Hard Money Facts

CNBC’s Squawk Box recently reported that through the first eight months of 2023, the real estate investment community turned to private lenders to fund their deals 70% of the time. It’s no secret why single-family real estate investors choose private lenders over traditional banks: speed. The private lending community moves faster than traditional banks and, thanks to their business acumen and experience, is more likely to take mitigated risks during uncertain times.

That said, it is not uncommon for real estate investors to hear “no” from lenders in periods of market volatility. When interest rates are high, lenders—especially those backed by Wall Street—are far more scrupulous of the deals coming across their desk, which can extend their time to approve or deny your loan. The longer it takes for your deal to be approved—the greater the likelihood of the deal falling through. A “no” hurts, but if received in a timely manner, still leaves you with time to find financing elsewhere. A “slow no” can be death by a thousand cuts, evaporating the time you need to find a financing solution. 

What’s an investor to do? Here are a few practices single-family real estate investors can employ to circumvent a “slow no” from private lenders, as told from three of Residential Capital Partners’ account executives, James Loffredo, Kyle Dreyer, and Hunter McLean.

The first rule of investing: don’t lose money. The second rule: don’t forget the first. (Thank you, Warren Buffet.)

Residential Capital Partners has been in the investment-making business for over 25 years. Along with my three partners, we’ve adhered strongly to rules one and two, as well as generating several other investment principles to live by, gleaned by our own experiences—namely in respect to the importance of due diligence, rigorous financial analysis, and conservative exit expectations to mitigate risk and protect margin.

The following principles have shaped the structure and growth of Residential Capital Partners over the past 15 years, but they’re applicable for any investor, whether you’re wholesaling houses, rehabbing and flipping houses, or investing in single family rentals to build wealth. 

In business as in life, you’re only as strong as your relationships. Which is why we’re so proud of our relationships with HomeVestors franchisees over the last 15 years. Our relationship spans the global financial crisis of 2008, the global pandemic of 2020 and the rising interest rate environment of 2023. Through it all, we have been honored to help the franchisees at HomeVestors succeed in good times and bad.

Henry Ford said it best: “Coming together is a beginning; keeping together is progress; working together is success.”

To tell our story of success with HomeVestors, we gathered Residential Capital Partners’ leadership and a couple of HomeVestors’ top performing franchisees for an interview that’s been a long time coming.

How did HomeVestors and Residential Capital Partners first join forces?

Paul: Everyone in finance has a story from 2008. For Residential Capital Partners, it was the beginning of our relationship with HomeVestors. The global financial crisis created a void of credit in the single-family rehab and rental marketplace and HomeVestors needed a balance sheet lender to supply financing for its franchisees. Wall Street shut down and traditional banks sat on their hands, but we decided to lean in and provide capital to the HomeVestor franchisee community because we were so impressed with their training, work ethic and values. Since that time, we’ve closed 3,153 loans for HomeVestors franchisees.

Single-family real estate investors are usually good with numbers – they have to be in order to achieve success in the real estate investment business. The math equation going into every real estate investment is paramount to profitability – which makes it easy to get fixated on finding the lowest possible interest rate (especially when interest rates are high), and potentially overlook the signs of a wily lender attempting a bait-and-switch.

Suspicious you’re not getting the deal that got you to walk in the door? Here are the telltale signs your private lender does not have your best interest in mind, and how to avoid the bait-and-switch trap:

Networking is an essential skill for success in any industry. For house flippers, it can open doors to new opportunities, partnerships, and perspectives that can help you scale your business. (Even when interest rates are high!) Business cards and social media groups are a good start – but the following underused strategies will give you an edge over the competition.

Demand for affordable housing remains high, which is good news for single-family real estate investors across America. As the single-family rental (SFR) industry continues to mature and become more institutional across the board, many investors are opting to keep their flips as rental properties.

The steps to fix-and-flip and fix-and-hold are similar, but there are important things to consider as you build a rental portfolio. You’ll want to answer some strategic questions on your journey to building long-term wealth.

Should I Choose a Fixed or Adjustable Rate?

After nine consecutive rate hikes by the Federal Reserve since March 2022 and a Fed Funds rate over 5%, every investor in America is acutely aware of interest rates and the impact they can have on their investment. For the SFR investor looking for the right financing solution for a rental property, there are two options: a mid-term or long-term approach.

