Bill Fairman (00:02):
Hello, welcome to The Passive Wealth Show. We're going to talk about whether a deal is a deal. We talked about this before that your hard money lender is the canary in the coal mine. We're going to go over some deals that came through and kind of get your judgment on why it was a deal and why we perhaps didn't think it was such a deal.
Jonathan Davis (00:28):
We all want to agree. It'd be great.
Bill Fairman (00:29):
That's right.
Bill Fairman (00:40):
Once again thank you for joining us on the Passive Wealth Show. I am Bill Fairman. This is Jonathan Davis and that's Wendy Sweet on her way to the outer banks of North Carolina.
Wendy Sweet (01:03):
That's exactly right.
Bill Fairman (01:05):
We are Carolina Capital Management. We lend money to real estate investors in the Southeast. If you're a borrower looking to borrow money, go to www.CarolinaHardMoney.com and click on the “Apply Now” tab. If you're a passive investor looking for passive returns, click on the “Accredited Investor Tab”. Don't forget the like share subscribe, hit the bell. We have a comment section on the right side of the screen or underneath depending on what platform you're viewing from. You can ask us any question that you like, and sometimes we actually answer it.
Bill Fairman (01:58):
Before we started today’s show, how's your trip Windy?
Wendy Sweet (02:19):
Well right now I'm at a standstill. I pulled over to the side of the road, so I don't go offline, but so far it's nice and clear and sunny and warm enough inside the car.
Bill Fairman (03:35):
We talk about these deals and the hard money lenders being the canary in the coal mine. Because if a hard money lender, doesn't want to do your deal. You shouldn't want to do it either. We're going to go over a few that we had. Wendy's got an interesting one. Why and perhaps it was just not the way the borrower wanted to utilize the property. It may be a good deal, but not the way you want to.
Wendy Sweet (04:07):
This one I thought was really interesting because we say is it a deal? or Is it a dud? There's really no true answer to that. Is it a deal or is it a dud? It really depends on what you want to do with the property and really how strong the borrower is in the first place.
That's what I went through in this conversation with the borrower. This particular borrower she's a first time investor. She's been going to different groups getting her education. Because I always recommend that people do that. She knows a lot for somebody who hasn't done a deal yet. But what she found is a package deal, with three different houses on a road. It's a two lane road, it's a busy two lane road in a great location.
Wendy Sweet (05:04):
It's a great location. The three houses are zoned commercial because everything on both sides of the house and across the street from the house are commercial. Now some of the houses have been turned into commercial. But for the most part up and down that road, right where these three properties are, they are commercial properties, like they're buildings that are built for commercial property to you hall rental place actually. There's self storage right there. It's all right there on that road. Her idea is to buy these houses, fix them up. In fact, not only fix them up, but add a footprint to it. She was going to add square footage to these properties and they're 800 square feet. She wanted to add another 300 square feet to it.
Wendy Sweet (05:56):
Plus her game was to turn around and sell them to an owner occupied person. Here are the things that make me nervous about this. This is important, not only for a borrower to think about, but it's important for you as a lender. If you're lending your money to someone, you need to be concerned about this. We both know, or the three of us know that they're going to have a tough time getting their buyer's lender to finance it because it's a commercially zoned property. That's one real big red flag. The fact she's a first time borrower, that's a red flag for me. Another red flag is when you add square footage to a house, if you're going to add to the footprint, that's a whole another series of permits. Putting in more of a foundation, there's a lot in that, especially if you're a first time buyer. The big thing is, who is going to want to buy their primary home in an area that's all commercial on both sides and across the street. A young family's not going to be, you don't want your kids riding the bicycle up and down that kind of a road.
Wendy Sweet (07:11):
There were so many things against her plan. Now here's as a lender, I'm going to be thinking, okay, well let's change that exit strategy a little bit. If she's going to turn these houses into short-term rentals, I think that's an awesome idea to get a house like that, just to refinance or to rehab them. I wouldn't add any square footage on there, but just to rehab them and put them on short-term rental would be perfect. It was really close to the whitewater center in the Charlotte area there. There's many reasons why short-term rental would work, but again, she's going to have to use a stupid money lenders to be able to do the long-term hold on a short term rental.
Wendy Sweet (08:03):
She's going to have a problem if she's going to hold it and turn it into a short-term rental or if she wanted to sell it as a rental, that's a possibility too. But then again, your market is so small if you tell it to. Now you're only selling it to an investor.
The big question for me as a lender, if I'm telling this person she's saying, well, now she wants to try to see if she can get it rezoned to residential. Well, wow. If anybody's ever been through that hold onto your horses there, cause that's going to be a tough one too.
Jonathan Davis (08:40):
Okay. Can I ask you a question?
Wendy Sweet (08:42):
Sure.
Jonathan Davis (08:42):
Are the three lots contiguous?
