3109: Accidental Hard Money Lending by Joel of 5AM Joel on Real Estate Investing Advice

[00:00:00] This is Optimal Finance Daily, Accidental Hard Money Lending by Joel of 5AMJoel.com Steve Hey Joel, can I borrow $50,000? Joel Uh, that's a lot of money. What are you going to do with it? Steve Well, I have an opportunity to buy a rundown house. My plan is to fix it up, put a renter inside, and then sell it to another investor as a turnkey rental property.

[00:00:30] It'll cost me about $50,000 all in, and I'll be able to sell it for $75,000 by the time I'm done. Joel Why don't you just borrow the money from a bank? Steve I could, but there are a couple of problems with bank loans. First, they're trying to sell me a 30-year mortgage. I don't need a loan for 30 years. My whole project will be wrapped up in 3-6 months. Next, the bank takes about 45 days to close on a loan, which is way too long.

[00:00:59] If I don't buy this house in the next 7 days, I'll lose it to another flipper. And lastly, the paperwork, red tape, and underwriting process is so painful, not to mention costly. I'd rather pay those fees to a friend like you and save all the headaches. Joel I don't know, man. It sounds pretty risky. How sure are you that this project will work out? Steve

[00:01:21] Very sure. This house is a great deal, and I know what I'm doing. I've completed six similar projects in the same neighborhood this year, and they've all been successful. I'll email you my past case studies and also some phone numbers of people I've borrowed money from before. If you call these references, you'll hear that I've never failed to pay back an investor. I'm good at what I do. Joel Wow, I had no idea. Are you putting in any of your own money too? Steve

[00:01:50] Yes, a little. I've already paid the $4,000 deposit on the house and about $800 for some inspections. You would be putting in the bulk of the money for this project, but I do have some skin in the game. Joel Okay, so if I did loan you $50,000, how much money will I make back in return? Steve Now we're talking. I'll pay you a 15% annualized return for however long the project takes.

[00:02:17] If the project takes six months, your return will be $3,750. The absolute maximum this will take is one year, in which case your profit will be $7,500. Joel Dang, that's pretty good. More than the average returns I'm getting with my index funds. And I like the fact that this is a rather liquid investment. I'll have all my cash back in under a year. Steve

[00:02:41] Exactly. It's a shorter term investment that gives some diversification to your overall portfolio. Joel Okay, let's take a step back and talk more about the project risks. I have some questions. Steve Sure. What do you want to know? Joel What is the absolute biggest risk in this investment? Steve The single biggest risk is me and my team not executing against our business plan.

[00:03:08] This is where 90% of house flippers and new investors go wrong. You see, any person can buy a cheap house and have good ideas to fix it up. But if they don't stay focused, follow through, and execute at a fast pace, then the project will fail. I take great pride in the well-oiled rehab business I've built. My partners and I have a combined 80 flips under our belt with a perfect track record.

[00:03:33] We only take on projects that are within our wheelhouse and ruthlessly execute our business plans. I'm confident we can smash this project and all make some money. Joel Great answer. But I thought that the biggest risk would be the economy crashing, like what happened in 2008. Steve A crumbling economy is certainly a risk. But the collapse of the housing market wouldn't be an overnight event. There are telltale signs for many months leading up to a downturn.

[00:04:02] Since my team are monitoring and tracking the area religiously, if there are any signs of a slowdown, we can wrap up our projects and exit the area before we get stuck holding real estate we don't want. We've done this before in other areas. Joel Okay, well what if the house burns down? Or what if someone hurts themselves or a contractor sues us or something? Steve Don't be silly. We have insurance in place for all that stuff. Protecting the investment and your money is my number one concern.

[00:04:32] Me and my team don't cut any corners. Joel Wow, this is starting to sound much safer than I first thought. You really do know what you're doing. Steve Yep, I do. I wouldn't ask for your money if I didn't have a thorough plan. Joel So if I was to invest, how do I send you the money? Do we sign some contracts or something? Steve The only contract you and I sign is a basic promissory note. Here's the one I've used with many other investors.

