You Could Have More Equity Than You Think! (How to Use It)

0:00Did you know that it's possible for your property to appraise for even more than you expected? Well, it can. And if that happens, you're going to have some great options on your hand that you need to think through. Today, we'll break down what to do if you find yourself in that fortunate scenario and much more.

0:21Hey everyone, Dave here. It's BiggerPockets Forum's question and answer time once again. Today, I have James Daynard here with me, and we're going to tackle a few of the most burning questions we could find from investors and aspiring investors in the BiggerPockets community. James and I are going to talk about how to approach interior design if you're doing a renovation, whether the 1 % rule is really, truly dead, how to pivot if your house is suddenly worth more than you expected, and a few other great topics. James, you ready to help the people? This is my favorite type of episode. If anyone has met me at BPCon, they know I just sit there and will talk and answer questions all day long.

1:00We picked some questions that are right up your alley, so I think you're going to like these ones. Should we jump in? Let's jump in. Let's see what the needs are. The first one comes from Katie in Richmond, who has a very good problem on her hands. She says, I found a duplex and negotiated with the seller to purchase under asking at$340. Awesome. I can rent it out for$3 ,000 a month total and project positive cash flow. Plan was to use a DSCR, which is a debt service coverage ratio loan to finance at 25 % loan to value. I just received the appraisal back and the house appraised much higher than I expected at 407.

1:37So she's got under contract 340, appraised for 407. She asked, for those of you that are more experienced, would you change your financing or business model based on this new information? James, what would you do? I'm sure this has happened to you in your career where you found yourself a great deal appraised for over-asking. Does it change your approach? It does. You want to use leverage correctly, though. The beautiful thing about that for her is the bank will lend her more now and you can get your cash back. As investors, we use cash as our gunpowder. How do we go buy another deal? And so I think the question would be, if I refinance out more, I don't want to take it past the cash flow.

2:15I want it to break even. Right. You don't want to take out such a big loan just because you can. You don't want to take on so much debt that you're now not going to be earning a return every month. Yeah, that's where everyone got in trouble in 2008. Everyone was doing that. Too much debt. Too much debt. And then it was like, well, I can take this money and go make more with it, which is true. But then once the wheels come off, you're in bad shape. And so I would say, you know, look at your monthly payment now. Talk to your mortgage professional. See how much can you pull out to where you still cash flow just a little bit.

2:46then you know what that number is. You know, let's say you can get an extra 30 grand out of that loan. But the thing you want to think about as an investor is, do I have a plan for that money? Can I go get another duplex and buy that? Or am I doing one for the year? If I'm going to do one for the year, I'm actually not going to lever up because why borrow money at a higher rate right now at seven and a half percent with a DSCR, if not higher. So in that case, you just sit on your equity, right? I just sit on my equity because it's like, don't take the money just because you can take it if you can then reinvest it and make more than eight and a half percent, whatever the interest rate is.

3:20That's always my question. What's my interest rate today? Well, if I can borrow from a bank of 8 % and refinance, get that money back out or have it, but then I can go invest it and lend money at 10 to 11 % with hard money, that doesn't make a whole lot of sense after tax. And so if you have a purpose that will grow higher than your interest rate and you feel good about it and then you can deploy it quickly, then I would look at doing it. If not, leave it alone. You don't need the money. Don't pay interest on money you don't need. Right, absolutely. I totally agree. And if you wind up not having something else lined up that you're excited to go buy, you can always refinance and take the equity out.

3:57You can get a line of credit against the property to go borrow against all this equity that you have sitting in this property. So you have options and it's not like you have to stick with that forever. But I totally agree with James. There's no reason, just because you can, you shouldn't do it. because it could be to your actual detriment instead of as a benefit. Yeah. And if I'm in growth phase where I'm like, I really want to take myself to the next level, get more rentals, really invest, you know, especially when I was a newer investor, I would always do it because it was like, all right, break even.

