Joe Calloway explains how the cost of capital differs depending on where the money is coming from.
Banks, friends and family, and other lenders all expect different percentages.
Mike: Welcome back to the FlipNerd.com REI Classroom where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Joe: Hi. My name is Joe Calloway with RE Investor Professor and RE360 Real Estate. I’ll be your host of REI Classroom. Today, we’re going to be talking cost of capital.
Mike: This show is sponsored by passiverental.com.
Joe: How much the money that you borrow should cost and some important aspects when borrowing money from people or banks? So first, you’ve got to understand who is lending it to you.
Number one, oftentimes it’s banks. Banks will give you money at very low cost of capital. They charge not a lot of money to borrow their money. Sometimes it’s 3% to 6%. That’s very cheap to borrow a lot of money. But they’re very particular on who they are going to lend to. A lot of first-time investors who aren’t well-established financially will not be able to get loans from banks. So you have to turn to other sources.
The next step would be friends and family. Friends and family are great. They know who you are. They know the content of your character. They will also lend you money at relatively reasonable rates in comparison with the next class of person which is the sophisticated investor.
I lend money out to people and I consider myself a sophisticated investor. I also demand a nice premium. The reason for that is because I can take my money and invest it myself and make a very nice premium. So in order for me to take the risk on you, you have to provide me above, not above average return, an above return of what I can get by doing it myself.
This is oftentimes 15% to 25%. That sounds very expensive. That’s why going to the first two asset classes or the first two investment classes is extremely important.
The other one is just using your own money. Everyone always overlooks the fact that you can work and save money and buy houses. That’s how I started out. I had a military enlistment bonus where I had $20,000 that I put it into my first investment. So don’t forget. You can actually do this horrible, horrible thing called work for it and then be able to buy an investment. So that’s important.
The next thing is when you’re dealing with someone and asking to borrow money these people are taking a huge risk. You have to put yourself into their shoes and understand what the risk is and you may be pumped up about this place you’re about to buy. It’s a beautiful house. It’s going to make you tons of money.
But they are seeing risk not only in the property, but also in you. You can fly in the middle of the night and leave the country with their money. You can leave them with a half done project and they can never see you again. You are an extreme risk. If you don’t see that actually look in the mirror and ask yourself this question, would you lend yourself $100,000 if you came asking for it? If you’re looking a little disheveled, unshaven and smelling like gin, then you’re probably not going to get the money from an investor. So that’s very important.
Another thing is make the deal enticing for the investor. Think about what the investor wants. If it’s a family or a friend they may just want you to be successful. So that may be enough to get them over the edge. But if it’s an investor, they may want upside in the deal. So you may have to put equity plus a return in order to borrow their money.
Keep in mind a lot of people are stingy when it comes to giving up equity or giving too high of a percent to an investor. But if you have no money, there is zero chance of you getting this deal done. You must get the money in order to do the deal. So in a lot of cases, you have to pay for that money because having the money and having the access to capital is the linchpin in any deal that you do.
So make sure you respect this money, make sure you’re a professional and you ask for it in the right way. It makes you understand what these people want from you and also make sure that you can return it. Because the best thing you can do in any situation when you’re borrowing money, is pay that money back because those people are going to come back to you time and time again and be your resource. So your cost of capital goes down and down and down and down.
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Please note, the views and opinions expressed by the individuals in this program did not necessarily reflect those of flipnerd.com or any of its partners, advertisers or affiliates. Please consult professionals before making any investment or tax decisions, as real estate investing can be risky.
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