How to Buy Real Estate Without Banks (Private Money Lending)

0:00If you're low on cash and your DTI is maxed out, there is another option to grow your real estate investing business, private money. I know it can sound intimidating or expensive, but private money is one of the most powerful tools available to investors if you use it safely. Today, we'll explain how.

0:25Hey everyone, I'm Ashley Kerr filling in for Dave Meyer today as guest host of the Bigger Pockets Real Estate Podcast. Today, I'm going to bring you all inside a private money deal to explain how it works and how you can use it to scale your portfolio. And I'm bringing on one of my favorite lenders to help me do it. I think you'll recognize him because it's James Daynard. James, welcome back to the show. You always just hit me up for money. You treat me like an ATM now. It is great having a sugar daddy. I will say that. So James and I are going to break down all the details of a recent lending deal we did together with full transparency about our numbers.

1:05You'll get to hear what makes a strong lending partnership from both sides of a deal. Typical interest rates to expect, how both borrowers and lenders can avoid some of the common red flags, and so much more. So James, let's jump right into this topic. Hey everyone, it's Dave. Before we get into the show, I wanted to let you know about something really fun Henry and I are doing that I am really excited about. We are taking BiggerPockets on the road this summer and we'll be driving around the Midwest to multiple different markets, looking for deals, meeting with agents, talking to the BiggerPockets community, attending meetups, it's going to be a great time.

1:44We're calling it the Cashflow Roadshow, and it's happening this July from July 14th to 18th across three different markets in the Midwest. We're starting in Milwaukee. You're going to check out some markets around there. Then we're going down to Chicago, ultimately winding up in Indianapolis. And we're going to be doing all the stuff I said, looking for on-market deals and looking at projects that BP community members are actually doing even in this market. And we might even do a deal or two of our own along the way. So make sure to follow along to all the content we'll be putting out about the Cashflow Roadshow.

2:17But I'm making this announcement because I want you all to join us. If you live in either the Chicago or Indianapolis area, we're going to be doing free meetups in those areas. The one in Chicago is on July 15th. The one in Indianapolis is the next night on July 16th. Henry and I are going to be there. We're going to be doing presentations. We're going to be talking about local market dynamics. There's going to be great networking. And we even have a few cool surprises planned as well. So if you live in one of those cities, you want to hang out with us, get into the BiggerPockets community in real life.

2:49Go to biggerpockets.com slash roadshow to learn more. And these events, they are free, but I should call out that you do have to RSVP because there are limits to the venues and they will sell out. So make sure to go to biggerpockets.com slash roadshow and reserve your spot today. Let's start with the very basics. Can you explain what private money is? How does this differ from hard money and other kind of conventional lending? So as investors, access to liquidity and capital money is essential for growth. You know, typically when you're buying like a fix and flip property or a BRRRR property, most of the time when investors are buying like value add, they're using a hard money lender.

3:29Now these lenders though are more institutional like where they have a lot more guidelines and rules and regulations like a traditional bank. They are a little bit easier to work with, a little bit quicker than a traditional bank, but they still have those guidelines and oftentimes they're raising capital when they're lending that out. A private money lender is someone that's more of an individual that makes up their own rules on every different type of loan. And so typically it's an individual who's going to lend the money to another investor and not be using a bigger institution. And so it's a private individual that's financing the purchase or the rehab, or in our case, I finance everything.

4:08So one thing you said there was that they get to choose their terms as the private money lender. So I'm a little bit unique because we own a traditional hard money business where we have guidelines that we lend on. And those guidelines are that, you know, our borrower needs to bring 15 % down of the project. We want to see some skin in the game. Now as a private money lender, I'm not using institution banks and other people's money to run that company. It's my own money. And I lend it out of my own bank account or my own 401k. And because I'm the actual lender, I can make whatever rules up I want, depending on whether it's a newer investor, I might want some more money down, whether I'm going into second position or whether I'll do those or not.