4:25I need that money back to go buy another house. And so, you know, as long as you have a purpose, it works out. All right. Well, I knew you were the guy to answer this question. I'm glad I had you for support. We do have another question that's right up your alley, James, but first we have to take a quick break. We'll be right back. How many deals have you lost just because you didn't follow up in time? Or maybe you missed a call from a motivated seller while you're on another appointment. That's where Resimply's new AI agents come in. They answer your calls, make follow-up calls to leads, score motivation, and even coach your sales team automatically.

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8:18Welcome back to the BiggerPockets podcast. I'm here with James Daynerd answering your questions. James, our second question is another one tailor-made for you. We cherry-picked it just for your expertise. It comes from T.O. Sam in Washington, D.C., who said, I recently purchased a property to fix and flip. I'm a contractor, so the renovation aspect well within my expertise. However, I'm facing a challenge when it comes to choosing the interior design elements, such as bathroom tiles, paint colors, fixtures, et cetera. I would love to hear how you approach this process. Are there any apps or tools that you find particularly helpful?

8:55Should I consider hiring a professional designer, even though my budget is quite limited? How would you answer this question, James? Hiring a designer and cramming it into a budget that we're already tied on can be difficult. I used to do it way back in like 2009 because a designer would charge me like 900 bucks because it was so slow in the business. People would just want to work, right? Find the gaps. Find when people are at work. Yeah. Like you said, a lot of gaps in 2009. Yeah. And nowadays, like I remember I met some designers out in Newport Beach just to get there and it was like 30,$40 ,000, if not more.

9:28Interior design can get expensive quick. Yes. And they're very talented. It's a different thing. I do think they're worth every penny for what they put out, but we can't make it work for us as investors. And so, you know, the best thing that you can do and you know, is you guys, when you're selling a flip property, it's not, I'm a firm believer. It's not about the discount broker that's going to cut your commission. It's going to be about finding the broker that you can get to do more things for you. And so first thing is best way to get ideas, take the comps that you used or actives that are pending or earn the same price point, go drive them with your broker and then make a spec list for it.

10:04You just have to copy whatever is selling at that point. You know, print out the photos. Worst case scenario, if you have no design, print out the photos of the house that you're using for your value. What upgrades did that? What tile did they use? What color cabinets? What countertops? And just do what they do. You know, if you walk into a house and you see a tile, how do you figure out what tile that is? You have to look at the materials for that. And for him being a contractor, But if you're not a contractor, you can, there's a lot of difference. It's important to go walk through these houses, a couple of them to go, okay, you know, what kind of floor is here?

10:36Is it LVP or is it engineered floors? Are the doors hollow or are they solid? You know, cause the style is easy to copy. It's about picking the right, you know, material quality and you have to touch it to see it. Now I have had, look, now my eyes so trained, I can look at a picture online and go, that's LVP just based on the shimmer of the floor or like how it lays out. but it just go walk through the projects and look through them. And then, you know, there is a lot of talented brokers throughout the whole U S that will do design suggestions. Oh, really? Based on you hire them, you know, our team at heat and dana real estate does it, but they're kind of trained that way.

11:11But many, many brokers like in Arizona, every broker I've talked to, they all have a design background here. And they're like, Oh, I can help you with this. And I can send you these colors. Cause I'm like, what's on trend down here. That's going to be different than the trend up in Washington. And so, you know, those things will really work. And then one other tip is go to your flooring and tile suppliers. Many of them will have a designer that will throw it in if you do your order. Oh, really? And they'll lay the whole thing out. Just make sure you bring them your allowance sheet. That's the biggest thing.

11:40I will not pay more than this for this type of floor or in general. And you can get free design services with a lot of these big companies. So just to recap, you basically start by doing your comps, right? Essentially copy what your competition is doing, right? You say, what is selling at the price point that I'm trying to sell for? What is my business plan? What are my layouts like? And then copy the quality and style that is working because, you know, you need to be competitive with what buyers are going to be seeing elsewhere, right? They're probably going to tour similar houses and you want to make sure that you're essentially at least matching the quality and probably something relatively similar in style?

