When you think about investments that will make you above average returns I doubt the first thing that comes to mind is investing in mobile homes. I’ll be honest, two months ago, I would have thought the exact same thing, so why have I changed my tune?
If you are a frequent visitor to Mr. Fi Guy you’ll know that my wife and I both work and we have a very high savings rate, around 70%, post-tax. We use that savings rate to max out all of our tax-advantaged accounts (401K, Roth IRA, and HSA), but we still have some money left over.
Rather than investing the rest of the money in the stock market, I decided to leave most of the excess savings in Ally Bank earning 1.75% interest. Which is good for savings accounts, but I’m still losing money to inflation.
In a pure personal finance sense, people will say I was making a poor decision, phrases like “you can’t time the market,” and “it’s not about timing the market, it’s about time in the market” come time mind, the advice would be to invest everything as soon as possible.
While I don’t disagree with those sentiments, I wanted cash on hand so I could be ready to invest when a good deal presented itself… the only issue was, I had no idea what that might be.
Passive income- Making money while you sleep
Who doesn’t like the idea of making passive income? When I started to accumulate more and more cash I was seeking out more ways to put that money to work (aside from the stock market), and the beauty is, the more money you have, the more opportunities become available to you.
I have a friend who has been working in real estate for the past 10+ years. I’ve discussed my interest in real estate with him in the past, but nothing concrete came of those conversations.
However, things changed several weeks back when he contacted me with an opportunity to do some hard-money lending on some of his properties. For those of you who are unfamiliar with hard-money lending, it’s essentially getting funding from an individual rather than going to a traditional financial institution. Since hard-money loans typically have much higher interest rates than traditional financing, hard-money is usually used for short-term holds like house flips.
So you’re probably thinking, why would either side be interested in this type of arrangement?
Pros to the investor-
- Ease of putting your money to work.
- Collateralized/asset-backed- since you are investing at a low LTV (Loan to Value) you are usually well protected if things go south. For example, if the property is worth $100k, a hard-money lender may lend $80k on the property. That way, the investor never has more invested than the property is conservatively worth.
- Typically a higher return than the market rate.
Cons to the investor-
- Once the money is invested you don’t have as many controls over the project.
- No upside- let’s say the property makes an absolute killing when it’s sold, you’ll see none of that excess profit… unless you write something in the contract, but that is rare.
- Not liquid- as soon as you give your money to someone for a property you have entered into a contract. So unlike the stock market, you can’t just pull your money out any time you need. For better or worse, your money is going to be tied up for several months at least.
- Things will get hairy quick if they go south- in the unfortunate circumstances that things go south, it may well be a huge pain to collect your money and make yourself whole coming out of the deal.
Pros to the flipper-
- Ease- rather than submitting complex models, comps, and projections to a traditional financial institution, it’s much easier to get hard-money. Not only this, but the contracts used by my many hard-money lenders might be only 3-4 pages, which is insanely short compared to the complex contracts from big banks.
- Quick close- speed is the name of the game when flipping houses. A person needs to find and close on a property almost immediately, otherwise, another flipper will. Hard-money is great because money can be available in hours, assuming the numbers make sense.
- Less documentation- since the hard-money lender primarily cares about getting paid according to the predetermined rates, they don’t tend to pester or require as much documentation about work being done on the property.
Cons to the flipper-
- Much higher interest rate- in some cases this can be as much as 10% higher than going through traditional financing. But if a flipper only plans to hold a property for a few months, it might be worth it.
- Typically shorter term to complete the project.
Recommendations to the lender
Since I don’t know anything about actually flipping houses, I’m just going to speak from the lender’s perspective. While there are no hard and fast rules in the wild west of hard- money lending, here are some of my recommendations if you’re interested in diving in:
- Ensure the flipper has a successful track record- in the day and age of HGTV, it seems like everyone is an aspiring flipper because of the seemingly easy-money to be made. Make sure that your flipper isn’t just trying to jump on the bandwagon, otherwise, this could really sour your real estate experience all together.
- Make sure you’re the first lien on the property- unfortunately, Murphy’s Law is a real thing, and you want to make sure you’re covered if things don’t go according to plan. I was once approached by an investor who tried to pitch me on being the second lien on the property. That would mean, since this property was taking traditional financing, if things went south and he couldn’t pay the bills, the first lien would get 100% of their money back, and I would only get money if anything was left over. I wasn’t comfortable with that arrangement, so I passed on the opportunity.
- Ensure you have a high enough risk premium- any time you invest your money there’s inherent risk. The more risk you take as an investor then the higher your return needs to be. Sticking my money in the bank has essentially no risk, and because of this, I can’t even make enough in interest to cover inflation. Real estate is a whole different animal, and you should be well compensated for putting your hard-earned money at risk.
The details of my deal
It’s not a great picture, but that’s the picture of the mobile home I invested in. High level, here are the details of the deal:
- First lien on the property
- 15% interest paid until the property is sold
- Ability to foreclose and take possession of the property after 1 year if the property isn’t sold
- The property was purchased at an auction and I gave $35K on the front-end
- The flipper will rehab the property, once it is rehabbed I will pay the flipper another $25K, increasing my all in total to $60K
- Comps for similar properties nearby that have sold in the recent past are around $90-$95K, meaning that I am well protected as I am not over-capitalized in the property
- I will be invested 60K when all is said an done (making 15% on all that money) on a property that comps in the neighborhood of $90K, giving me a $30K buffer. Even if I did have to foreclose on the property, I should be able to make an exit and reclaim my entire investment, plus some
While there is inherent risk with any investment, I’m excited to be venturing into hard-money lending. Just to put things into perspective, at 15% interest, if I were to invest $200K, that would equal $30K in annual interest. That’s not bad at all, especially considering I don’t ever have to pick up a hammer.
I’d love to hear your thoughts on hard-money lending.