Leveraging Your investments - Pros and Cons
Leverage: in a fund structure, loans last longer than 6 months. If you have $10 million to invest, a credit company may give you a credit line of $10 million. However, the credit company is in first position should something go wrong.
Leverage is a business term that refers to how a business acquires new assets for startup or expansion. When a business is "leveraged," it means that the business has borrowed money to finance the purchase of assets. Businesses can also use leverage through equity, by raising money from investors.
Bill talks about a leverage situation that occurred in 2008. And the collapse that happened as a result.
Carolina Capital is a hard money lender serving the needs of the “Real Estate Investor” and the "Small Builder" borrower who is striving to build wealth and generate income for themselves and their families. We offer “hard money rehab loans” and "Ground up Construction Loans" for investors only in NC, SC, GA, VA and TN (some areas of FL, as well).
As part of our business practices, we also serve as consultants for investors guiding them to network with other investors and educating them in locating and structuring transactions. Rarely, if ever, will you find a hard money lender willing to invest in your success like Carolina Capital Management.
Hi, I'm Wendy Sweet and I'm Bill Fairman and we are
welcoming you to our show today. We wanted to do a quick little covering of the
benefits and the dangers of leverage in a fund. Yes, that's really important,
right? Yes. Why don't you talk to us a little bit about that brother Bill.
Okay. Is it was my turn. It's your turn and then I'm just kidding. I always
have to talk about the boring stuff. Okay. Because you know it all. Yes, I do.
Once again, I'm not a tax professional or an attorney. This is purely for
educational purposes. Okay. But I've been in the mortgage business for 30 plus
years. I've had some really good mentors in the fund business as well. People
who have been there, done that. I have gone to the bottom and come right back
up because they were at the top in the first place. Markets change, things
change.
welcoming you to our show today. We wanted to do a quick little covering of the
benefits and the dangers of leverage in a fund. Yes, that's really important,
right? Yes. Why don't you talk to us a little bit about that brother Bill.
Okay. Is it was my turn. It's your turn and then I'm just kidding. I always
have to talk about the boring stuff. Okay. Because you know it all. Yes, I do.
Once again, I'm not a tax professional or an attorney. This is purely for
educational purposes. Okay. But I've been in the mortgage business for 30 plus
years. I've had some really good mentors in the fund business as well. People
who have been there, done that. I have gone to the bottom and come right back
up because they were at the top in the first place. Markets change, things
change.
And these are, things I like to talk about. So you have
them in the back of your mind when you are investing in a fund. There's a
couple of things about leverage that you need to be aware of. And what do I
mean by leverage? So in a fund structure, a fund, let's say for example, you
have a $10 million fund, which means you're kind of limited to what you can do
with $10 million. If you were doing, you know, $40 million a year in loans and
if they're all four month loans and you might be able to use $10 million a year
cause you're turning it over for time, right? But in reality, most loans are
going to last longer than four months. At the same time, if you want to buy
properties as part of your ownership of properties in your fund and you have a
$10 million fund, you're going to have a limited amount of properties you can buy
with a $10 million fund. Unless of course you're buying double-wide mobile
homes, then you probably have, you probably have more money than you need.
them in the back of your mind when you are investing in a fund. There's a
couple of things about leverage that you need to be aware of. And what do I
mean by leverage? So in a fund structure, a fund, let's say for example, you
have a $10 million fund, which means you're kind of limited to what you can do
with $10 million. If you were doing, you know, $40 million a year in loans and
if they're all four month loans and you might be able to use $10 million a year
cause you're turning it over for time, right? But in reality, most loans are
going to last longer than four months. At the same time, if you want to buy
properties as part of your ownership of properties in your fund and you have a
$10 million fund, you're going to have a limited amount of properties you can buy
with a $10 million fund. Unless of course you're buying double-wide mobile
homes, then you probably have, you probably have more money than you need.
That said what you can do with leverage and there are
credit facilities and typically they're banks and hedge funds that will look at
your assets and they will loan against their current assets in the fund. And
they will leverage them two to one or, or three to one even. So what does that
mean? And if I have $10 million in assets, they'll give me a $10 million credit
line, right? So now you have the power of $20 million, right? But now you as
the investor, basically we're in first position on the 10 million. Right. Now,
the credit facility is in first position and you're now in second. Now, there's
nothing wrong with that. If you had twice the earning potential being in
leverage, then your yield or your return, it should be a lot higher including
what you pay them as being in first position, right? No, that has no, It's
right..
credit facilities and typically they're banks and hedge funds that will look at
your assets and they will loan against their current assets in the fund. And
they will leverage them two to one or, or three to one even. So what does that
mean? And if I have $10 million in assets, they'll give me a $10 million credit
line, right? So now you have the power of $20 million, right? But now you as
the investor, basically we're in first position on the 10 million. Right. Now,
the credit facility is in first position and you're now in second. Now, there's
nothing wrong with that. If you had twice the earning potential being in
leverage, then your yield or your return, it should be a lot higher including
what you pay them as being in first position, right? No, that has no, It's
right..