The mid-term solution comes in the form of a 5, 7, or 10-year interest-only, adjustable-rate mortgage (ARM). The benefits of a mid-term solution are two-fold: 1.) You only pay interest on the principal balance of the loan, which means cashflow is higher than that of a fully amortizing loan, and 2.) You have a window of time to assess long-term interest rates and plan for the day when you ultimately lock in a long-term 15 or 30-year financing solution. The risk of an ARM is that long-term interest rates move higher than your existing interest rate during the 5, 7 or 10-year window and you get stuck in a negative leverage situation.

The long-term solution comes in the form of a 15 or 30-year fully amortizing, fixed rate mortgage. The benefits of the long-term solution are also two-fold: 1.) You have certainty of what your mortgage payment will be over the long-term, regardless of what happens in the interest rate market, and 2.) At the end of the financing period, the asset will be free and clear of all debt while still providing a steady stream of cashflow. The downside of a long-term solution is that these mortgages typically come with hefty pre-payment penalties over the first five years of the mortgage period, which makes it more costly if you want to refinance the asset as/if long-term interest rates move down during that five-year period.

Related: 5 Ways Rental Properties Make You Money 

The terms of fix-and-flip private loans can differ from lender to lender, and sometimes even deal to deal. (Sadly, the bait-and-switch method still lives on in private lending. Luckily, our terms never change.) It’s a frustrating task to try and create an apples-to-apples comparison of loan terms, which is why sometimes investors eschew much of the information about their loans to focus on a single element: interest rate. But interest rates are only one influencing factor in the overall cost and quality of your loan. It’s mission-critical to understand each line item of your terms and know exactly how much you’ll have to bring with you on closing day (ideally… as little as possible!).

To understand the big picture, let’s unpack the most common terms written into a fix-and-flip private loan, and their impact on your ROI.

Amount Funded

It’s always a good day to get a check in the mail (or transfer to your account) from your rental properties. Your net cash flow is the money you get from your tenants, minus expenses and your loan payment.

Example: You purchase a $120,000 rental home. Tenants pay you $1,200 monthly. If your expenses and loan are $1,100, your net cash flow on a monthly basis is $100. Granted, $1,200 a year isn’t a large chunk of change. It’s more like the cherry on top of the other ways rental properties make you money. Compare it to the dividend of a stock; it’s likely not your primary reason for the investment, but it sure doesn’t hurt.

Related: Learn tips and tricks on calculating ARV from Michael Blatney, Portfolio Underwriting Manager.

Does this scenario sound familiar?

You find an amazing investment property. Your heart is set on it. You scramble to find a private lender to close the deal—and things fall apart. Perhaps the lender denies you because it’s not one of their target markets. Or you can’t get them on the phone and another investor beats you to the punch. Or maybe—most infuriatingly—a Wall Street market turn makes your lender lose confidence and you’re left at the closing table without a closed deal wondering…. where did I go wrong?

There’s only one way to prevent every one of these scenarios: begin with the end in mind. (This is also one of Stephen Covey’s seven habits of highly effective people.) Select your lender before you look for properties, and do so with scrutiny. Choosing your lender first allows you to position your dominos so you can knock them all down, flawlessly, on closing day.

There are numerous private lenders out there. So how do you begin to compare? Ask the following questions, and the right relationship will become apparent:

Here are some things to consider when budgeting to flip vs. hold.

What is your private lender’s source of capital?

Few investors pay much mind to where their lender’s cash comes from. But you should, because many private lenders are backed by Wall Street sources of capital. So when the capital markets are all up and to the right, these private lenders close a high number of deals. But when the winds of Wall Street change—which they do from time to time—they cancel deals, alter terms or close up shop until the wind blows over leaving you, the investor, stranded.

Look for a private lender that uses their own money: a balance sheet lender. Residential Capital Partners is a balance sheet lender that controls its own destiny as well as yours through use of its own capital on each closed deal. That’s how we thrived during the 2008 housing crisis and throughout the 2020 pandemic. We approved countless deals for investors whose initial lender changed the terms of the deal at the closing table or flat out walked away from the closing table during a bear market.

