If you watch HGTV’s Flip Or Flip, you’ve heard Tarek El Moussa say, “We buy houses for cash.” If you watch regularly you may have also heard him say that they don’t always use their own cash. Not using your own cash is a consistent bit of advice from everyone from Than Merrill to Phil Grove.
But if you have enough money, why not use your own?
Honestly, if you have enough money to complete a purchase and remodel on your own, you probably should do your first one or two deals with your own money. But you really don’t want to continue that practice for several reasons:
- It limits the number of deals you can do at one time.
- It lowers your return on the money you invest.
- It ties up resources you might be able to use for bigger deals or personal emergencies.
But, to me the most important reason to use other people’s money (OPM) is that doing so enables you to spread the rewards of this business as well as the risk.
I seldom fund a project completely with my own money. Why tie up $100k on one project that returns $30k when you can tie up $40k on two projects that return $25k each in the same amount of time and still have a reserve? (All numbers in this post are provided to illustrate points and do not necessarily reflect any given project.)
So where do you get OPM?
Here are some sources:
- Hard money—Hard money lenders are bricks and mortar businesses, like banks. But they play by different rules than banks. They generally charge the most points and highest interest rates of any source.
- Private money—Private money lenders are people like you and me. They loan you their money to complete your projects in return for the guarantee you’ll pay them back.
- Banks—You’ve probably heard the myth that banks won’t loan money on distressed houses. What that means is you can’t get a traditional mortgage on a house that isn’t up to code. But you can get a one or two year construction loan. In many cases, these loans are interest-only until due, and they are at a much lower interest rate than hard or private money. The catch is that you must already have a proven track record and assets to get a bank to finance your project.
- Owner financing—Owners are the least likely source of capital. If they had the money to fix up their house and sell it on the open market, they probably would. But you can offer to fix up their house for them and split the proceeds.
My favorite source is private money. Even when a bank finances the purchase, private money often finances the renovation. Why? That’s the topic of my next post.