Your same amount of money will have a higher yield because
it has much more buying power, earning power there. Basically doubling your,
your money, but your money hasn't really doubled. Just your earning power. The
downside to this is if you're using an IRA to invest in this, IRS, as I said in
an earlier episode, does not like leverage. So they're going to, or you are going
to be subject to, unrelated business taxes. So you may have to pay 45% of your
profit based on the amount of leverage. It doesn't mean this 45% of your
earnings, it's 45% of whatever you would have earned based on the additional
leverage. Okay. So it's real fun to try and figure out that I don't have to do
it once again, not a tax person or an account.
it has much more buying power, earning power there. Basically doubling your,
your money, but your money hasn't really doubled. Just your earning power. The
downside to this is if you're using an IRA to invest in this, IRS, as I said in
an earlier episode, does not like leverage. So they're going to, or you are going
to be subject to, unrelated business taxes. So you may have to pay 45% of your
profit based on the amount of leverage. It doesn't mean this 45% of your
earnings, it's 45% of whatever you would have earned based on the additional
leverage. Okay. So it's real fun to try and figure out that I don't have to do
it once again, not a tax person or an account.
Now, as I was saying, the benefit of that is you have
twice the buying power, and twice the earning a potential. The downside comes
is that, let's say for example, the, most of these credit facilities are there.
They're like a line of credit. They're only available for a finite amount of
time, right? And then you have to refinance that or you have to get an
extended, and there are no commercial banks out there. If you ever got an a
commercial loan, you can't get a loan that is a 30 year fixed, you know, any
kind of commercial product. It's usually a, yeah, five years or seven years.
They may give you payments based on 15 or 20 or 30 but the loan is only for a
finite period of time. Why? Because markets change and they don't want to be
locked into a longterm contract. Right. Okay. So I'll give you an example of a
fund that I know of that had leverage through a large bank. We all know who
they are. I'm not going to say who, but there. They're one of the big three and
they love America. Everything.
twice the buying power, and twice the earning a potential. The downside comes
is that, let's say for example, the, most of these credit facilities are there.
They're like a line of credit. They're only available for a finite amount of
time, right? And then you have to refinance that or you have to get an
extended, and there are no commercial banks out there. If you ever got an a
commercial loan, you can't get a loan that is a 30 year fixed, you know, any
kind of commercial product. It's usually a, yeah, five years or seven years.
They may give you payments based on 15 or 20 or 30 but the loan is only for a
finite period of time. Why? Because markets change and they don't want to be
locked into a longterm contract. Right. Okay. So I'll give you an example of a
fund that I know of that had leverage through a large bank. We all know who
they are. I'm not going to say who, but there. They're one of the big three and
they love America. Everything.
Anyway, everything was fine. They were going to extend it
and this was in 2008 as things were going down, right? They were, they were
going to extend, extend, extend, and then when they got right down to it, they
said, yet, Nope, we're not extending. Now you owe me the other 10 you know, the
$10 million we loaned you already out in debt. It's already out in loans. What
do you do? Well, at the same time, we're going through a big crash, right? And
the assets that were currently under management, the assets that we're loan
against, those people were having trouble, right. And they were doing it and
they were having to do a lot of foreclosures. And the ones that weren't being
foreclosed on, they couldn't sell them anyway. Even if they were paying, they
couldn't sell them because the values keep going now. Right. So what happens is
you as the investor or getting paid nothing because all the money it goes to
the credit facility first and waterfall, we were talking about that, that
waterfall agreement means that, leverage, yes. First income. And then when
payouts come, they get the first part of that. So you're getting nothing. So as
an investor, you're not making any money and you can't get your money out. So
how's that? Not too good. So there's dangers.
and this was in 2008 as things were going down, right? They were, they were
going to extend, extend, extend, and then when they got right down to it, they
said, yet, Nope, we're not extending. Now you owe me the other 10 you know, the
$10 million we loaned you already out in debt. It's already out in loans. What
do you do? Well, at the same time, we're going through a big crash, right? And
the assets that were currently under management, the assets that we're loan
against, those people were having trouble, right. And they were doing it and
they were having to do a lot of foreclosures. And the ones that weren't being
foreclosed on, they couldn't sell them anyway. Even if they were paying, they
couldn't sell them because the values keep going now. Right. So what happens is
you as the investor or getting paid nothing because all the money it goes to
the credit facility first and waterfall, we were talking about that, that
waterfall agreement means that, leverage, yes. First income. And then when
payouts come, they get the first part of that. So you're getting nothing. So as
an investor, you're not making any money and you can't get your money out. So
how's that? Not too good. So there's dangers.
All right. So the, the reason that we bring this up is
because when you're reading those PPMS, almost all of them and ours included
says that we can get leverage if we want, as the management, we can choose to
do leverage. And now we choose not to do leverage because of that, that same interest,
same thing that happened. So our friends in 2008 now, we're at a point now or
everything is really good and you know, you could utilize leverage, but you
never know what happened. So it's a tough decision. It works out for some, you
don't have to get three, two, one, you can, you don't have to get two to one.
