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Tag Archives: Hard money exit strategies

A Glossary of Hard Money Lending Terms

After rehab value (ARV): The market value that the investment property is expected to have after it has been improved or renovated.

Appraisal: A professional estimate of how much the property is currently valued or will be worth after updates.

As-is value: The property value as it exists, as of the appraisal date.

Bridge loan: A short-term loan used to bridge the gap between one obligation and the next. Bridge loans are a great way to move from one investment to another.

Capitalization rate: A real estate valuation measure used to compare different real estate investments. It represents the ratio between the net operating income produced by an asset and the original capital cost or its current market value.

Commercial use: A property with no residential component that is only used for a business.

Cross-collateralize: A lending technique in which collateral for one loan is also used as collateral for another loan.

Default: The failure, for longer than 30 days, to meet the legal obligations of a loan.

Distressed properties: Properties that are in poor condition or near foreclosure.

Draw schedule: A detailed payment plan for construction projects. This schedule helps hard money lenders determine when they need to provide funding to borrowers based on the work completed.

Escrow account: An account run by a third party that disburses payments based on the loan agreement. The money is typically used to cover property taxes and homeowner’s insurance.

Exit strategy: A real estate exit strategy is how the borrower plans to pay off the loan and reduce liability. It is a plan for how to exit one situation for a better one. Tip: have three exit strategies in mind – a best-case scenario, back-up, and “last-ditch” plans. Here are four common exit strategies.

Foreclosure: The process through which the lender legally takes control of the property due to the borrower missing loan payments.

Guarantor: The person who promises to pay a borrower’s debt if the borrower defaults on their loan.

Hard costs: Direct costs relating to the construction or improvement of a building or structure.

Hard money loan: Also called a private equity loan or a private money loan, a hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by real estate property.

Holdback: The portion of a hard money loan that is not paid until the project reaches a certain stage, such as completion of the framing.

Holding costs:  Costs associated with owning a property for a period. This includes insurance, taxes, and utilities.

HUD-1: A form that lists all the transaction cash flows between the property’s buyer, seller, and lender.

Interest Rate: A percentage of the principal loan amount charged by the lender for use of money.

Lien: A legal form filed by a lender showing possession of property belonging to a borrower until the debt is paid off.

Liquidity: How quickly an individual or firm can purchase or sell a property due to having cash on-hand.

Loan broker: See: real estate broker below.

Loan officer: Person who evaluates, authorizes, or recommends the approval of loan applications.

Loan points: An origination fee. One point is equal to one percent of the loan’s principal amount. Two points on a $100,000 loan would be $2,000. Most private money/hard money loans fall between 2 and 5 points.

Loan to Cost (LTC) Ratio: Compares the financing amount of a commercial real estate project to its costs. It is calculated by taking the loan amount and dividing it by the construction cost.

Loan to Value (LTV) Ratio: Compares the proposed loan amount to the appraised value of the completed project.  (Loan amount divided by appraised value)

Maturity: The date the final payment of a loan is due.

Private lenders: Individuals or companies that lend to real estate investors and developers. Finding the right private lender can be tough – here are five qualities to look for in a private lender.

Proof of funds: A document or bank statement proving that a person has the financial ability to perform a transaction.

Real estate broker: Someone who acts as an intermediary to facilitate real estate transactions. In the case of a hard money loan transaction, they gather important information from the borrower such as income, employment documentation, and credit reports to assess how much the borrower can afford.

Real estate investor: Someone who purchases properties with the goal of making a profit, either through renting or reselling.

Refinance: Replacing an old loan with a new one. Typically, people refinance to take advantage of a lower interest rate, but can also refinance when an old loan becomes due.

Scope of Work: An outline of all the renovations scheduled to be completed before the property is sold, including their estimated costs.

Short Sale: A situation when a seller is selling their property for less than they owe on their loan. A bank or lender must approve the sale at the lower price.

Soft costs: Non-construction costs such as legal, financing, architects, etc. required for the project.

