Investment strategy question.............is the a GOOD thing??? - Posted by Mack D.

Posted by Jim_MA on October 14, 1999 at 12:02:03:

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Investment strategy question…is the a GOOD thing??? - Posted by Mack D.

Posted by Mack D. on October 14, 1999 at 07:51:18:

I’m rehabbing, flipping and the like…I have a line-of-credit…is it okay to use money from the LOC to pay the monthly payment on the LOC?

I know I CAN do it but I want to know if it’s a normal strategy. My dilemma is I can buy more houses but I do not have the disposable income to pay the monthly payment. Should I wait until I have more disposable income before buying more properties? Or should I go ahead and buy the properties with the LOC and pay the monthly payment with the same LOC?

Mack D.

Re: Investment strategy question…is the a GOOD thing??? - Posted by Tim Randle

Posted by Tim Randle on October 15, 1999 at 08:26:38:

Mack, I have a couple of small LOC’s that I obtained within the last year after I decided the traditional “buy and hold” methods weren’t moving me forward fast enough. My suggestion would be to NOT use the LOC to pay interest on the LOC.

One of the best lines in Kiyosaki’s “Rich Dad Poor Dad” is to ask ourselves “how can I afford it?” as opposed to “I can’t afford it”. It helps spark the creativity necessary to consider other alternatives.

I will finally get most of my credit lines paid off next week, but it’s been a worrisome burden for months now because it’s such an easy crutch. Even though I “viewed” it as my money, it didn’t actually come out of our savings accounts, so it didn’t “sting” like it should have. IMHO, you should find other sources of cash to increase your business to increase your disposable income to pay the monthly payments on your LOC.

Re: Investment strategy question…is the a GOOD thing??? - Posted by Ed Garcia

Posted by Ed Garcia on October 15, 1999 at 03:56:27:

Mack:

First of all, you don’t tell us how you are structuring your deals ?

That’s important because if your deal is strong, then you have room for
mistakes, if it is marginal, then you will be dancing with the devil if
something goes wrong.

Remember, you make your money on the buy.

Now the answer to your question, GAME PLAN.

Each deal speaks for it’s self. For example, if I bought a house for lets
Say $50,000 and had to put $10,000 into it for fix up. I’m in this deal
$60,000. Now what would that house have to be worth in order for me
to feel comfortable to buy it, and debt service it on my line of credit.

$70,000 ? No I don’t think so. I have no room in this deal for error.
What if after a month or two I don’t sell it ?
Now remember, we can play the what if game all day. I can create a fast
Sale for the purpose of this posting to make myself look good, but that’s
Not the answer. So remember we have to always be careful with
hypothetical questions and answers. The profit structure on this deal is not
good enough for me to do the deal.

$80,000 ? Were getting better, but No. I have to keep in mind that things
can go wrong with my deal. What if I sell it after 2 months, and then the
sale falls through after being under contract for 45 days because of financing.

Now I have had the property for 31/2 months, and have to put it back on
the market again. Also what if the market changes or slows down ?
Even though I show on paper that I have a $20,000 profit, that’s not so.

For the fun of it, lets take this so call $20,000 profit and structure a
Game Plan around it.

(1.) I plug in 6 month worth of debt service on my deal. I’m in the
deal $60,000. Interest, depending on the interest of your credit line,
Let say for the benefit of our example is 9.5%. Our payments would
Then be $475 per month. 475X 6 = $2850.

(2.) What ever the market value you come up with, always cut it 5%.
Because realistically, the potential buyer is going to want you to
Discount your price. Now if you don’t have to, great. But lets face
It. If you were trying to sell it for $80,000 and someone offered
You $ 76,000, you know you wouldn’t want to wait for another
Buyer. You would still be debt servicing the deal.With you luck,
You wait another month or two and the next buyer would make
The same offer. Terry Vaughan will tell you, that the first 10% of
a deal is water. I agree with Terry, but for the purpose of this
deal we’ll just keep it at 5%. So lets take off another $4000.

(3.) I always plug in a realtor. Now I know that there are a lot of
Geniuses out there that don’t need them. They are so great that
they can sell the property themselves. Great, you plug in a
Realtor. 76,000 X .06 = $4,560.

Lets recap. A sale of $80,000, gives us on paper a $20,000 profit.

$20,000
-$ 2,850 Debt service
-$4,000 5% Discount
-$4,560 6% Sales commission.