12:20Yeah. I will say a lot of buyers, you know, it depends on the market that you're in. I think Newport Beach, the buyers really understand product and quality almost too much. But I will say I've sold a lot of houses where I'm like, this is a much nicer house. Like I, you know, I have one right now where the quality of build is phenomenal with what we started with. I would never put this stuff in this house if we flipped it. Buyers really look at the cosmetics more than anything else. And it's about picking the right design. They don't really know if it's a dollar tile or$3 tile and a lot of flips.

12:53And that's a lot of price points, especially under a couple million. It's more about the design and look and how you pull that off. You don't always have to spend the most on your materials. You just got to implement it the right way. Great. Well, very good advice here again on flipping houses from James Daynard. Let's move on to our third question, which comes from a BiggerPockets forum poster named Jonathan, who says, I've researched private lending and decided that's how I'd like to enter the real estate space. I have enough capital that I can make a few loans while still maintaining a healthy stock portfolio.

13:25How do I get the ball rolling? Do I begin by getting a solid contract from an attorney? Do I contact appraisers and title insurance agencies to find one that I could use? since they only want to lend locally. How do I get my name out there and start my search for borrowers? I don't want to come across as not serious and waste time for agents or borrowers. James, you do some private lending. So tell us a little bit about your recommendations for getting started in what I think is a great business, really interesting, lucrative niche of real estate investing to be in. Private money lending is one of my favorite investment engines that I do, you know, I buy rental properties for assets to grow.

14:04I use private money lending for my passive income. And honestly, I keep probably 50 % of my capital now in that because it does so well. And just before you do that, James, let me just describe for people what that is because they might not know what private money lending is. But basically, at least for you, right, you're lending to flippers, to developers, people who need relatively short term loans to do a renovation or do a big project, sort of a shorter term loan at a higher interest rate, somewhere between 10 and 15%. You charge a couple points at the beginning of the loan. And so you can make double digit cash on cash return relatively easily.

14:40That's what you would expect as a hard money lender as a private lender, right? Yeah, depending on who the operator is, what position I'm in in the loan, I'll charge more and more interest. If I'm in a second position alone, I'm going to charge a lot more. If it's an experienced operator, I might charge more for security because there's risk with every type of deal. And that is the one thing about private money lending. It is great for passive income until it goes wrong. And if it goes wrong, I've seen people lose millions of dollars in bad loans, especially when I remember in 2008, when there was a lot of seconds and thirds floating around, we saw just flat lines on big companies.

15:16And so you have to be careful. And so how you protect yourself, the first thing that you want to do if you want to become a private money lender is to go talk to a securities attorney and a real estate attorney because the documents that you're going to create as your loan docs are what protects your money against that asset. You can take a template, but bring it to someone local in your market that really understands the lending laws, what you can do, what you can't do, and then have those documents tweaked and corrected. Make sure your documents are good. The second thing is don't worry about finding the loans yet.

15:48Build the team that can underwrite your loan correctly for you. In every market that I lend in, I have one broker because if I don't know that market that well, I have to understand, you know, if a flipper is sending me a package, I got to verify those numbers. And so you have to be able to look at the asset and find out where you are at as far as a loan to value, because the loan to value is what protects you on your money. You know, if something goes wrong as a lender, if we have to take it back, we want to know that we can sell that and either get our balance back or even maybe make some money.

16:19And so those are the first two people. Finding the operators. There's some really cool different data providers out there. They will pull you flippers in your market that have been buying and selling. And you can also see how many deals that they've done. Those are the best operators to talk to because they've been in the market a while. They know what they're doing. And if something goes wrong, they know how to kind of mitigate that risk. And so I would start going that way. Look for the bigger guys because the first people you're going to find, and there's nothing wrong with this, but they're going to be a lot newer.

16:49They need the money. They need to get in the game and they're going to do whatever they can to get that money. And the operator is really what's going to protect you. And so start with experience, you know, and I lend money to new investors all the time, but I can kind of look at the deal. I can look at the person. I can take their answers. I can gauge it a little bit better. So start with the experienced ones in your market, reaching out to brokers that you see selling a lot of flips in your market. Call them, talk to them. Who are their clients? Who are their bigger clients? Do they need capital?

