Real Estate 031: Finding Private Lenders Script

As investors work towards building their portfolio, they often might run into an issue of finding capital to fund their deals. I have also run into this problem as I was taking down almost 1 deal a month in 2018, and needed to find a private lender (e.g. family, friends, coworkers, and other acquaintances that you have met/talked a couple times) that will help provide me with a short term loan while I execute the Buy, Rehab, Rent, Refinance, Repeat (BRRRR) strategy to force appreciation (build equity) in lieu of a 20-25% downpayment. I will share with you the steps that I took to raise capital and create win-win situations for myself and the lender.

My first private lender was an investor friend of mine, as such, we knew of each other's deals, experience, and goals prior to entering into a financial relationship. I knew that as I engage other potential lenders, I needed to be able to explain clearly what I do, my experience, and the potential returns on their investment.

My informational package included the following items:

• Business name/contact information

• Business mission and objective

• Description of how my business operates (e.g. Market, Team, Investments)

• Explanation of Private Money and how to fund a deal 

• Business track record, including photos and videos

• Referrals from previous investors or mentors

• Expectations for both parties in the deal

• Frequently asked questions

Remember that content, not format of the information is key. Be prepared to fully answer any and all questions that the potential lender may have as most private lenders do not do this on a daily basis and will need some education in the beginning

Once this was put together, I provided this information to the potential lender and walked them through the entire process. Remember that real estate is all about building relationships, so even though this potential investor may not pan out, there may be someone he/she knows that is interested or they may return in the future once they are comfortable with the concept. As much as they are interviewing you, you are interviewing them to make sure that they are not going to be a hindrance and obstacle in operating your business. Is this person a nervous individual who will be calling you every day for an update, or a pushy investor? Or will this investor be in it for the long haul and be with you on multiple deals? These are questions to carefully consider before entering any agreement with your lender.

Next, you want to learn about your potential private lender and their main concerns. During my experience, I learned that lenders mostly care about three things:

1. Return on Investment

   1. What if the rehab goes over budget

2. Securing their Investment

   1. What if the appraisal does not come in at ARV

3. Timing of their Investment

   1. What if the economy changes

   2. What if the borrower goes bankrupt

These are all important questions that you should proactively address during your walkthrough and calls with the lender as follows (Investor Script taken from the BiggerPockets forums):

“As you know, these are ‘investments’ that we’re talking about, so there is no guarantee of success. There is risk involved with any kind of investment, but as our successful track record testifies, the way we invest in real estate seeks to minimize the risk at every turn. We offer a first lien position on any property we lend on, which means if I end up breaking any of the terms in our agreement, you could foreclose on me and take the property."

“Also, because of this lien, you will get all your money back, plus interest, before I ever see a dime. I only make money if you make money. Additionally, we will sign a promissory note that clearly and legally spells out all the terms and conditions of our arrangement. Finally, we only invest in amazing real estate deals that will have significant equity in right off the bat, so we are protected against a drop in the economy. Because we buy only good deals, there is significant monthly cash flow following conservative estimates, and we set aside money each month for future expenses. All these factors help limit risk and ensure that your investment is as solid as possible.”

Below is a sample rehab and FAQ sheet that I also share with my potential lenders as appropriate:

By advising your potential lending partner on these concerns up front, you are able to build a stronger relationship and trust so that you are both on the same page. Show them different versions of a proforma on a sliding scale that show a best to worst case scenario. Although you do not want to scare off the lender, it shows that you have done your homework and will put them at ease when you run into roadblocks and have to make adjustments.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Book Review 010: Linchpin by Seth Godin - Are You Indispensable?

Linchpin: Are You Indispensable?

In his book Linchpin, author Seth Godin tells the readers that every person faces a choice: You can choose to live day after day, year after year, languidly going through the motions, doing work devoid of excitement and imagination. Or, you can choose a path that promotes uniqueness and ingenuity by becoming a “linchpin” – an invaluable, indispensable employee, the center of a company’s activities. He challenges us by stating that if we believe in our self-potential for greatness, we need to embrace risk, ignite the creative spark within us, and seek out the good in other people to become an influential linchpin. 

If you decide to absorb all of the business teachings of Seth Godwin, be warned that you can very well end up feeling overworked and underappreciated. His message is so effective that it may have unintended consequences of making you the "go-to" person for the entire organization. 

Here are the main lessons of his book:

1. You do not have “Job security”.

Many people may already know that truth be told, they are replaceable. You may be the only Manager in a district, or have hit a million dollar in sales, but we all know you are only as good as your last sale and that the business environment can change in a minute. For over a century, Companies have promised employees decent wages, good benefits and job security in exchange for workers who met expectations, punched their clock in and out, and followed Company rules. Fast forward to the present, where economic and technology changes have wiped out job security. The current workforce is victim to globalization, reduction in force, and reduction of benefits as employers look to cut costs if that means an increase to the bottom line. This generation is different from the previous generation, and that means there are two sides to the coin.