Potential Profit $8,590.

As you can see the profit dissipates quickly. And personally I don’t think
It’s enough to take the risk your taking with your line.

How about $90,000 ? Now all of a sudden the deal can make sense.
We have between a $17,500 and $18,000 profit.

Lets look at our LTV (loan to value). 60,000 divided by 90,000 =
67% LTV.

So you see Mark, maybe I would or maybe I wouldn’t. The deal speaks
for it’s self, but the structuring of a deal with a Game Plan is what will
let you know if you should do the deal.

Good Luck,

Ed Garcia

Re: Investment strategy question…is the a GOOD thing??? - Posted by ray@lcorn

Posted by ray@lcorn on October 14, 1999 at 10:51:26:

Mack,

Your question is a good one. I’m going to give you a very long-winded answer to what you may have thought was a simple question. Any one that plans to stay in this game eventually realizes that the very thing that affords us entry to the game, namely leverage i.e. borrowed money, is also the thing that can hasten our exit. As someone that has been on both sides of the eight ball, my sometimes painful experience has taught me that the judicious use of borrowed money can maximize my returns, and that the injudicious use of borrowed money can be my downfall. Finding the proper balance between debt and equity is one of the most critical decisions we face.

For me, the answer is in cash flow. Let me elaborate. I spent a dozen years as a builder of single family homes. In that business, it was (and is) common practice to operate on a credit line, or a series of construction loans. These loans were commonly funded at 80-90% loan-to-value of the retail contract, which in our case translated to 100-115% of cost, and meant that we were taking most of our projected profit out of the deal as we went along. In the process of building the house, we would get “draws” from the credit line or construction loan based on the degree of completion of the house. Usually the lender would “drag the interest”, meaning that when the draw was funded the lender deducted the interest due on the loan from the funds. This arrangement worked well for both parties, because the lender controlled the payment of his interest, and we didn’t have to dip into our operating funds to carry the loan. We included the interest in our hard costs for the house, and budgeted our markup (profit) accordingly. As long as everything came in on time and pretty close to budget, the loan would be paid at closing with the retail buyer, we got the remaining profit on the house, and the lender got his profit on the money. But it didn’t always go exactly as planned. (Surprise!) This is similar to how you are operating with rehabs, but in your case you are acting as your own lender.

When the house didn’t close when planned, or there were cost overruns, or it took longer to finish the house than estimated, then the interest meter kept ticking? through weekends, holidays, rain, snow? you get the idea. Being inveterate optimists, we usually budgeted a contingency fund of maybe 5% of the cost of the house to cover unforseen costs or circumstances. On a $50,000 house, that would total $2,500. One bad subcontractor could blow through that like a tornado in a cornfield. Or maybe the buyer got hit with extra closing costs that he couldn’t cover and we had to. The list of what can happen goes on and on. Because we operated with a high degree of leverage, we rarely had enough money budgeted to cover delays and extra costs. So it could and did happen from time to time that when it came time to close on house, the construction time had gone way past estimates, we may have had a couple of cost overruns, and boom!, we actually had to carry a check INTO closing to cover the outstanding interest on the loan. Now that is a bad day. All of a sudden, operating on the bank’s money wasn’t fun anymore. As long as we had several deals going, and other sources of cash, then we could cover the losers and keep on trucking. But when things slowed down, as they ALWAYS will, the day came that there wasn’t enough cash in the system to cover all the obligations. And that makes for several bad days.

Can you see the parallels to your own situation? I hope so, because it is crucial that you build in a safety zone when working with borrowed funds. Take a look at your operation just like any business. Try to forecast a year, two years, three years, and see what kind of operating capital you will need. Use your past experience as a guide. If you are doing three or four rehabs a year and want to increase that to ten, then make sure you factor in the increased exposure to the risk of things not going as planned. Never stretch yourself so thin that you can’t bail out at wholesale prices. Above all, in working with flips and rehabs or any short term deal with construction involved, don’t borrow your profit. Worst case DOES happen. Be prepared for it. If the numbers work on that basis, then you should be able to sleep well at nights.

ray

Re: Investment strategy question…is the a GOOD thing??? - Posted by Jim_MA

Posted by Jim_MA on October 15, 1999 at 12:49:24:

ed, you must be working too hard…the first 10% is air not water…LOL