Scaling a Portfolio: Hard Money Loan
First off, what is a Hard Money Loan? According to Wikipedia, the source of all knowledge:
A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by real property. Hard money loans are typically issued by private investors or companies. Interest rates are typically higher than conventional commercial or residential property loans, starting at 7.7%, because of the higher risk and shorter duration of the loan.
In my experience, hard money is often looked at with disdain. Probably because you can get into a lot of trouble if you do not know what you are doing. The high rate, balloon payment at the end of the term, the short time frame, and up front points are all very good reasons to stay away from these types of loans. Let's say you were doing a flip and used hard money to do so. If the market collapses and you do not have enough margin built in (the difference between your total all in cost to the expected value after all repairs are done), you could be left with "the bag in your hand" and your hard money loan due with lots of interest. This would result in a loss even after all of your efforts. That being said, with the right team and the right deal, these types of loans can be used to scale your business in a responsible manner. I used to get confused a lot between Private Money Lenders and Hard Money Lenders. There are some technical differences, and Private Money Lenders seem to really not want to be put in the same category as Hard Money Lenders, but as far as I'm concerned, they look the same to me, the investor. They all:
Have short term loans that vary from 6 months to 1 year
Have higher interest on their loans, going anywhere from 7.5% to 13%
Generally collect some sort of points (generally 1-3) on the loan (an up front fee that goes for usually 1% per point)
Provide funding percentages for both the initial purchase and the renovations
Have the real estate asset as collateral in the loan
Have annoying fees associated with every step of the way (withdrawal fee, document fee, etc)
Note that when I refer to Private Money Lenders, I'm not referring to investors that you have access to such as family, friends, or your network, which is Private Money (yes, confusing I know).
These types of loans are very valuable and can allow you to invest in new deals with little money out of pocket. Despite the bad rap, this is a strategy that I am turning to. It takes a while to shop around and find a lender that works best for you. You can only do these types of deals if you are purchasing below-market properties and doing some sort of value add with a team that you know can execute, otherwise you should STAY AWAY and just go with a conventional loan.
My general criteria for these types of loans is to have as few points as possible up front in favor of increased interest (because I generally can purchase and renovate within 1-3 months), at least 1 year term, and the option for extensions should they be needed. The more the purchase and rehab is below the ARV, the less out of pocket you need to bring to the table. In my case, because I am going through a contractor, my % ARV is a little higher than typical (~80%). I accept that percentage because I can utilize a highly experienced team and have little of my own time involved, but it means that I need to put in a bit more capital into these types of loans.
Private money loans can be a solid play if you have the right deal and a reliable team to execute the rehab with. With this strategy, I should be able to double the amount of deals I would normally be able to do in a year.