Hard money lending for the VP?

[jason]

It appears there hasn't been any discussion on this topic in years.  Hard money lending investing is where you, the investor, lend money, typically to a hard money lending company, who in turn lends the money, at a high interest rate, to borrowers for real estate-related loans.  For example, someone who buys a condemned house for $100,000 with the intention of living in it or flipping it definitely can't get a mortgage.  Or, even if the house isn't condemned, the borrower may not qualify for a mortgage because they have already maxed out their loans based on their income (DTI).  Either way, these types of borrowers have access to high interest, highly collateralized loans.  Most hard money lenders will only lend up to 50% or 55% of the current appraised value of the property.  So, if the borrower defaults, the lender is able to foreclose and sell the property.  Generally, the property would have to lose 50% or more of its initial value for the lender to lose money on the investment, more or less.  Does anyone in this forum do this type of investing? 
Here's the pros and cons as I see them:

Pros:
-High pre-tax returns of 9 to 10%
-Loans are highly collateralized, reducing risk

Cons:
-Income treated as ordinary income - after-tax returns in taxable accounts are less appealing
-Counter-party risk - the hard money lending company can steal your cash or may mismanage the risk on the loans - they may disregard their own caps on the ratio of loans to property value, incorrectly appraise the value of properties, and so on.  This risk can be partially offset by only investing with companies that have been around a long time, are audited, and have great reputations.
-Likely will not perform well in an hardcore economic/housing crash.  In the Great Depression, for example, real estate values dropped more than 50% in some areas.

Does anyone have any pros or cons to add to the list.  I am wondering if anyone else thinks this is an investment seriously worth considering for a VP.

[Mark Leavy]

When I sold my house, I sold it to a flipper - and spent a lot of time talking to him about the economics of his business.

I've thought seriously of doing hard money lending - but have not yet done it.

These are the things that I would want before I would invest:

1) Part of a small group.  8 or 10 folks where you have a good relationship with at least a few of the people.
2) Know the guy that is doing the flipping.  Check out his other work.  He should spend his money on the yard and the kitchen and the paint and the roof...  Find out if he has legal or family troubles pending in the courts.  Find out how much of his own money versus Friends and Family versus Hard Money is going into the deal.
3) Insist on seeing the inspection reports, the sewer line video, etc.
4) Don't lend more than than 75% of the expected after repair sale price.
5) Don't lend more than you can afford to lose.
6) Look for 15% or better interest plus 2 to 4 points.

[jason]

When I sold my house, I sold it to a flipper - and spent a lot of time talking to him about the economics of his business.

I've thought seriously of doing hard money lending - but have not yet done it.

These are the things that I would want before I would invest:

1) Part of a small group.  8 or 10 folks where you have a good relationship with at least a few of the people.
2) Know the guy that is doing the flipping.  Check out his other work.  He should spend his money on the yard and the kitchen and the paint and the roof...  Find out if he has legal or family troubles pending in the courts.  Find out how much of his own money versus Friends and Family versus Hard Money is going into the deal.
3) Insist on seeing the inspection reports, the sewer line video, etc.
4) Don't lend more than than 75% of the expected after repair sale price.
5) Don't lend more than you can afford to lose.
6) Look for 15% or better interest plus 2 to 4 points.

That's a bit more hands-on than what I had in mind. I was thinking along the lines of writing a check to a reputable  hard money lending company with a long track record and letting them do everything. I know it would essentially eliminate counter-party risk by forming my own lending group, but that reduction in risk is cancelled out by the fact that I don't know what the hell I am doing. 

[Kriegsspiel]

I wouldn't put my money into something if I didn't know what the hell I was doing. If you wanted to do hard money loans, I think the best way is to learn about it, get into your local REI scene, and find local real estate guys to lend to, and work with them and establish relationships.

Something else you could look into is investing in tax liens. There is a good Bigger Pockets podcast about it with a guy from NJ. It's one of the earlier ones.

[sophie]

How is this different from Lending Club?  That's unsecured loans, true, but this doesn't sound a whole lot better as there's still plenty of third party risk.  Which is reflected in the stated 12% return.

I'm currently getting a 15% annual return in my little Lending Club VP, although I expect that to level off eventually to around 10-12%.  Not shabby, although the tax treatment is a big drawback.

[MachineGhost]

How is this different from Lending Club?  That's unsecured loans, true, but this doesn't sound a whole lot better as there's still plenty of third party risk.  Which is reflected in the stated 12% return.

I'm currently getting a 15% annual return in my little Lending Club VP, although I expect that to level off eventually to around 10-12%.  Not shabby, although the tax treatment is a big drawback.

Hard money is backed by a first or second position lien on the property, so worst case you can foreclose and acquire it.  I can give some advice based on sore experience: never take a second position lien.  You have no power at all to effect a foreclosure unless the lender (almost always a bank that securitized and sold off the note, so good luck waiting for them to find any documents) in the first position chooses to do it on their own time table (or not) and in some states, the second lien can just be ignored or wiped away if the first decides to foreclose.  And you need to come up with the cash for the entire foreclosure judicial process; possibly rehabbing the property, marketing the property to sell, etc...  Bum deal all around! 