Wendy Sweet (08:47):
They are together. They're all very much alike. They're all one's brick. The other two are vinyl siding, but they're well built. They're all built in the, I would say the fifties. The lots are all about the same size. It's a good project to look at, it really is. But the other question that I'm going to look at as a lender is how much money does this person have in the bank? Because if they're still insisting on doing it and they think they can make all these changes. I know as a lender, I'm most likely going to have this person sitting in this loan for a while. How long can they afford to make the payments?
Bill Fairman (09:36):
Yes, what's the highest and best use? Even if you do get it rezoned to a residential, it's not taking it away from all the other commercial that's around it. It's still on a busy road, what good is that going to do?
Jonathan Davis (09:47):
And correct me if I'm wrong, but the ingress egress and like road frontage, side frontage that you have to have for all the residential is different than commercial. They might not like the houses. They might tear it down if you want to build on it, if you want to convert it into residential, because you don't know what kind of zoning regulations are at that point, you look them up.
Wendy Sweet (10:17):
Right, There's so many things, it's really a scary move, especially for a first time investor. She's not just your normal newbie, she's somebody who's really educated at this point. She's an engineer, a smart girl, if anybody could pull it off, I know that she could do it. But gosh, that's scary getting into something like that. With so many unknowns.
Bill Fairman (10:54):
In this market, you could probably get away with it more than any other market because existing homes are so hard to come by. It’s just, you're very limited in your exit strategy.
Bill Fairman (11:15):
The last thing you want to do is be limited in your exit strategy, because we've all been around long enough to know you need multiple ways to move this thing if you have to.
Jonathan Davis (12:02):
Well, you did the deal, right?
Wendy Sweet (12:06):
Actually I told her to do some more due diligence and come back to me, she needs to talk to the city.
Bill Fairman (12:11):
Find out about the zoning. There's a lot of things. I put all the issues out in front of her and told her to investigate. She's gonna come back and we'll talk about it some more to eliminate some of the issues that are out there. She's not worried about somebody selling it about the seller. Selling it before she can get back to them because any buyer's going to have the same issue with these properties.
Bill Fairman (12:48):
Well, not necessarily somebody could come in and buy it for a commercial purpose.
Wendy Sweet (12:52):
That's another positive thing about this. I mean and literally she's right next door to a self storage place and we know how well those are doing these days.
Jonathan Davis (13:09):
The first reason I asked whether the lots were contiguous was how much square footage does a lot equal, assuming it was big enough. My first thought would be to put townhomes, to build new townhomes there now that it's a first time home that's probably not for her. But in that kind of area, townhomes are far easier to unload than a single family home.
Wendy Sweet (13:37):
That's a great point.
Bill Fairman (13:41):
We'll, I guess we'll see this again.
Wendy Sweet (13:50):
Well, the thing is you've had a conventional underwriting background. There's a lot of things about this project that you wouldn't understand what the issues would be. Everybody needs to be, especially if you're a lender, you really need to be concerned about who, what the end buyer is going to be able to do as far as financing is concerned. Because it can kill everything. What looks real pretty on the outside, when it comes down to the time to close, it's really hard to get a conventional lender to do certain things.
Bill Fairman (14:30):
Sure. Well, let's say you do buy it as a long-term hold, then you short-term rent it and it stays a commercial zone. Then one of the units catches on fire. Are you going to be allowed to build back the house?
Wendy Sweet (14:47):
That's a great question.
Bill Fairman (14:49):
You may not be able, you may have to knock it down or build something kind of commercial building.
Jonathan Davis (14:54):
Yes
Wendy Sweet (14:55):
Right.
Bill Fairman (14:55):
Those are some of the things you have to be concerned about with that type of zoning happening to borrowers that we're aware of in the past.
Bill Fairman (15:08):
How about you Jonathan, do you have any field you want to talk about real quick?
Jonathan Davis (15:16):
A couple, but we might only get one or two. This is what Wendy and I looked at. It is a five unit multi-family in Rock Hill. We have this borrower bringing it to us. They are purchasing it for X amount. They're putting this rehab into it. They're going to add a little square footage. Basically what it boils down to is they want to rent them out. We're probably looking at about $1000 up to $1100 a month for each unit rented once fully rehabbed. When I'm looking at this deal, I'm thinking, okay, where are they coming in at on the price per door? When they purchased it, they're purchasing it for $50,000 a door. Then what do they have to put into it?
Jonathan Davis (16:12):
They're putting in $28,000 a door, that's a significant amount of money on a fiveplex. Then like, okay, well what is it worth on a cash flow basis? What's their net operating income? If we hit a thousand dollars a month, 5,000 across five units, and it's 60,000 a year. 5,000 times 12 simple math will tell you that you have to play. If you put a 5% vacancy on it. Now you're down to 57,000 instead of 60,000 and then you put a 35 per share on it. And now you're at 37,000. Then, okay, so we're at 37,000. What are properties five-plexes in our area trading for the capitalization rate? Most of them are trading between six and eight on a cap rate. Let me see at a six and a half cap rate, we're at a 592 value.