Title: Proof of ownership on a real estate investment property.

Turnaround time: The amount of time from when an investment property is purchased to when it is sold.

Underwriting: The assessment of how much risk a lender will take on for an investment property. Underwriters will verify the borrower’s income, assets, debt, and property details before approving a loan. Hard money and private money underwriters are typically more concerned with the property’s value than the borrower’s credit history.

Top 4 Hard Money Exit Strategies

No successful investor enters the market without forming an efficient business plan – and having an exit strategy in mind before purchasing any investment property is a key part of that plan.

What is an Exit strategy?

As the name suggests, a real estate exit strategy is a plan in which the investor intends to remove themselves from a real estate investment. Essentially, an exit strategy is a plan for how to exit or reduce one situation (or liability) for a better situation (or liability).  Investors often fail to realize the importance of an exit strategy which in turn can lead to reduced profits and increased risks.

How to Choose the Right Exit Strategy

There are many elements to consider when planning an exit strategy, all of which can greatly affect the potential profitability of a deal.  The following factors are critical for every investor to consider when planning an exit strategy:

  • Short and long-term goals
  • Experience level
  • Time to close
  • Purchase price
  • Terms
  • Property value
  • Condition of property
  • Supply and demand
  • Location of the property

Understanding each of these factors will help determine which exit strategy an investor should choose, and will ultimately determine how successful their real estate investing career will be.

Top 4 Exit Strategies

There are countless ways to make money in real estate, but below are four main exit strategies most commonly used by investors of real estate to realize capital appreciation and cash flow opportunities:

  1. Build and Sell
    Build and Sell is the most traditional exit strategy for investors looking to acquire land, either a raw or developed lot, contract a building on it, and then sell the completed units. The investor’s goal is  to build units on the property which can be sold individually as single-family homes or townhomes, therein maximizing their profits at the time of sale
  2. Build and Hold
    Buy and Hold is a popular exit strategy for investors looking to hold onto a property. While they are interested in raising the net operating income (NOI) from the property as high as possible, they are more interested in generating  a steady monthly income over a long period. Investors interested in using this strategy are looking for safe, low-risk properties that will offer a stable NOI. They expect to make a profit over a long timeframe through appreciation and property management.
  3. Flipping
    Flipping, also commonly known as rehabbing, allows for high profit margins as it allows an investor to purchase property below market value, quickly renovate  and re-tenant the property. To be successful, they will need to make sure the property is in a market with high demand, have a reliable team of contractors available that can stay at or below the target budget for renovations, and then sell the property quickly.Some investors prefer to find investments that have “easy fixes” such as properties that are undermanaged. Their goal is to increase the net operating income by increasing tenant occupancy, raising the rent, and then selling the property for a lower cap rate , making a profit in the process.
  4. Wholesaling
    Wholesaling is a great way to get started in real estate investing. Essentially, the real estate investor acts as the middleman between a seller and buyer. Wholesalers never need to have ownership of the property – just the rights to purchase it. They can either sell or “assign” their purchase contract to the buyer, or they can close on the property and immediately resell it to another investor in the form of a “double close.’

A couple of Insider Tips…

  1. Have three exit strategies in mind. The first strategy should be a “best case scenario” designed to maximize profits, with a back up plan that can be implemented quickly to compensate for expense overruns or other unforeseeable issues. It’s always important to have a “last ditch” plan in mind that is designed to allow an investor to quickly exit a deal with minimal to no loss in profit.
  2. If a “take-out lender” is involved in the transaction, make sure there is a mutual understanding of their expectations prior to finalizing the deal. Take-out lenders can collect mortgage payments, interest, a portion of the rental profits and at the time of sale, they can receive a percentage of the difference between the sales price and cost of construction.

What’s the best exit strategy? Well, it all depends on your goals. Take time to research all your options so you can ensure you make the right choice for you and your market. Have questions? Contact one our lending experts today.