3 Reasons To Think Twice About Using A Real Estate Lender
Building your team and executing to get deals done in real estate is no easy feat. Networking is crucial in this business and being smart about who you trust on your deals is just as important. Everyone wants to close their deal. However, you need to make sure that your deal works for you and the investor.
Actually, it’s not always straightforward. There are several factors that can significantly impact your real estate business’s ability to succeed when selecting lenders.
Here are three things to look out for when meeting (and speaking with) real estate lenders before making the decision to invite them into the bigger picture: your awesome project.
Go With Your Gut
I know, this sounds like a cliche but in most cases your gut reaction is right. If something seems too good to be true it probably is. You want to be working with people whose goals are aligned with your own.
Tip for new investors: If you are just starting out and have decided on clear objections for your next year’s investments and an investor comes along trying to change everything you don’t have to say yes.
While it might feel like you are passing something up if it’s not what you’re actually looking for, then it’s not.
Trust me, hold your ground and keep looking.
You will know when you come across the right person. I have gone with my gut more times then not and in every situation I’m happy I did.
Let me give you a personal example of a time I went with my instincts and how it paid off, big time:
An investor flew in from abroad to look at our business model with the objective of deploying equity. We spent a few days touring our real estate projects and answering questions about who we are, our past projects, the future, and our business operations. During our time together, he made comments about his expectations in terms of equity, operations and project management that did not fit well for the future growth of our company. Specifically, he required a large ownership of net profit of each project and expected similar ownership of our business.
The rest of our meetings went fairly well, but one thing that stood out throughout our conversations were the comments he made regarding terms of his capital and more importantly, his attitude towards ownership.
This was the antecedent to our decision to turn down this lender’s offer of a $5 million equity injection. Not only did his comments show that he did not understand our business and that he may have been a bit greedy, but we had a gut feeling that it just would not work out. It didn’t feel right and when I told him no, it felt good saying so.
While there are some people that might laugh at you for going with a “feeling,” I guarantee that your own intuition will be right 9 out of 10 times. If you get the feeling that someone you’re about to go into business with might not be the right person you’re looking for, do not be afraid to say “no,” or at least “let’s pause and think about this for a minute.” Doing so shows your inner strength and the ability to consider all the facts prior to making an important decision.
The same can be said about the startup world. Not every capital partner is the right capital partner for your business. Some will be passive and prefer quarterly updates on progress. Others will want to play a more active role and if expectations and roles are not set appropriately at the onset of the relationship, it could lead to more maintenance that you would prefer.
Having a sound inner voice that guides your decision making, especially when you’re about to start your first business, is a beneficial resource.
What if you have yet to develop your inner voice?
If this is the case, then find a mentor to can provide guidance. Your mentor shouldn’t be a friend; s/he should be an accomplished individual in your space that can give you honest feedback.
They Don’t Have Clearly Defined Objectives
There are two warning signs that comes with lenders: insufficient knowledge about the industry and opportunity they will invest in, and unclear investment objectives.
Insufficient knowledge about real estate or about a market is an automatic red flag. Real estate investing is it’s own niche. When lenders don’t know the first thing about the industry it raises the question, why are they choosing to get involved?
There are always exceptions here, but typically if someone has no knowledge or interest in the industry I can’t help but wonder how this partnership is going to work out. Especially if you’re new to the industry and are really looking for someone to be in it with you.
The stock market is a prime example of people investing with zero clue what they’re doing. It’s easy to throw investment dollars at a ticker symbol.
Are these investors really taking the time to do the necessary due diligence on the company’s financials (looking at YTD chart doesn’t cut it by the way!) and joining conference calls to better understand why the company and its management is a good investment?
For most, the answer is no, when in reality, the answer should be yes.
Now, I am 100% okay with doing the legwork. When you’re asking for capital, it’s your responsibility to provide the lender with all the necessary numbers, comparables to show the AS-IS value and the After Repair Value (ARV) of the property, etc.
However, if your lender hasn’t looked over the deal at all this raises some level of concern. Every opportunity is different, and therefore, investors must know, and should want to know, all of the nitty gritty details from start to finish. From the onset of a discussion, if investors are not inquisitive about your business model, the people behind it, financials, business development goals, operational protocols, etc., count it as a red flag.
The last red flag is investors who don’t have clearly defined objectives. This is generally a sign that you’re working with a novice. Without a clear plan on capital structure, amount and terms, novice investors have a tough time pairing themselves with the right opportunities. Vet your investors thoroughly and stay away from those who are too new in the industry, especially if you’re new yourself. There is no room for the blind leading the blind in real estate investing.
A quick rant:
When I’m vetting potential borrowers to lend my money to for their real estate deals, I don’t want them to have this stock market investing mindset because real estate is a very different investment model.