What's better on the pecking order than mortgage liens?  Tax liens, of course!  Like student debt, they never go away.  That's my preferred poison now.  But it's not a market for the n00b anymore -- its gone online and is brutally competitive with yields forced down to 0% or even negative from really desperate investors in some cases.  It's a sad commentary about the ZIRP world.

@MangoMan You're referring to GF or RM, right?  Just asking in case I missed one.  Crikey, I just realized I probably need to file for another state for the K-1 but since Turbotax only offers one state for free, I ignored it!!!

[Mark Leavy]

Jason : "Hard money lending, you say?"
Sophie : "Why not just peer to peer?"

Voila!
https://www.peerstreet.com

I just saw this referenced in a Mr Money Mustache post.  I don't know if it is trustworthy or not, but it is a peer to peer hard money lending startup.

[MachineGhost]

Jason : "Hard money lending, you say?"
Sophie : "Why not just peer to peer?"

Voila!
https://www.peerstreet.com

I just saw this referenced in a Mr Money Mustache post.  I don't know if it is trustworthy or not, but it is a peer to peer hard money lending startup.

[MachineGhost]

Maybe not so "excellent!"  The minimum is $1K per loan.  That makes broad diversification problematic.  Anyone got $400K they want to lend me?

Maybe they'll lower the minimums after May 16 once (if) they drop the accredited investor requirement.

[MachineGhost]

RealtyMogul and RealtyShares. Idk what GF is unless you're talking about the house my girlfriend owns. 

https://www.groundfloor.us/

RealtyShares looks like the easiest way to enter at this moment in time.

But who is in the pole position for P2P real estate?  I don't want to deal with tier players.

Since I'm well exposd to tax liens, I'm thinking real estate equity exposure could be enough of a kicker.  Needs to be bigger potential upside to bother with the hassle.

[Kriegsspiel]

MG, don't you live in California? From what I gather, California is a tax deed state, are you going out of state to get your tax liens?

[MachineGhost]

MG, don't you live in California? From what I gather, California is a tax deed state, are you going out of state to get your tax liens?

Yep, but I didn't know tax deeds were an alternative -- and perhaps superior -- way to invest.  Need to look into that.

This isn't a bad retirement job to generate income if one really want to get into it (its complex, but you just need intelligence).  The Wall Street funds have size concerns so they're not gonna waste time bidding for smaller liens.  They're fine using millions to bid 16% down to .25% because they get a guaranteed return + their management fees.  What a racket!

[Kriegsspiel]

MG, don't you live in California? From what I gather, California is a tax deed state, are you going out of state to get your tax liens?

Yep, but I didn't know tax deeds were an alternative -- and perhaps superior -- way to invest.  Need to look into that.

This isn't a bad retirement job to generate income if one really want to get into it (its complex, but you just need intelligence).  The Wall Street funds have size concerns so they're not gonna waste time bidding for smaller liens.  They're fine using millions to bid 16% down to .25% because they get a guaranteed return + their management fees.  What a racket!

I guess it would depend on the specific state and situation. From what I can tell, tax deeds are a more expensive way to get control of property(you are bidding based on what the house appraisal is), whereas with tax liens you are only paying off their taxes, the property value doesn't come into play. So you could eventually come into a property for a few thousand dollars (?) instead of $15,000 or whatever the deed would cost. And if the owner does pay you for their lien, you'll be making money that way too. I am not sure if deadbeats are required to pay interest on the tax deed "down payment"/title research/etc, are they?

[MachineGhost]

In the forum's down time, I had a chance to check out the real estate P2P ecosystem.  There's a lot of players now.

The "LendingClub" of them all is FundRise.com.  They originally offered P2P real estate investments, but have since pivoted their business model into offering non-public eREIT's.  This is a smart move as the investment minimums will be lower and allow for broader diversification.  Being accredited (whether by old-school self-affirmation or JOBS Act explicit verification) isn't required.  Come May 16, there will be a flood of non-accredited Boobus Americanus all looking for startup and alternative investments.  Their new equity fund closed the very first day to process the first batch of investments within the 10 minutes or so after I discovered it by happenstance.  How annoying!

The rest of the ecosystem is full of startup wannabes looking to hit it big, but they have high minimums, mostly indirect investments, accreditation requirements and lots of "man in the middle" fees.  A notable exception may be RealCrowd.com which acts just as a conduit for direct real estate investments and charges no fees to the investor.

Give the troubles Prosper.com has had lately, I'd recommend sticking to Fundrise.com.  It's bad enough to take on the risk of real estate without having to also worry about counter-party risk with a middleman servicer.

Do note that the very best of the best real estate deals are highly funded up by established, private, accredited investor networks before they show up on these P2P sites.  That's another arrow for FundRise's sling.  May 16 is going to change the signal to noise ratio and I doubt it will be for the better, so you want to keep an eye out in terms of maintaining "elite access".