You’re not alone. Nearly one year ago, lenders across the United States froze their fix-and-flip lending programs in response to the COVID-19 pandemic. Today, the market is strong and a resurgence of programs abounds—with one pesky problem: they’re nearly all the same.

Susan Andress is the Business Development Director for Residential Capital Partners’ Correspondent Lending Program. In this role, she’s heard the stories of many lenders facing this conundrum first-hand and helped them make their programs more competitive by using Residential Capital Partners’ platform.

Download the Fix & Flip Correspondent Lending Program Highlights to learn more about our 100% fix-and-flip lending program.

Blazing fast approvals.

The market is hot. Turn-around time is critical. Andress says, “The greatest value I can offer my correspondent is responsiveness and speed in underwriting and closing. We’ve made it a very tight process. Lenders will ask me: ‘How quickly can you close?’ and, I say: ‘As soon as you provide us with a complete file!’”

Residential Capital Partners’ program has an edge thanks to their relationships across the nation. Andress reports, “We have an exhaustive list of appraisers in every market which helps the turn-time on every deal. We also have two dedicated people monitoring the underwriting and approval process.”

Residential Capital Partners has also streamlined the process by providing proof of funds letters to approved borrowers. These letters help borrowers secure a contract from weary sellers trying to pick the right buyer.

Correctly calculating ARV (After Repair Value) is no cakewalk. The market changes daily – by city, neighborhood, and street. To be a great ARV calculator, you must be equal parts historian, detective, and fortune teller. Perhaps Zen master, too, because the stakes are high: calculating ARV incorrectly can literally cost you hundreds of thousands of dollars.

ARV, by its nature, is a moving target, and most fix-and-flippers never hit a bullseye. Yet, Michael Blatney, Residential Capital Partners’ dedicated Portfolio Underwriting Manager, is one of the industry’s sharpest shooters. Why? Because he’s been flipping houses since before there was a name for it – and more or less discovered the concept of an ARV.

Make your next property walkthrough a breeze.

So, if you want to turn a profit flipping houses in 2021, when the market is tight and inventory is low, keep reading and heed his advice.

Panic is the enemy to your investment strategy. Choosing the right hard money lender might just be the antidote.

As any neuroscientist can tell you, humans make poor decisions when they panic – and property investors are no exception. Panic literally disengages our pre-frontal cortex – the area of our brains that brings logic and flexibility into decision-making. Under duress, our brains instead rely on the amygdala – the part of your brain that responds to instinct, emotion, and the impulse otherwise known as “fight or flight”. You know, the stuff any seasoned real estate investor will tell you to avoid when making an investment.

Any hard money lender worth their salt will tell you to avoid these very same impulses when a crisis hits while offering sage advice such as “your safest bet is to stay the course” or “maintain objectivity”. So why is it so many lenders haven’t taken their own advice, and either stopped giving out new loans or inflated their interest rates in response to Coronavirus?

Perhaps it’s not so easy for lenders to walk the talk without prior experience lending during a turbulent economy.

The coronavirus outbreak— and the subsequent turbulence of the stock market—has revealed stark differences between private lenders’ customer service models:

1. There are hard money lenders that rely on Wall Street to buy loans they have placed on a warehouse line. They treat loans as transactions.
2. And, there are lenders that have used their own balance sheet to fund loans. They treat loans as relationships.

Did your lender back out of your loan? Are you struggling to get them on the phone? Or get a straight answer to questions when you do? This is a sign your lender uses a transactional business model. This is also a sign that now is the time to find a hard money lender with a relationship business model.

“A lot of our competitors have said they’re relationship partners, and coronavirus was the end of that relationship.”

COVID-19 Reveals the Downfall of the Transactional Business Model

Private lenders with a transactional business model will tout both their customer service and the expedience of their capital, which they may deliver when Wall Street will buy up their loans. But what happens to customer service when the expedient capital goes the way of Wall Street’s fear? It evaporates and the very nature of a “relationship” evaporates with it.

In the words of Paul Jackson, Principal of Residential Capital Partners, “A lot of our competitors have said they’re relationship partners, and coronavirus was the end of that relationship. We want to be the lending partner of choice for our customers in good times and uncertain times.”