4:51And I get to evaluate the deal truly for myself, the more risk in a deal, I'm going to lend a little bit higher, the less risk I'm going to lend a little bit less. And so it allows me to do whatever I want with my own capital. And there's no general structure. I do every deal a little bit different. What would you say an average interest rate in terms of a deal that you're doing right now? So maybe an investor that has some experience, but it's their first time coming to you. What would you say a typical deal kind of looks like? You know, it kind of depends on loan to value and skin in the game or money that the investor is bringing in.

5:23But on my typical loan, where it's just a first position loan, I'm usually charging about 12 % and two points for my funds. So if I'm lending out 100 grand and it goes for a year, I'm going to make roughly$12 ,000 in interest and$2 ,000 in points. Now, if I'm going into a second position, which is riskier, I charge a lot more because the more risk in the deal, the more I'm going to charge. And so I usually charge about 15 % to 16 % on those loans. But it really comes down to who the operator is, who's buying the property, how experienced they are, and then adjust the interest rate. James, before we go any further, can you kind of explain what a first position lien is and a second position lien and how they differ?

6:08Yeah, there's a big difference between first and second position lien. So when someone's purchasing a property, they're going to bring in a down payment. there's always going to be what they call the senior lender. And that's where, you know, if I'm bringing in, let's say 10 % down on a purchase, that lender's financed me 90%. So they are actually in the title chain as the first position lender for the purchase. When that property sells, they're the first lender to get paid off. So let's say the lender lends me$80 ,000 and I sell that property for$100 ,000. No matter what, before I see my money or anyone behind that lender, they're getting paid off first.

6:46So they're in the safest possible position. The second lender, which is a riskier position, is when someone comes in and they finance this behind that senior lender, which is going to mean that they're going to get paid off second on the transaction. So in that same scenario, if I sell that property for$90 ,000 and my first position lender was$80 ,000, they get paid off in full. But if my second position lender in a riskier spot has a$20 ,000 second, they would only get the first$10 ,000. And so they get paid back second behind the first. And that's why it's a little bit riskier position. So now when you're structuring this type of deal, you're not getting equity in the property.

7:22Can you explain what the advantages and disadvantages are of being just a private money lender of taking on the debt of the deal compared to if you actually partner with somebody and have equity in the deal? Yeah. And I actually do both as an investor, passive investor. I do both for a couple of reasons. When you're lending out and you're just being a lender where you're financing the deal and you're charging an interest rate points and terms, that loan, I have a personal guarantee signed on that loan. And so if you, you know, on the loan we did, if you went into default and you didn't pay me back and it sold for less than what I lent you to for, I would have debt that I can still issue and go get the money back from.

8:03And so the big difference is, is you're guaranteed your rate in return. turn. When I'm lending you money, I know what my interest rate is. I know what my points, which are the origination points. That's when you're charging a percentage of the note balance as a fee, as a processing fee. And when that deal sells, no matter whether it makes money or loses money, I will be paid back in full for my full loan terms. Now as an equity lender, which is a little bit different or a joint venture partner, it's when I come in and I finance your deal and I maybe don't make any interest on the property and I'm making a percentage of the profit.

8:40Now, in that scenario, if you sell that property and let's say it loses money, I'm the lender that actually takes the loss, not you as the operator. If I take that loss, I'm not going to have a personal guarantee against you too. It's my risk in the deal. The benefit to equity is you typically will make a lot higher return. On my joint venture equity loans, I typically will make about 23 % to 24 % instead of 12%. but if the deal goes bad, it's my responsibility, not the operators. And so that's the big difference is as a hard money lender that charges just rates, points, and interest, you're guaranteed you're rating points as long as the borrower can pay you back.

9:19With equity, you're investing in the property, and so you're risking that return more. This week's bigger news is brought to you by the Fundrise Flagship Fund. Invest in private market real estate with the Fundrise Flagship Fund. Check out fundrise.com slash pockets to learn more.

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12:23let's go into an example and let's use one of the deals that i've done with you to kind of share the process of what this looks like so the first thing is i have to have a deal and you have the money so can you explain what you want from somebody when they're asking for money so what are the things that you're looking at on the property to determine the risk and if you should lend on the property? What should they have prepared and ready? Well, the first thing is I want to look at them more than even the deal as a lender. I want to know who the operator is, what their experience is. And if you're going to ask people to borrow money, then, you know, prepare a resume.

