I’m not a professional money lender. I know next to nothing about lending regulations, underwriting, foreclosing on non-paying borrowers, etc. So, why am qualified to write this post on real estate financing? Because if you’re a real estate investor – or want to become a real estate investor – your best bet for borrowing money may be from a guy like me.
You see, like millions of regular people out there, I have money in my retirement account. And when the right opportunity comes along, I’m happy to loan that money for very reasonable returns. Not only am I happy to loan that money, I’m THRILLED to loan that money. If I had to choose between putting that money in stocks, bonds and CDs that may or may not generate a decent return and putting that money into a secured real estate investment that could consistently earn 10-12%, I’d much rather put that money in the hands of a trustworthy investor. And I promise you that you have professionals in your network (your doctor, lawyer, accountant, etc.) who also have money in their retirement accounts and would be just as happy as I am to get 10-12% secured returns on their cash.
These people are often referred to as “Private Lenders,” and they are the bread-and-butter of the real estate lending world. Ask any successful real estate investor where he gets his financing, and there’s a very good chance he’ll tell you that he’s borrowing money from friends, family and professionals in his network who are loaning retirement funds and extra savings at rates between 10-12%. There are two reasons why real estate investors prefer Private Lenders over other types of real estate financing:
– Compared to hard-money loans, private money is tremendously inexpensive. Hard money these days typically charges between 12-18% with 3-5 points upfront. Add in the appraisal fees, documentation fees and other “junk” fees and these types of loans can turn even a very good deal into something closer to break-even;
– Compared to bank financing, private money is tremendously uncomplicated. Banks require lots of paperwork, property documentation and can take weeks to fund a loan. In addition, many types of conventional bank financing won’t allow for the purchase of distressed (non-move-in-ready) houses. Private lenders generally don’t care about the nitty-gritty details (of either the property or you financial situation), as long as they can be confident their money is secure.
Which takes me back to my original point — while I’m not a professional lender, I do know what it takes for a real estate investor to convince me to loan to my hard-earned retirement funds – and this is likely what it would take for you to convince those in your network to loan their money to you. Below I list the four areas you should focus on when pitching you and your investment to a private lender:
1. YOUR EXPERIENCE
Smart people recognize that the best indicator of future success is past success. Therefore, it’s important that you convince your private lenders that you have been – and are – successful at the things you do. If you’re just starting out investing, you may be saying to yourself, “How can I prove my real estate success when I don’t yet have any?!?!” Note that I said past success if the best indicator of future success; I didn’t say this past success had to be in real estate. Unlike me, most private lenders aren’t well versed in how flipping houses works. They don’t understand what it takes to buy, renovate and resell a house, and they don’t care to know. What they DO want to know is that you have the ability to successfully pull off the project. And if you have previous success in any area (even if not real estate), this will go a long way towards convincing your private lenders that you WILL be successful at this as well. So, put together a list of your previous accomplishments – real estate or not – and present yourself to your lenders as someone who has been – and will continue to be – successful.
2. YOUR DEAL
While putting their money in the hands of someone successful is of utmost important to a non-professional lender, there’s another half of the equation that’s equally important – a secure investment. Even the most successful people can sometimes find themselves on the losing end of a deal, but when a successful person has a great deal, the risk is minimized. The best way to do this is to prove to your lender that not only do you have a Plan A, but that you also have a Plan B and Plan C, and that as your lender, his money will be safe regardless of which plan plays out. You’ll want to present Plan A as your main exit strategy – obviously, if things go as planned, the lender will get his money back with the return he expects. Plan B should be an alternate exit strategy that also allows the lender to get his money back with the return promised. Plan C is the worst-case scenario where you skip town or stop paying on the loan, and the lender has to foreclose on you – if you can convince the lender that even in that case he’ll get his money back and then some (which he will if the deal is good enough), he’ll be a lot more comfortable handing over his hard-earned cash. This is why it’s so important that the deal you bring to your lender isn’t just good…it’s great.
3. YOUR “SKIN IN THE GAME”
While the two points above – a successful investor and a great deal – are the most important when it comes to attracting private money, having skin in the game will go a long way as well. By “skin in the game,” I mean that you have your own personal financial investment in the property, even if just a small investment. You see, even if a private lender knows he has the ability to foreclose and get his money back should you walk away, most lenders aren’t going to want to deal with that hassle. Instead, they’d rather be convinced that you would never walk away from the project, and the best way to ensure that’s the case is for you to have at least some of your own money at risk. When I loan money, I like to ensure that the borrower has at least 10% of the purchase plus rehab costs invested from their own funds. I’m still happy to lend 90% (which is more than most banks and hard money lenders) because I know that even 10% is enough to keep most people emotionally and financially invested in the project.
4. YOUR ATTENTION TO DETAIL
The last big thing I look for when loaning money to an investor is his/her attention to detail. While I don’t need to understand every detail of the project, I want to be confident that my borrower does. In my experience, attention to detail is what separates successful investors from unsuccessful investors, and knowing that the details are being looked after will go a long way towards convincing me to invest. My recommendation is to put together a detailed plan that lays out the pertinent information about both you (the investor) and the project that you’re borrowing money for. This should include your history of success, your team, the financial analysis for the project, the budget, the schedule, the list of contractors you’ll be using, etc. You don’t need to present this to the lender – he most likely won’t care about most of these details – but just the fact that you have all of these information documented and well-organized will provide the lender confidence that you are on top of the details and have the project under control.
Follow these four guidelines when approaching and pitching your private lenders, and you’ll find that borrowing money is easier than you could have imagined.
J Scott is a professional real estate investor who currently resides outside of Baltimore, Maryland. Since 2008, J has flipped 60+ houses around the country, and is currently focused on residential new construction, including luxury spec homes. J runs the popular investing website www.123Flip.com and is author of two top-selling books – “The Book on Flipping Houses” and “The Book on Estimating Rehab Costs.” J can be reached at firstname.lastname@example.org.