In today’s competitive real estate market, an increasing number of real estate investors are turning to private money lenders to help them close deals faster, enhance property valuations, and increase their returns.
The problem with private money lenders is that good ones are hard to come by. Let’s look at what private money lenders do and how they operate, as well as the potential benefits of using private or hard money loans and how to locate and select a reputable private money lender.
How to vet a private money lender
Anyone with a little extra cash can become a private lender, but that doesn’t mean that every private lender is a good fit for a real estate transaction. The following are some helpful suggestions for vetting a private money lender:
- Request a list of references for other real estate investors who have recently completed transactions with the lender.
- If your state requires a lending license, make sure a the lender is licensed.
- Examine previous transactions with a lender, such as funding renovations on investment property, to better understand the lender’s experience with diverse real estate projects.
- Understand where the funding comes from, whether it’s from the lender or a syndicated loan with funds given by multiple investors.
- Inquire about whether funds are issued in one lump sum or via a draw method, in which loan money is obtained at various phases of the transaction.
- Examine loan terms from private lenders, such as the documents required from borrowers, the yearly interest rate, the fees, and points length of the loan and amortization period, the penalties for early loan repayment, the prerequisites to extend a loan, the duration required to finance a loan, and whether the private money lender has ever backed out of a loan.
How to Locate a Reputable Private Money Lender
In comparison to larger banks or even a local credit union, private lending is more reliant on relationships. The better a private lender’s chances of acquiring money for future projects are once they know they’ll be reimbursed on time and can trust a borrower.
Because private lenders rely on word-of-mouth rather than advertising to the broader public, they can be more difficult to locate, but they are well worth the time and effort.
1. Gain a basic understanding of how private loans function.
The first step is to consider a private money loan from a lender’s perspective. Unlike a major bank that the Federal Reserve backs, a private money lender is risking his or her own money.
A private money lender will want to know the following things, in addition, to understanding the asset and how a private loan will be utilized to boost value:
- Will the loan be secured by the value of the property, other assets owned by the borrower, or a mix of both?
- How do prospective risks stack up against expected benefits, such as obtaining zoning approval to convert a basement into a studio apartment to increase rental revenue and force appreciation?
- Is the potential return to a private lender greater than the dangers of an investment, such as a borrower failing to complete a project or having a poor track record?
- When will the lender get a return of capital (funds borrowed) and a return on capital (interest earned on the funds borrowed)?
2. Establish a private money lending network for real estate.
Real estate is a people-oriented industry, and practically everyone in it knows that. A private money lender who is excellent at his work can typically be found by asking fellow investors and others in a real estate investor’s network, such as:
- Brokers of insurance and appraisers of real estate
- Contractors, suppliers, and handymen are all available.
- Escrow officers and title agents.
- Property managers and real estate agents who are interested in working with investors.
- Even if a mortgage broker or conventional lender is unable to fund the transaction, they might be able to refer.
Private money lenders can be located inside and outside the real estate business. “Even though a lender lacks real estate experience, if a potential deal is appealing, he or she may be prepared to supply financing,” says Joshua Blackburn, CEO, Evolving Home. “Working with a private lender outside of the firm, on the other hand, may necessitate an investor spending more time discussing the deal’s characteristics to the private lender,” he adds.
3. Put together a deal pitch book.
Like any other lender, a private money lender does not want to have to follow down a borrower for a missed payment, foreclose on a loan and reclaim the property, or get a smaller return than projected.
A pitch book, also known as a deal book, is a presentation prepared by an investor for a private money lender that describes the deal, how it works, and how both the investor and the lender would profit.
The following is information to offer to a private money lender:
- A summary of the deal, including the purchase price and appraisal, the planned renovations or expansions and costs, the after-repair value (ARV) based on recent comparables, and the expected return on investment (ROI).
- The transaction’s investment team’s resume includes an investor’s business partners, renovation contractors, insurance agents, and title firm or attorney conducting the closure.
- A copy of the buy and sale agreement indicates that the transaction is ready to close once the funds are received.
- Photos, videos, drone aerials, floor plans, and a site plan of the property being acquired to help visualize and comprehend the transaction.
4. Make a list of potential lenders.
Developing a relationship with a potential private money lender is a two-way street. A private money lender likes to be impressed by a borrower, as an investor wants to feel at ease with a client.
The slow and easy approach usually works well when meeting with a private lender. By talking to a lender through each step of the proposed agreement, including anticipated expenses, dates, and how predicted profits will be distributed, an investor can improve his or her chances of securing a private loan.
The more at ease a private money lender is with the borrower and proposed project, the more possible an investor is to receive funding from a private lender.
Grant McDonald is vice president-corporate development at 14th Street Capital.
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