You can just get a little bit more and make sure you still do the leverage, but
make sure that it's small enough where it's not going to hurt you terribly.
because when you're reading those PPMS, almost all of them and ours included
says that we can get leverage if we want, as the management, we can choose to
do leverage. And now we choose not to do leverage because of that, that same interest,
same thing that happened. So our friends in 2008 now, we're at a point now or
everything is really good and you know, you could utilize leverage, but you
never know what happened. So it's a tough decision. It works out for some, you
don't have to get three, two, one, you can, you don't have to get two to one.
You can just get a little bit more and make sure you still do the leverage, but
make sure that it's small enough where it's not going to hurt you terribly.
If they call it due we're late, they can't get it
refinanced or extended. Right? So aren't you all cheered up looking forward to
signing up for that? But what we want to do is we want to make sure that you're
looking at your PPMS in the right way and asking the right questions and
understanding the ramifications both on the positive and negative and, you
know, make up your own mind because it's a risk going into anything. Yeah,
there's risks with any type of an investment, but you have to look at all the
possibilities and understand what's going on. If you're with the good manager,
they're going to explain it to you. And by the way, this same fund that we were
talking about, they went through some tough changes with this because they
hadn't, like I said, they had investors that weren't earning anything and they
had to wait through this and eventually they, as a matter of fact, I was just
recently told that they just, and it's selling their last asset and they
retained almost all their investors and almost all their investors that didn't,
you know, get out early or try to get out early or get their money back.
refinanced or extended. Right? So aren't you all cheered up looking forward to
signing up for that? But what we want to do is we want to make sure that you're
looking at your PPMS in the right way and asking the right questions and
understanding the ramifications both on the positive and negative and, you
know, make up your own mind because it's a risk going into anything. Yeah,
there's risks with any type of an investment, but you have to look at all the
possibilities and understand what's going on. If you're with the good manager,
they're going to explain it to you. And by the way, this same fund that we were
talking about, they went through some tough changes with this because they
hadn't, like I said, they had investors that weren't earning anything and they
had to wait through this and eventually they, as a matter of fact, I was just
recently told that they just, and it's selling their last asset and they
retained almost all their investors and almost all their investors that didn't,
you know, get out early or try to get out early or get their money back.
Plus they made money even though this was the worst
catastrophic thing that could have happened.
catastrophic thing that could have happened.
Right. But it's all about relationship communication,
making sure that you're transparent with the investors that are in your fund.
Yup. And just being all out honest, whether they like what you're saying or
not, you've got to be able to really be honest and carry that relationship
with, with strong, thorough communication on what's going on. Really making
sure that the folks in your fund understand every side, everything that you're
dealing with. And if you gain that kind of trust and relationship with people,
you can go a long way cause you do much better in a group then everyone out
there buying for themselves. Right?
making sure that you're transparent with the investors that are in your fund.
Yup. And just being all out honest, whether they like what you're saying or
not, you've got to be able to really be honest and carry that relationship
with, with strong, thorough communication on what's going on. Really making
sure that the folks in your fund understand every side, everything that you're
dealing with. And if you gain that kind of trust and relationship with people,
you can go a long way cause you do much better in a group then everyone out
there buying for themselves. Right?
Absolutely. So thank you so much for watching. Don't
forget to subscribe and like us, we do have some more episodes in other places.
If you want to find them somewhere. Yeah, you click on them. Our website is
CarolinaHardMoney.com. You click on the investor tab or if you're looking to
borrow money, there's a apply now, but because we do give loans as well, don't
we, yeah, well we need the money in order to make loans. That's right. That's
right. Have a wonderful, you know what, we're Oh, I can talk about next time?
forget to subscribe and like us, we do have some more episodes in other places.
If you want to find them somewhere. Yeah, you click on them. Our website is
CarolinaHardMoney.com. You click on the investor tab or if you're looking to
borrow money, there's a apply now, but because we do give loans as well, don't
we, yeah, well we need the money in order to make loans. That's right. That's
right. Have a wonderful, you know what, we're Oh, I can talk about next time?
I don't know. Let's figure that one out. We were talking
about it earlier. The next episode will be a surprise for you. That's right.
That's right. You have a great day. Thank you very much for joining us. Hope
you had a good time. Got a little knowledge as well. Don't forget to subscribe
and like us, and if you like to see some more episodes, right? You can go over
here or perhaps up here or perhaps down here, but there's a place to press to
get to the other episodes. Enjoy
about it earlier. The next episode will be a surprise for you. That's right.
That's right. You have a great day. Thank you very much for joining us. Hope
you had a good time. Got a little knowledge as well. Don't forget to subscribe
and like us, and if you like to see some more episodes, right? You can go over
here or perhaps up here or perhaps down here, but there's a place to press to
get to the other episodes. Enjoy
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