13:04And those resumes should have in their past deal experience. What's your background in real estate? If you've done deals, how did those look like? Little mini case studies. Those are very helpful for me as a lender to go, okay, this person knows what they're doing. Even if there's a bad deal, that's a good thing to put in the resume. Hey, this deal went bad and this is what I did to fix it. That's really what I want to see first. Like who's the borrower? How experienced are they? And also warm them up, guys. Like if you're asking for money, like get to know the person. Don't just come in straight in the DM box going, hey, you want to lend me some money?

13:36It's, you know, you got to warm up. The next thing that I look for as a lender is, okay, so I got a good operator. Maybe it's even a new operator. But what does that deal look like? And so what I'm most concerned with when I am looking at loan is what is the loan to value? What is the purchase price of the property? How much are they requesting for on the loan? And then what is that property potentially worth? Because that's my mitigation against risk. You know, that's how I can reduce the risk in this deal. The borrower or the investor needs to submit to show what that property is worth to make someone like me feel comfortable.

14:10I'm lending money like with you. I lend it in New York. I don't know New York that well as far as values go, but I can take a look at the comparables for the house. What do those look like? How close are they? How long did it take them to sell? And then I request a scope of work. I want to know a detail of what you're doing to that property in the upgrades and what that's going to cost. Because if I'm lending money, and even if I'm lending it$100 ,000 and the property's worth$200 ,000. If the rehab is$150 ,000, that's a problem because they're going to be well in the red and how are they going to pay me back if they're going that far of a budget?

14:45Or it's never going to be able to be sold and get my money back. And so I'm really looking at the loan to value. The loan to value is on loan amount, the rehab funds going in, your total cost, purchase price rehab, and then what is that property worth fixed up? And typically I want to be at least a 30 % spread. So I want a 70 % to 75 % max loan to value. Because if the market goes down or something happens with that operator, there's still equity in the property where I can hire it, figure it out, fix it up and sell it and not take a loss. You know what I'm going to do for everyone is I'm going to upload the comparable worksheet that I used when I sent my deals to you as to like, here's the comparables in the area.

15:27So you can be able to see like every, you know, line item as to what I showed as to here's how this house is different or similar. And then the other thing you had me do was submit a very detailed scope of work too. And what the cost of that scope of work would be each line item with the cost is too. And I think that probably helps you, you know, figure out the risk as if somebody just sends you rehab house,$50 ,000 ish compared to here's a detailed breakdown that I've put together, with my contract or what the cost will be if they actually have a contingency or not in place too. So maybe you could go over what are some of the red flags that you see when lending?

16:14What are some of the things you said no? The more detailed you are submitting this loan request, it shows me how you are as a person. How do you run your job site? How professional you are? And so if someone reaches out and the first thing is, hey, James, you want to lend me money. That's my first red flag. I'm like, I don't even know you. That's just strange to me as an investor. The second red flag is when I'm looking at the comps and they're really far away. So I try to stick with like appraiser's rules where I'm sticking within a quarter mile, half mile or a mile. If they only have one value and it's a mile away, well, where's all the other data points in the sales that are around my house because that's a little bit unusual.

16:54The second thing is I want to know that detailed scope of work. A detailed scope of work isn't I'm putting in paint, carpet, cabinets. This is what I'm doing and here's actually what I'm putting in the property. And so just vagueness is always the biggest red flag to me because if you're not prepared in sending it to me in the correct way, it means you're not going to be able to run your job site that well as well. And so, you know, I'm always looking at the data points. Is there enough? Are they using appraiser rules? Is their scope of work a detailed breakdown or is it kind of throwing mud at the wall?

17:26So this property that I had presented to Jimmy was a single family property. It was three beds, two baths. It was in a cute little neighborhood. It was definitely a starter home per se. And this was going to be the first flip that I had ever done on my own without James as a partner. So James had trained me. I'd done a couple of deals with him in Washington. Now it was time to spread my wings and go out on my own. So I hired a great contractor that I had used before for other properties. And this property, I was actually a pocket listing. So my agent called me and said, Hey, I have this person.

