorce, a medical condition, or job loss. The subprime mortgages and the interest-only loans have created a large amount of distressed homeowners who can’t pay their monthly mortgages.
They have banks, attorneys, and creditors breathing down their necks and they feel like they are on a sinking ship. They are motivated because they absolutely have to be.
Working with a motivated seller saves you time and money. They need your help and don’t have the time to be wishy-washy over price or whether or not they would consider a “carry-back, subordinate second” on $20,000 or even $40,000.
It’s the easiest way to put no money down and get cash back at closing. The lender likes it because the deal is creatively structured to be very attractive and skin is in the game. The borrower likes it because they don’t have to use their own money to put into the home. And the seller likes it because they have sold a cumbersome property and will see the rest of their money in the very near future.
It’s a win, win, win situation!
If you are pursuing bank-owned or short sale properties, this strategy will not work for you. That’s why when we get clients strapped for cash; we don’t pursue listed, bank-owned, short sale or HUD properties. Instead, we go after unlisted, sale by owner properties or out-of-state free and clear properties where we know, without a shadow of a doubt, that the seller has equity in the deal and is willing to participate in the financial packaging and structuring of the loan.
This allows my students and clients to come to the table with no cash. Think of it this way, if you never had to put any of your own money into a deal, how many deals could you afford to invest in before you run out of money? The number is unlimited and depends entirely on your goals and time budget. Better that, than your monetary budget, right?
Bank Owned and Short Sale Properties:
Bank-Owned and Short Sales also have huge income potential. If you do want to invest in these types of properties, you need to go into the private money negotiations with cash, collateral, or a partner.
If you have a partner, you will need to split the profit with them after the property sells. However, this can be a great fit for you if you’re just beginning and need to build up your real estate portfolio and reputation. Eventually, after doing it this way on a few deals, you’ll have enough cash to do the deals by yourself and keep 100 percent of the profit.
This is how I first started in real estate. I was a bag boy at a local grocery store in Spokane, Washington making $3.90 an hour. On the first four deals I invested in, I partnered with the pharmacist at the store. He put in the money, I put in the sweat equity, and we split the profits.
After four deals, I had enough liquid and reputational capital to do deals on my own and reap 100 percent of the profit for all my hard work, time and effort!
Always be looking for people you can partner with that either have good credit and can go out and get conventional financing so you can borrow money at 4, 5, or 6 percent, which will increase your cash flow or people who have cash, but no time. They want to make more money; they just don’t have the time or resources to do it. That’s what you bring to the table.
Most, if not all, private money lenders are not in the business of acquiring properties. They truly want you to succeed at this endeavor for both your sakes!
Therefore, when you approach a lender, you need to have a solid, cohesive plan in place for the future of the property. Begin with the end in mind.
Do you intend to:
- Flip the Property
- Rent and Flip the Property
- Rent and Hold the Property
- Lease Option the Property
- Wholesale the Property
- Refinance the Property
Lenders want to see the loan perform and eventual repayment on the property, and a well-thought-out exit plan gives them peace of mind.
Step Six: Follow Up:
How you respond and act in the early stages of the relationship, will set the tone and stage for how the rest of the relationship will work throughout the term of the note. It’s always important to be quick on your response in business and to always follow up and follow through, but when dealing with lenders, and especially a lender you’ve never worked with before, you need to be “Johnny on the Spot” and respond quickly.
- Return phone calls and emails promptly
- Answer any and all questions honestly
- Never fudge the numbers
- Stay organized (provides requested documentation on time and in an orderly format)
- Follow up constantly
If they call you for more information, a signature, or an approval of something, you need to drop everything you’re doing because “Money is calling you.” In this day and age, that is a rare thing indeed, and if you want “money” to continue to call you, you always need to be available and amenable to its requests. You are proving to them that you are a person of integrity, a person of your word. You show them that you do what you say you’re going to do when you say you’re going to do it quickly and on time.
Think of it this way. If they’re writing a six-month paper, it’s like you’re on a six-month interview for whether or not they will ever lend to you again. And I can tell you that having a constant and ongoing relationship with a private lender is your bread and butter in real estate, especially in this economy.
It’s a night and day difference between being a successful real estate entrepreneur with a huge and burgeoning portfolio or being a mediocre or dejected real estate entrepreneur-want-to-be.
It’s Called Reputational Capital:
What you are building through this process is what I believe to be the most valuable and profitable thing in business. It’s more valuable than gold and yet many times it’s the last thing a busy business entrepreneur thinks about or spends time and effort on. It’s far beyond bank lines of credit and cash. It’s called “relationship capital.”
Reputational capital spends like currency. If you want to get to a place where you can pick up a phone and get a lender to wire you funds without having to sign a single document, you need to build relationship capital, and you do this by fanatical follow-up and follow through.
The better you are at this, the better you’ll be at finding funding on every deal, every time.
Step Seven: Perform, Perform, Perform
Staying current on payments may seem like a no-brainer. It’s what you committed to in the establishment of the loan, and it’s the very foundation of your relationship with the lender. But sometimes life gets in the way, and other payments—cable, phone, or Internet seem more important.
If you want to keep your head above water in this industry and your reputational capital free and clear of the scrapes and bruises that leave the tell-tale signs of default, then you need to pay your loan on time, every time.
It’s a smaller world than you think and whether you like it or not, your reputation proceeds you into a deal. If your past lenders won’t touch you with a ten-foot pole, you’ll find that new lenders will use a twenty-foot pole.
Here are a few ways to make sure your priorities are straight in a deal:
Procrastinating Your Payments
Procrastinating your payment on loans, or writing the loan off completely as unobtainable, will destroy your ability to be successful. Avoiding the language “can’t or never” will help keep you on the straight and narrow path to accomplishment with your lender. Here are some ways you can stop the procrastination that’s keeping you from paying on your loan and reaching your goal:
- Stop looking at your loan like it’s an insurmountable mountain. Chop it down to scale and give yourself a realistic time frame to pay it off.
- Eliminate “can’t” and “never” from your daily speech.
- Make detailed plans for achieving both short- and long-term goals on the property.
- Get it done. Fulfill your exit plan. Once you do so, you’ll have more money to put into more deals and eventually you’ll be able to participate in the “Circle of Wealth.”
If you’ve never gotten a private money loan before, don’t let the information scare you away. We’re here to help guide and educate you so you can borrow successfully and have profitable investments.
If you still need more guidance on funding, a Funding Tour is a great place to start!
Learn the basics of private money in the classroom with the experts from the Lee Arnold System of Real Estate Investing team!
Click here for more! And join us back here weekly for the most information for your real estate investing.
To your Success,
Lee A. Arnold
The Lee Arnold System of Real Estate Investing
CLICK HERE to learn about all of our certifications.
You can bring your questions to a Business Development Consultant today by calling (800) 473-6051.