Self Storage University Podcast: Episode 41

“Hard Money” Creates Hard Decisions

Just like a chair cushion, most people are not attracted to “hard” options – but how does that work with self-storage investing? In this Self-Storage University podcast we’re going to discuss when the seller wants “hard” money to go under contract, as well as “hard” money lenders. While there may be some deals that necessitate dealing with “hard” options, you need to understand what the risks are so you can make the right decision.

Episode 41: “Hard Money” Creates Hard Decisions Transcript

Webster's Dictionary defines "hard" as done with a great deal of effort. Now, this is Frank Rolfe, the Self Storage University podcast, we're going to talk about two things that take a great deal of effort, things that are hard things that are scary, and probably rightfully so. The two we're going to talk about is number one, putting up hard money on a self storage facility. And the second is hard money lending.

So let's start off with putting down hard money. What is hard money in that case? Well, it's a little different definition that means something that's solid and firm, if you look up that dictionary, but once again, it's scary. And there's effort involved. And there's a lot of risk and worry involved. And here's how it works. So somebody, when you want to go ahead and put that self storage property under contract tells you, "Well, I'll do it. But you got to put up $5,000, non refundable," or $10,000 or $50,000, or whatever the number is. And we call this hard money, because you're not getting it back. If you cancel during due diligence, what do you get back? Well, nothing, zero, zilch. You're just off the hook from advancing farther, but you don't get any of any of your money back. The problem when you have that kind of situation is, number one, why does the seller want that? Why is it important to them, they don't have enough confidence in their own property to run with a good old traditional method, that you go ahead and do all your inspections, and then you have the right to cancel or not. So what's going on there? That seemed kind of strange, like how come they don't trust the system?

And often, if you look into it, the reason is people have tied it up many times in the past and dropped. And that should be a terrible sign. Because what it means is that they assume that you're going to do that, that there's some latent defect, that's going to be a complete turnoff to you. The other issue is, at that point in the movie, the seller knows everything and you know absolutely nothing. So the deck is completely stacked in their favor. If you let them force you into agreeing to put up money that you never get back, before they reveal to you all the different issues, well you know there's probably something in there. A lot of properties you feel good about on the front end, looks good and everything. And then you start doing your due diligence. And you say, wait a minute, this isn't nearly what I thought it was. The occupancy isn't the right amount, the rents aren't the right amount. There's all kinds of latent defects in the property, oh, my gosh, it's got roof problems and foundation problems, and all these things. Well, the seller knew that from day one. You didn't know any of that, but they did. So as a result, it pretty much comes with the territory that you're probably going to get in trouble when you do that hard money down. Because you're not getting the money back. And more than likely you're being taken advantage of.

I have watched with my very own eyes deals that have gone through the hands of several buyers over time, all without hard money down. And the seller would just clock in each one as a profit center, because lo and behold, they knew there was some reason no one would ever buy the property. Something to do with location, could even be environmental contamination, whatever the case may be. So don't get trapped into that now. Can you do them? Yes, you could do hard money if you have to. But just know on the front end, that don't do it unless you can afford to lose the money. So if someone wants $10,000 hard and you do that, and then lo and behold, you find something terrible wrong with the property and walk the deal and lose the $10,000, make sure you can afford to do that not go nuts. I wouldn't do it if you can't. So if losing the $10,000 is going to destroy your life, destroy your will to live, whatever the case may be, then just don't do it. Because the odds are the simple fact someone's asking for that more than likely me something terrible is going to happen. Now, if you want to remain competitive, which most people like to, then you may do it simply because everyone else is agreeing on this one property because the deal appears so attractive. But by and large, the hard money down route is a very sad route, and often is going to be something that does not work out for you.