2. Embrace hopelessness or opportunity.

The result of economic and technological changes have brought about a new wave of entrepreneurs and business opportunities, mainly through the internet and ability to connect with people all around the world. Instead of feeling hopeless and stuck, employees can climb out of the trenches and seize the opportunity to create a different, better future for themselves. Our society often discourages change and creativity. Many people are so accustomed to following rules and working diligently, they fail to realize that there other methods, new rules, in which people can stand out and become innovative.

3. Become a “linchpin.”

In the midst of the herd who simply follow the rules, you can choose stand above the crowd by becoming a linchpin – an invaluable, indispensable employee who inspires everyone else. By projecting a winning attitude even when naysayers surround you, you will become the person others ask for help, and when your colleagues depend on you, your firm will pay you accordingly. 

Remember that Linchpins aren’t brilliant all the time. They stand out due to their ability to recognize and seize opportunity. Godwin says that to be a linchpin, you must be smart and crafty, as well as hard working. Linchpins surpass their peers by combining wisdom about the job with shrewdness. Every interaction with your colleagues or clients is an opportunity to act as a linchpin in some way. For example, musicians and artists create work because they must share their gifts with the world. Often times, financial reward is much less motivating. In the same way, becoming a linchpin means becoming an artist. It means performing at your best because you simply can’t do otherwise.

4. Tune out your “lizard brain.”

Your lizard brain is wired for survival and fight or flight. It fears risk and sows self-doubt and mistrust. It evolved earlier and has greater power than the creative part of your brain. Creative, optimistic, successful people tune out messages from their lizard brains. They don’t take failure personally and don’t think of themselves as losers. They gain strengths from setbacks and find ways to pivot and change their plan of attack.

When you reach that uncertain stage about making a change, Godin says go for it - avoid analysis paralysis. To evolve, ignore tasks that aide procrastination. The nearer you are to a breakthrough, the more you will embrace distraction. Surfing the Internet or checking your email is a lot easier than being creative and initiating change. Most people won’t commit to self-discipline, but that’s the key to productivity.

5. Give more, take less.

Generous, committed people understand the power of giving. They recognize the value of supporting others – with time, money or talent – and being part of something larger than themselves. By giving, you are able to fortify bonds between people and strengthen the overall tribe. For example, Alcoholics Anonymous (AA), charges no dues and its meetings are free. People attend to receive and to give help – a philosophy that makes AA a powerful, close-knit community. You do not have to wait to become successful to practice generosity. Many people do not chase after money, but it is a result of their efforts of giving value to others first. As you progress to become a linchpin, consider how you can donate your art, your creative efforts, your inspiration and your energy to others around you.

Life will throw you curveballs and challenges out of your control. Remember to develop the right perspective and see things for the way they really are. If you head into a meeting with a client or partner anticipating the outcome, you may find yourself setup for disappointment. Godin warns us not to emotionally invest in a situation with many variables for which we cannot predict the outcome. Linchpins will accept the things they cannot change and move forward. Its easy to settle for mediocrity because change is intimidating. However, you can defy the status quo, look beyond the horizon, and strengthen your relationships. Persevere, and ignore lizard brain self-doubt messages. Don’t get in your own way of success.

Hope you enjoy this book!

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Linchpin: Are You Indispensable?

Real Estate 030: Cash on Cash Return vs. Overall Return

In my previous blog posts I discussed cash on cash return, debt service coverage ratio, net income and how these metrics are used by real estate investors to evaluate a potential acquisition and proforma over 5, 10, and maybe 30 years down the line. Other investors may look to buy all cash and consider comparing cap rates to make sure they are getting a healthy return when including other factors such as neighborhood class and type of property (e.g. single family rental vs duplex, etc.). While these metrics are valuable, they do not paint the entire picture, especially for savvy investors who are looking for value add opportunities.

By value add opportunities, I am talking about forcing appreciation on your deal by raising rents to market, rehabbing the property, and other things such as sub-metering individual units on a 2-4 unit and reducing your overall expenses. Value add opportunities allow investors to “force” appreciation in a short period of time.

To evaluate a value add deal, one must consider not only the cash flow, but appreciation, tax benefits, and loan paydown when financing your property. This is also known as the overall return. To calculate your overall return on a deal, you must add up the benefits realized in these profit centers and divide it by the number of years you held the property and total monies invested. 

Lets view an example below:

• Purchase price: $150,000

• Cash all-in (Downpayment, repairs, closing costs): $45,000

• Loan amount: $112,500 (75% LTV), 30 year fixed at 5% interest

• Annual Cash Flow: $3,000

Lets say that after 10 years, you decide to sell the property for $250,000, which reflect a gain of $85,000 after selling/closing costs of $15,000.

• Cash flow: 10 years * $3,000 = $30,000

• Appreciation: $85,000

• Tax Benefits: $1,000 * 10 years = $10,000 ($3,636 depreciation per year * 28% tax bracket = $1,000 per year savings)

• Loan Paydown: $21,500 ($112,500 - $91,000 Balance after 10 years)

Total return over 10 years = $30,000 + $85,000 + $10,000 + $21,500 = $146,500

Overall ROI: $146,500 / 10 years / $45,000 = 32.55% return

In this example, this means that your average return during the 10 year holding period was 32.55%. By using this simple formula, you will be able to better understand your overall return on the deal and compare it to others in your lead generation pipeline when having to choose one over the other.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!