THIS IS SUPER IMPORTANT: If a borrower wants to lend them capital on their deal, I want them to actually be “invested” in the deal as well. This is bad news for all you “gap funders” out there. Do I believe gap funding serves a purpose? Yes, but not a good one. Essentially, gap funding allows borrowers to get away with not putting their own skin in the game for the real estate deals they choose to borrow money for to do.
Here’s how gap funding works:
For example, if I buy a home for $70,000 with a budget for renovations of $30,000, my total project cost (without lender points, closing costs, etc) is $100,000.
Lets assume I’m responsible for a 20% down payment, which is equals 20% * 100,000 = $20,000.
Let’s further assume I don’t have the $20,000 available. I would find a private individual (“gap funder”) to lend me the $20,000 so I can secure senior debt.
The problem with this strategy is: because the borrower doesn’t have money in the game to lose, it’s easier to walk away from the deal if it doesn’t work out.
No Proven Business Model? Beware!
There are many different real estate lending businesses out there with equally as many strategies of how to get where the business wants to go.
Some want to lend specifically for transactional funding. Others may want to lend for those flipping homes between $100,000-$250,000 and other lenders may consider higher value flip projects or sizable single family rental portfolios.
One thing that everyone thinks about when starting a lending business can agree on is the background work that goes into getting it up and running — everything from federal and state regulations to the “borrower box” to specific lending criteria.
There is a plethora of information available to help lenders decide on the most effective business model, borrower acquisition strategy and revenue generation ideas. And just because lenders think something “could” be a stellar product/service/etc does not mean it is going to.
I’m saying this to say, by the time a lender or lending group is ready to deploy capital to you, the borrower, there should be a clear understanding of: why they are lending, to whom they are lending, where they are lending, and the terms associated with borrowing their capital.
If all of these pieces are not made abundantly clear, then make sure to immediately pass on the lender and find a new one to work with.
I highly recommend checking out the American Association of Private Lenders because they are “THE leading member association in the private lending industry. We are defined by a set of clearly defined and well organized principles of cooperation, education, ethics, and accountability.”
If you’re a borrower, this is a tremendously awesome resource to use to find a lender that meets your needs. Also, my team and I have access to funds that have capital they’re willing to lend.
Fill out your deal information here by clicking on “DO YOU NEED CAPITAL” and my team will get back to you with some awesome lending terms based on your deal!
If you’re a lender and you’re interested in joining the ranks of lenders held to a high standard, consider joining AAPL. Membership benefits are awesome and truly build to support your efforts as a private lender. Use the code DEALTALK and get a discount made available by AAPL to all Real Estate Deal Talk followers!
Here’s the bottom line: whether it’s you, the operator, or a lender, if the pieces of your real estate business are not put together and running smoothly, you most likely have no business taking on lenders and borrowing capital or lending capital for real estate projects. For everyone’s sake.
I’ve seen instances, especially in hot real estate markets, where lenders will demand an unreasonable amount of equity; this absolutely does not make sense for a seasoned flipper who can find capital at a cheaper cost.
During my years as an entrepreneur, I have always ensured that I had my business model figured out and consistent long before I approached investors. The same is the case for my real estate deals. Doing this has nearly guaranteed my success in my businesses.
Because this builds the reputation of a business and promotes its growth. If you’re in the beginning stages of building your real estate business, it may not be the right time to look for a lender that will fund your deals. And maybe, you should consider starting with wholesaling and work your way up to flipping. There is absolutely nothing wrong with this, we have all been there. It may just not be the time to look for a lender. At this stage, you want to continue to network and learn from people who are where you want to be. This way, when you are ready you’ll have met plenty of real estate lenders and hopefully have a few people in mind whose goals align with yours.
To wrap it up, let’s remember these three things to look out for when meeting (and speaking with) investors before making the decision to invite them into the bigger picture.
If your gut tells you that you are not a match with an lender, go with it. Always. Second, a lender has insufficient knowledge about the industry or opportunity, and unclear investment objectives. These people are not worth your time. You want someone who is invested as much as you, or as close as possible. Finally, they want to invest with you without seeing a proven business model. At this point, you don’t want to be even looking for a lender yourself. Hold off until it makes sense.
These are, of course, just a few points that personally stood out for me as an entrepreneur of many years. There are other factors that business owners should look at when taking on lenders. Do your homework! Ask them to talk to their previous clients. There is nothing wrong with doing your due diligence. Frankly, the lender should see this as a good sign and if they don’t that’s not your problem and a potential warning sign against them. Making mistakes with lenders can get very costly — and not just financially, but for your overall brand. Ask me how I know!
This is your business and it’s your job to protect it! Remember to dot your Is and cross your Ts with every step you take.