Jonathan Davis (17:27):
That's pretty good. Now looking on the other side is saying, okay, if I were to buy this property, what's the most, I would pay for it as an investor? Not what it's worth on the cash flow basis, but what is it worth to an investor to come in and buy? Most investors like to make won't pay more than 1% per month on their income. So what do you do? Take the income $5,000 divided by 0.01, you get 500,000. They don't want to pay someone. If you're buying this to come in and as an investor, you wouldn't pay more than $500,000 for it. I know that the bottom line price for these five flex items is going to be $500,000. I also know that the top end market value for this house or this fiveplex is going to be close to 600,000.
When I'm looking at that and I see what they're buying it for, where are they at? When I'm analyzing the numbers on this house, it's a slam dunk. This guy has done a fantastic job sourcing this property. If you're talking about if he sells it, he's going to make between 22 and $34,000 per door, depending on if he sells at 500 or 590.
Bill Fairman (18:53):
Is that his plan to sell or to hold?
Jonathan Davis (18:56):
He's going to hold it. The plan is to do the rehab and get out within a year. They get the rehab done refinance into probably what Wendy calls, stupid money.
Bill Fairman (19:09):
Well, it has to be a commercial loan cause it's more than four doors. It's five, it now has to qualify for a commercial loan. It changes the lending level. If it doesn't go into a non-conventional type of multi-family,
Jonathan Davis (19:44):
Well and honestly, that's why we're seeing the deal is because one unit took it over and it's too difficult for other lenders to understand or move quickly because there's one extra.
Bill Fairman (19:55):
But at the same time, if you're fairly new in the multifamily sector, buying these five or six unit buildings is a great way to get your experience level up. Then you can go in and look at complexes with a lot more doors. The conventional lenders that do that type of financing, once they see that you have a track record with the smaller ones, they're more than happy to give you loans on the bigger ones. It's the person that has never bought a multi-family before that was in a single family. They may have a portfolio of 15 properties, but it's not the same thing as a multi-family. And the conventional lenders they're not giving you credit for that type of experience.
Jonathan Davis (20:41):
The other piece of this is there's a lot of lenders. There's a lot of ways to look at deals like this. I remember having a conversation a year or maybe more ago with a group of guys who are trying to understand buying rental properties. Whether it was a fixed to rent or just kind of like a purchase bridge. At hard money it was fully leased out, it's going to be cash flow neutral. It's going to just break even.
Bill Fairman (21:15):
Yes.
Jonathan Davis (21:15):
It's going to break even. There's a lot of guys out there if the guy's not making money, then I don't want to do the deal. And to an extent, I get and understand that. But his goal isn't to stay in hard money the whole time, the goal is to acquire a fix and then exit. If he does acquire and he does fix it, but he doesn't exit, I know that the property can support my rate of return after a 35% expense ratio and a 5% vacancy.
Bill Fairman (21:52):
That's with a hard money loan.
Jonathan Davis (21:53):
That's with a hard money loan. When I see that, I think, okay, I don't want this property back.
Bill Fairman (22:00):
Right.
Jonathan Davis (22:00):
But if we had to take it back, it could support itself. That's all you want the property to do is support itself.
Bill Fairman (22:08):
That's why we're in the lending space that we're in with affordable or attainable homes. Because if we end up having to own them and rent them, they still produce the rate of return that we would normally get with making the loans.
Jonathan Davis (22:24):
Then the other piece of it is on the exit. When you exit with whatever lender it is that they're going to, their max is going to be 80%. That's going to be the max LTV that a lender will land on a project like this. As an investor, what would I pay for it? If I say, “Oh, I only pay 500,000, that's what it's worth.” Well, even at 500,000 value, our loan is still 73% LTV, which is still plenty of buffer to the 80, for them to be taken out.
Bill Fairman (22:59):
True.
Jonathan Davis (22:59):
At the value on a capitalization rate, which is more likely where the value is going to be skewed to on an appraisal, it's at a 65% LTV. We have plenty of room on that side.
Bill Fairman (23:15):
Sure.
Jonathan Davis (23:16):
Putting all of those factors together, this is.
Bill Fairman (23:19):
A deal.
Jonathan Davis (23:19):
This is a deal.
Bill Fairman (23:38):
Let us wrap up this show. We are Carolina Capital Management. We are lenders in the Southeast for real estate investors. If you're interested in borrowing money, go to our website, www.CarolinaHardMoney.com, click on the Apply Now Tab. If you are a passive investor looking for passive returns, then click on the Accredited Investor Tab.
Don't forget to like, share and subscribe, hit the bell to our show. Thank you for joining us on The Passive Wealth Show.
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