[00:04:59] It states all the payment terms, collateral, dates, and clauses for both of our protection. Feel free to have it reviewed by a lawyer. It's pretty standard stuff. Joel Thanks. May I also take a look at the house inspection results? Do you have area comps to prove that the house is worth what you're paying for it, etc.? Steve Of course. My books are always open and you can have a copy of any document you want. Here are the quotes I got from three different rehab contractors.

[00:05:28] And if you look at this financial projection sheet, you'll find it's quite conservative. Joel Thanks. I don't mean to be a micromanager. I just always like to do my own due diligence as an investor. Steve No worries at all. I like working with experienced investors and I'm glad you take this seriously. If you notice any errors in my calculations or have questions about my business plan, please let me know. It's always helpful to have another pair of eyes on the deal. Joel

[00:05:55] Sweet. Let me review everything and I'll get an answer to you before the end of the day. Steve Cheers. Look forward to doing more business with you. What is hard money lending? The previously mentioned was a real conversation I had with a buddy last year. I never really knew what hard money lending was until this opportunity fell into my lap. A hard money loan is just a simple private agreement between two people. A loan from one to the other, backed by real estate.

[00:06:26] It's not as complex as most people think. That being said, easy in theory investments should not be mistaken as easy profit investments. There's a high amount of risk involved with lending money, especially for inexperienced investors. So what's next for me? Although this investment worked out well for me, it ended up taking nine months. I earned a $5,625 profit. I won't be doing any hard money lending again.

[00:06:54] Here are a few realizations and things I learned this past year. Number one. In the exact nine-month time frame I was in this investment from December 2018 through September 2019, the S&P 500 index returned an annualized 22%. I only earned 15% and in a much riskier way. Number two. Trustworthy flipping partners and well-vetted deals are hard to find.

[00:07:21] It could be many months before I find another good deal. Sitting on $50,000 in cash in the hopes that I stumble across another hard money lending deal isn't smart. And number three. Being completely honest, I was kind of f***ing my pants in months six to nine of this deal. Although Steve said it could take up to a year, my expectations were higher. That's my own fault. I don't really enjoy investments that make me worry or I get nervous about.

[00:07:49] All in all, I'm going to stick to syndications and buy and hold fourplexes as my primary strategies going forward. You just listened to the post titled, Accidental Hard Money Lending by Joel of 5amjoel.com. And now a word from our sponsors at Betterment. When investing your money starts to feel like a second job, Betterment steps in with a little work-life balance.

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[00:10:12] Shopify.com slash OFD. I found this article super interesting. Frankly, I'm not too familiar with hard money lending. But I enjoyed the back and forth conversation to get a better sense how someone might vet something like this. And despite having a pretty good experience with hard money lending, I really appreciated Joel's explanation as to why he wouldn't do this again.

[00:10:39] Even if Joel's return ended up being higher than what he could have gotten from investing in a total market index fund, I suspect he would still have decided that the larger return wasn't worth the stress. There are so many ways that we can invest our money. But I think we need to pick the ways that best align with our unique skills, preferences, and circumstances.

[00:11:02] This reminds me of a breakout session I participated in at a Camp Mustache event a few years ago. Four of the attendees, including me, opened up our books, and we showed the group our finances in the form of case studies. We outlined our income, expenses, investment strategies, and overall plan to reach financial independence. And then the audience was welcome to poke holes in our plan or offer suggestions for improvement.

[00:11:32] Two of the other case studies had real estate investing as the crux of their strategy. And despite the fact that their yearly salaries were half of what mine was at the time, they were still projected to reach financial independence faster than me due to their aggressive investment in real estate. It made me reflect on my own investment strategy and question if I should be investing in real estate like they were. So I grilled them on how they were doing it,

[00:12:01] how much time they were putting into it, what stressors they were experiencing that they didn't expect, how they were navigating the risks, etc., etc. And I walked away from those conversations perfectly content with my decision not to invest in real estate. Reaching five faster isn't a good enough reason for me to add the additional stress of an investment style that doesn't align with my unique skills, preferences, and circumstances.

[00:12:29] Remember, personal finance is personal and reaching financial freedom is not a race. That should do it for another edition of Optimal Finance Daily. I'll be back tomorrow as usual, so I'll see you there on the Wednesday show where your optimal life awaits. I'll see you there on the Wednesday show.