I’m amazed at how easy it is to get money for my deals. Sometimes I’ll just be talking to an acquaintance who will offer to invest large sums of money.
Occasionally, I even get contacted by people out of the blue who are interested in investing in my projects. I am quite surprised just how quickly people are willing to turn over large sums of money to someone they don’t know or barely know.
I greatly admire the spirit of a person who wants to plunge into a different type of investment, and I’m humbled by the trust that some people have in me, but I am absolutely horrified by the risk they’re taking. I know just how shady some operators are in this business.
I know a lot of private lenders and I read a lot on the subject. I know that most people think their money is secured by a piece of real estate. Even the pros seem to think that if they’re only lending 50 or 60 percent of what a home is worth, then they are well-protected. But the reality is much different.
I’ve seen flippers who take people’s money and start a project. They use shoddy materials and unlicensed and or unqualified workers. From there, the scenario can take all kinds of bad turns. The county can come in and put a stop order on the project. Or the flipper decides to go on vacation and spends the money that was intended for renovations; often, that money was taken from the lender for the purpose of doing the renovation.
At that point, the lender or partner has only bad options. They may have to foreclose on the property, which takes time and money. When they finally take ownership of the property, the value has been diminished and the renovation costs have skyrocketed because they have to redo much of the work that’s already been done.
I tell lenders that they should be investing in the operator as much as they are investing in the property. But the real-estate gurus out there are telling people that they need no experience, and their credit is not an issue.
A good operator cannot save a bad deal. But a bad operator can destroy the very best deal with ease.
I am all for investing in real estate. You can even put your 401(k) into a self-directed IRA and use your retirement money in real estate investing. I have one myself. I love it, and I think it’s a great tool for some people. I agree completely that the low-interest rate environment is killing many people’s savings and because of that, many people are flocking to the stock market. All that money is out there looking for better returns, and in my opinion, it has overinflated the stock market. It’s also having an effect on real estate.
The money is making people crazy again. I talk to private lenders who are raising their rates up to 14 percent interest plus points because they’re seeing increased demand for their money. However, many operators willing to pay that rate weren’t in existence even three years ago. The lender looks almost exclusively at the deal, not the operator, and they think they’re protected. Many lenders don’t even know how to properly evaluate the deal, and they don’t conduct inspections of the property.
The real scary thing is that many of these lenders are not using their own money. They are advertising to wealthy people to get their money to put into deals. And with crowdfunding, some of them are advertising to the general public. They entice people with promises of high returns. This is all fine now, but there will be another turn in the market and when that happens, a lot of people will get burned.
Getting money for a good real estate deal is so easy. It’s much more difficult to find a good deal. It always has been.
There are a lot of good reasons to put some of your money into real estate. If you’re determined to get into real estate investing and you have the funds, then I think lending is a great way to get a much better return on your money without all of the work and much of the risk or aggravation.
However, you have to be smart and protect yourself. Here’s how:
• The most important aspect of any deal is the person leading it. I see a lot of people giving money to a family member who just attended a seminar and wants to jump into real estate flipping with both feet. This is dangerous. Any reputable investor will have a portfolio of projects they’ve completed. Ask for it. Before investing with anyone, consider asking them whether you can watch one of their ongoing projects. Ask them to treat you like a lender now. Watch the deal as it progresses through renovation and sale. Ask a lot of questions and visit the property regularly.
• Secure your money with a claim to the property. In most places, that is a mortgage or a deed of trust. Never give someone unsecured money. I see it all the time.
• Get an attorney involved. You’ll need one to register the deed of trust, but you also should have an attorney look at your agreement. Many lenders do a joint venture with the operator, where a portion of the profits will be split at the completion. Make sure your roles and responsibilities are defined.
• Make sure you get a lender’s title insurance policy. Make sure the operator has proper insurance on the property. I see it all the time. A flipper buys a home that needs significant work, and he gets a simple owner’s fire policy. That does not cut it. You need a commercial builder’s risk policy. You as the lender need to be named and insured on that policy. Demand to see it. Title companies are not going to ask for that.
• Find out who will be doing the work. I would be very reluctant about a deal where the flippers are doing the work themselves. If they are doing the work, are they licensed to do it? The problem here is that you really can’t be sure of the costs. I frequently see flippers underestimating the cost of work. It’s always a good idea to get outside bids. If the deal goes wrong, you may need to bring in an outside contractor anyway. I always feel more comfortable when a third-party contractor is doing the work. It always costs a lot more to fix bad work than to do it right the first time. Prepare to get soaked if you have to bring in a new contractor to complete a project.
• If the work being done needs permits, make sure the operator is getting them and that all of the inspections are performed. There is nothing worse than having a home that’s complete, and you have to go in and tear out work to get inspections. It’s easy to check for permits now, and home buyers are doing it.
There is no such thing as easy money. You have to do your due diligence. No matter how much you prepare, real estate is a learn-as-you-go business but you need at least the fundamentals before you get started.
Money for real estate is easy to get, but I am always looking for new sources and so is every other real estate investor in the world no matter how big they are. The reputable operators are in this business for the long haul, and capital is the lifeblood of their business. They treat their investors well. I’ve even taken a loss to keep the investor whole so they’ll be with me in the future. But there are a lot of people out there who don’t care about tomorrow.
Real estate is lucrative, exciting and fulfilling, but make sure you know what you’re getting into before you take the plunge. Trust no one and verify everything.
Justin Pierce is a real estate investor and real estate agent who regularly writes about his experiences buying, renovating and selling houses in the Washington area.