18:07They've come to me and their mom passed away. It's two sisters. They need to sell this property. I told them that you might be interested if you can get close to what they want, they would rather just sell it and not list it and have to deal with showings and things like that. So I went and saw the property. We negotiated back and forth a little bit. One of the things that I always like to do when I'm dealing with an estate is offer for them to leave everything. And I will take care of that. And that was a huge benefit for them because both sisters lived out of town. They didn't really have any connections in the area or anything and just wanted to be done.

18:41So that was like one of the big things we made the deal work. So I was able to get that under contract. And then that's where James came in and we negotiated the terms of him lending on this property. So for this property, we did two points and 12 % interest and the interest and the points were rolled and wrapped into the loan to be paid in full when I sold the deal at the end of the six months term. Whatever came sooner, six months or when I closed on the deal. Yeah. And I will say that, you know, I don't do that term for every type of borrower, but you know, when the longer relationship that I build with a borrower or an investor, that's where I lent you the points and the interest were all paid off at the end.

19:28So you really had no money out of your pocket on this deal. Because you did 100 % financing of the purchase price. So that was $161 ,500. I paid the real estate commission of$8 ,500. That was part of my deal with them is that I would pay the full commission on the property, which is$8 ,500. I paid that out of pocket. And then I paid the rehab on the property too, which was about$50 ,000. Yeah. And because you came out of pocket with the rehab, that keeps my loan to value down. And so that's where I can defer my interest in points. Because what I'm looking at is if I want to be below that 70 % loan to value, when you purchase that property at 60%, I can put the points at the end, I can put the interest at the end.

20:14But once we start getting close to that 70%, that's where I'm going to want you to make that monthly payment and even maybe prepay your points. Because that's my guideline is be below this debt ratio. So it protects me as a lender. And I will have to say like, it was actually pretty close to the six month deadline. I think there was like a week left when that happened. So we had had some conversations about like what happens if I don't close. But one thing I did do, and I recommend if you're nervous about taking private money lending and you like want to make sure you pay somebody back, have a line of credit or have access to other funds that you could use.

20:53So in my situation, I didn't want to have to use my line of credit, but I was going to be able to use my line of credit to pay off James and then just wait for the deal to close. There ended up being something, an issue with the sump pump inspection that delayed our closing by almost three weeks, which pushed our timeline back. So I think that's kind of like a safety nut because for a long time, I only had one private money lender and it was basically like, here's a check. And, you know, it was like one piece of paper agreement, no liens, anything like that on the property. and it took me a while to be like, okay, if I want to grow on scale, I have to find other people that will lend me money.

21:35And I highly advise for everyone to not lend money like her last private money lender. You know, because you have to protect yourself, right? And so, you know, like when we did our loan, I secured my money, right? I was able to lend you the money to get your purchase done. I'm making a great return for me, which is 12%, two points. You absolutely crushed the deal. so it was worth the expense of the money. But then you still have to protect yourself. Like just signing a guarantee or a promissory note with the flipper or the investor, that's risky because if that person just goes into bankruptcy or something really happens or a lien hits them, that personal guarantee is not that good.

22:14So what you always want to do is also file the right paperwork against the property to protect the loan. And so I always file a note in deed of trust, which is the terms of the loan, what we're agreeing to when it's due, If there's an extension, what does that look like? Is there a cost for it? Is there a higher interest rate? So everyone knows the terms of the loan. And then it is filed with a note in deed of trust and a promissory note, and it's recorded against title, and it always closes with title insurance. It's very, very important as a lender. The loan has to be insured, because if I just lend you that money and there's no insurance, and let's say there's a big lawsuit because it was a fraud sale, or it was something that could unwind the whole deal, my money is not going to be protected.

22:59And so having the right paperwork is essential in this business. We're going to take a short break, but when we come back, we're going to talk more with James on how to protect yourself as a private money lender. I just booked a trip to the coast and I cannot stop thinking about it. Waking up early, walking somewhere I've never been, finding a little cafe with no plan except to see what the day brings. A few days to explore, try new restaurants, smell the salt and citrus in the air, and remember why we left to travel in the first place. That feeling of being somewhere completely new, that's what keeps me chasing the next trip.

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