$25,000 Mistake With Hard Money Lender

Business & Real Estate

?In this blog, I’m going to share the $25,000 mistake I just made on my latest acquisition.

Today, I’m going to tell you how I made a $25,000 mistake on a triplex I just bought and what I intend to do about it to lessen the blow.

? Triplex Property

On September 15th, 2021, we put a Triplex under contract for $410,000.

We ultimately closed on the property on December 17, 2021. 

It took 90 days to close because there was an oil tank on the property. 

It took a while to get it removed and then receive an NFA letter from the state.

While we were getting the oil tank removed and doing our due diligence, we weighed our exit options.

Our first preference was to assign the contract and wholesale the property to another investor. 

Our second preference was to buy the property, spend very little money cleaning it up and immediately relist it on the market.

Our third preference was to buy the property ourselves, renovate it, rent it out, then refinance into long-term fixed-rate debt. 

Our final preference was to fix and flip the property. We believe with $140,000 worth of work, the property would be worth $675,000.

That would make for a total gross margin of $125,000.

Wholesaling the property while it was still occupied by the sellers was difficult.

We couldn’t get investors into the building so they had to make offers based on pictures.

The best offer we received from an investor was $450K, but we knew that was well below what this property could fetch on the open market.

So we decided to buy the property with a purchase and construction loan.

That way, if we couldn’t clean it up and sell it off immediately, we’d do the work ourselves and decide what to do with it later.

??‍♂️ Here’s where I made the mistake

To finance the property, we used a new Hard Money Lender that funded 85% of the purchase and 85% of renovations at 8.5%.

Our renovation budget was just under $145,000 so our total loan amount came out to 472,000.

After we closed on the property, I listed it on the NJREIA Facebook Group to see if anyone was interested in taking it off our hands. 

The post got a little bit of traction so we decided to do a showing the very next day. We got an offer for $500K at the showing and had a signed Letter of Intent for $515K a few days later.

We just bought this property a few days earlier for $410K.

The spread was too good to pass up so we decided to move forward with the buyer.

I called my lender and asked him to send me a payoff statement for 1/31/22 assuming it would take a little more than a month to close. He hesitated then asked if he could call me back.

When he called me back he said based on the terms of the loan, the payoff amount was going to include a prepayment penalty for 6 months of interest plus a 2 point penalty because we didn’t use any of the construction reserves. 

I closed my eyes and asked for the number. He said it came out to just under $25,000.

That was roughly 25% of our gross margin on this deal. 

But it made sense.

2 points on $472,000 is about $9,500 and 6 months of interest at 8.5% on our purchase money loan of $345,000 is just over $14,500.

Together, that adds up to $24,000.

So this is quite a costly mistake, but it’s not the end of the world.

If we can actually sell it for $515K in the next 30 days, we stand to make roughly $65K in gross margin.

Let’s compare that to the value generated if we actually execute our business plan.

So if we spend the $140K here over the 6 months to renovate the property, our total cost basis would be roughly $590K.

The property would then be worth $675K. 

We’d have $85K of equity but if we wanted to realize it through a sale, we’d likely net the same $65K after paying out realtor commissions and other costs associated with a retail sale.

So is it better to pay a $25K toll today to net $65K immediately, or should we do all of the work over the next 6 months, save the $25K fee to ultimately make the same $65K down the line?

The answer seems kind of obvious when you put it like that. 

I don’t want to count my chickens before they hatch, but we’ve already introduced our buyer to our lender and we’re trying to see if we can get him approved for the same loan we took and somehow just transfer our loan to him in an effort to reduce our fees associated with the sale. I’m not sure if this will happen but it’s at least worth a shot. 

At the end of the day, the fact remains: I made a $25K mistake by using this new hard money lender whose terms are less flexible when it comes to multiple exit options.