Let's move on to hard money lending. That's a much more interesting topic. So what do you have in hard money lending? Well, you're trying to borrow money, but it's outside of the realm of a bank. Now, why would you want to do that? Why would you want to borrow money but not through a bank? Well, the regular answer is you're doing that because the loan is not something a bank would do. There's two reasons why the bank won't do it. Number one, the property itself has got problems. Or number two, you as a borrower have problems. Maybe you had a bankruptcy, foreclosure, whatever the case may be, you can't obtain regular bank lending. So you're going to go with a substitute. Now, hard money lending has been around for I don't know, maybe since the founding of America, maybe since the founding of civilization. It's when private individuals make loans, typically higher rates of interest. So it's not a new concept. But you have to be aware that there's a lot of danger when you are out there engaging in borrowing outside of the banking industry.

That's not to say that all banks are wonderful people. They're not all saints. But here's we have a problem, a complete divergence of courses between banks and hard money lenders. See, hard money lenders, they are hoping that you default typically, but the bank is not. So when you  do a hard money loan what you have to watch out for, yet they all engage in, what's called loan to own. They make the loan with the full knowledge, you'll probably not be able to pay it back because the most profitable thing for them is to foreclose. If they take the property away from you, because you were unable to make the payments, then they got to keep your down basically. And they get to go ahead and operate and sell to someone yet again, for really, really high profit. Regular banks don't really engage in that. I've never seen a bank that did loan to own. Most of your banks, they just want their interest and to live for the weekend. And that's about it. But when you do a hard money loan with someone, not all of them, but many of them, a little bit they're kind of hoping you default. And that's not going to help you very much because they're kind of hoping to get you in trouble.

Now, the problem with hard money lending is these people are not, there's no oversight from the US government. There's the laws, of course that we have of America and things like that. But you know, banks have a lot, a lot of banking laws. And they don't really want to run afoul of those because it might get them examined by the Banking Association or who knows what. Hard money lenders don't typically have the same concerns. The hard money lender is just a business, just more like a pawn shop than it is like a bank. So they'll extend money on to you. But at the same time, they don't have to fill out all the forms, they don't have the banking examiner's coming down pouring over their records and criticizing them, they don't have to risk any of the liability factors that banks have and how they deal with you as a customer. So the bottom line is you don't really have any of those federal protections that you have when you borrow from a bank. So when you have a hard money lender, you're kind of on your own.

Now hard money lenders sometimes have really scary reputations. I know somebody did a hard money deal, it scared them to death. It was oh, they had borrowed from the mob. The guy couldn't make his payments, they came after him and threatened with physical harm. That's not the way I want to operate. And that's not true of all hard money lenders. But if you're going to use a hard money lender, by all means, please check out the references. Call multiple customers that they currently bank with and say, "Hey, I'm looking at doing this deal. Are these people legitimate? How does it work out? How has it worked out with you? Because you got to make sure you're getting in with the right crowd. If you don't, it might take something which seemed as benign as banking and turn that into maybe your largest problem. Maybe the property is doing well, but your banking relationship is not, that's not a very good position to be in whatsoever. So just be very, very careful.

I think that's the key. And whenever you do these hard money loans, you got to make sure that A, you need to be doing it, that you're not truly bankable, because typically if you are bankable, you'll get a real loan. But if you really can't get a real loan, just be very, very careful. And don't confuse the fact that all lenders are, or think that all lenders are created equal because there's not. There's very, very much different between a hard money lender and a bank. And the time to learn that is not after you've already made the loan.

Also another trick you can do to really make sure that you're going to be okay and all this is to go ahead and maybe talk to some banks, just to make sure the property is financeable in the future. Maybe years from now when the hard money loan comes to you, you're going to want to go ahead and get back into the mainstream banking industry. Make sure the thing has all the right items and profiles for a regular bank to make that loan. Last thing you'd want to do or I'd want to do is be stuck in the hard money lending world forever. Because again, typically hard money lending is the bastion of people who need it because they can't get a regular bank loan at that moment in history. But the hope is that one day you will be able to get a traditional bank lender and then no longer be in the hard money lending space with the traditional banking space.

The bottom line to it all is the word "hard" is scary, it needs to be scary, it needs remind us that there is inherent risk. We need to do all we can do escape it and mitigate it. This is Frank Rolfe for the Self Storage University podcast. Hope you enjoy this. Talk to you again soon.