17:18That helps the broker get a deal done. Those are great ways to get started. Awesome. Great. So just to recap, James said, first thing that you should do is talk to a relevant attorney, either securities or real estate or both types of attorney to make sure that you're getting your documents in a row and that you're properly protected. And I want to talk just in a minute about how to protect yourself and sort of the mechanisms for that. But the second thing James said was finding someone to help you underwrite that deal. James gave the example of working with a local agent who can help pull comps for you to understand what the true value of the property is today, what the after repair value is going to be after the work is all done, to make sure that as a private lender, if the operator does not perform, you have to take that property back.

18:05And you don't want to be paying full price for that. That's going to put you in a bad position. You should be able to retake that property at a 70 % LTV or an 80 % LTV or whatever it is you deem appropriate. So that was step number two. And then the third step was going to find operators. And James, I think, rightfully recommended trying to focus at first on experienced operators who have a very high chance of performing before moving on to perhaps some of the riskier types of assets where you could maybe earn a stronger profit, but that's going to be just a more complicated procedure. Did I get that right, James?

18:36You nailed all three. Good. But you mentioned something a little bit earlier about first seconds and thirds and sort of getting your ducks in a row, getting your documents in a row. So just so everyone knows, when you take out a loan against a property, there are different positions. So your first position loan, like if you go to buy a regular house, your mortgage is going to be a first position loan, which means that if you default on your loan, that bank has the first claim to the asset, right? And then if there's a second loan, like say you take out a second loan to pay for your down payment.

19:11That might be a second lien or a second position loan, and they can only get paid back once the first position is paid back and so forth. And so the first position loan usually has the lower interest rate, but has less risk. Second position loan, higher interest rate, but higher risk and so on. And you talked a little bit about how you adjust your own rates, James, based on whether you're first or second position. But as a new investor, would you even recommend people go into second position loans or should they try and do first position loans? First position loans are the safest ones. That's where you want to be.

19:45And I would recommend that people go that way. The one issue with the first position loans a lot of times is some private money lenders that are lending 50 grand at a time or 100 grand at a time. They don't have enough to cover that whole loan. First can be big. Yeah. It's just, they just don't have the liquidity, but they want to keep their money working. And so, you know, if you can be in a first position loan, that's where you want to be. But if you can't, that's where a lot of people have to go into those seconds. And that's also where the biggest demand and need are from investors because they want more liquidity.

20:17They can get, you know, getting a first position hard money loan from an institutional company a lot easier. They need that gap funding in there. And so I just don't want to promise Sunshine and Bunnies that you're going to get all these loans because you have to have enough capital to cover, too. For sure. And so then it comes down to if you have to go into a junior lean position, a second or third. Don't recommend third. for people, try to stay in a second position, making sure you understand what that first position loan is. You need to know what the terms of that loan are. What if it balloon payments in three months and you're promising to give the guy a loan for 12 months?

20:53So to reduce the risk, you got to understand what's the terms, how long is it good for, what's the interest rate, what's the total loan balance out of that. And I like to know if it's on a construction loan because the loan balance could be less if the operator doesn't finish the project out. And so I want to know all those things. And then also, what is their default clause? Because some hard money lenders will charge 24 % on the way out the door if they fall behind, which will, you know, you have to look at that. If that compounds on your balance, you can go from a 70 % loan to value to 85 % really fast.

21:28Yeah. All right, well, that's good advice. Thank you, James. I, you know, I've started dabbling a little bit into private money lending. And it's a great business. You can earn really solid returns, but I do them sort of in funds or I buy notes. I don't underwrite them myself, at least at this point in my career. But if you have the capital and you are looking for cash flow, I really recommend people learn more about it. There's actually a great BiggerPockets book called Lend to Live. It teaches you all about the basics of private money lending. And if you are looking for cash flow, really, really good business to consider.

22:00I think it's something that a lot of people, later in your investing career get into and just realize that it can be a really good business. And definitely recommend you check it out. Private money lending is great if you don't want to deal with tenant headaches because you actually make more on your return as far as cash flow goes, but it is high tax. So you got to watch that too. I knew these questions were right up your alley. You're just knocking these down one at a time. We got two more for you, but first we have to take a quick break. We'll be right back. Most investors only think about insurance when something goes wrong.