Derek Dombeck is the co-owner of Best REI Funding, a private money lending company. In this episode, he shares how he reinvented himself and his business after losing everything in the Great Recession, why he’s not a fan of banks, and how working alongside borrowers as a financial partner has helped him maintain a low default rate.
Derek Dombeck | Real Estate Background
- Co-owner of Best REI Funding, a private money lending company.
- Portfolio:
- Two mineral quarries
- Several residential complexes
- Based in: Green Bay, WI
- Say hi to him at:
- Best Ever Book: Rocket Fuel by Gino Wickman and Mark C. Winters
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TRANSCRIPT
Slocomb Reed: Best Ever listeners, welcome to the best real estate investing advice ever show. I'm Slocomb Reed, and I'm here with Derek Dombeck. Derek is joining us from Green Bay, Wisconsin. He's a co-owner of Best REI Funding, a private money lending company; also co-owner of an acquisitions company primarily focused on single-family flips and other rehabs. His current real estate portfolio includes several residential complexes, and also two mineral quarries. Derek, can you tell us a little bit more about your background and what you're currently focused on?
Derek Dombeck: Yeah, absolutely. And Slocomb, thanks for having me on the show.
Slocomb Reed: You bet.
Derek Dombeck: I started off years ago, in early 2000s, just fixing up rental properties... Ideally, everything I bought, I held on to. That was the plan. And my wife Tracy and I grew our portfolio for the first few years in the business fairly rapidly... And then we hit the downturn of 2007, and we lost damn near everything that we had built up. So we had to reinvent ourselves, and being able to still continue our business without the use of bank financing, or good credit, because we didn't have either available to us anymore... And moving forward, we learned how to get creative, structure deals in different ways, using partnerships, using private money, doing seller carry-backs, and options, and leases, and subject-to purchases, things of that nature.
So that was the first half of our career, and in about 2012 I met my current business partner, Jeff; we're, again, primarily in the residential space, but we started lending. We've always raised private capital for our own deals; we had more capital than we had deals, and we built up our lending company as an arbitrage business. So to this day, we still don't have any institutional backing, or any institutional thumb on us telling us what we can and can't do, and it's been a great transition.
Slocomb Reed: Derek, I have to ask you... You didn't mention the mineral quarries at all. What's the deal there? You own two mineral quarries?
Derek Dombeck: [laughs] Well, I will never turn down a lead. When a lead comes in, there's a way to monetize it, or to maintain that lead for the future, or at least leave value, we do that. The first mineral quarry that we developed came to us because there was a farmer who was losing his farm to foreclosure, and he was in bankruptcy. And he made a comment - and I think this is important, because whether you're in commercial or residential, I firmly believe that people don't spend enough time learning how to communicate and negotiate properly... So in that communication, the farmer had made a comment that if I could just get my property out of this agriculture program that he was in, which was designed to save real estate property taxes, he said "I could buy myself out of my troubles."
And what he meant was there was millions of yards of sand underneath his farm fields, but he was not allowed to sell a single scoop of it because of this ag program he was in, which is designed to keep the land in agricultural use. But a new owner could. So we structured the deal where we bought the farm, we short saled it, because he was in foreclosure on two different defaulted loans... Short saled it and we kept him and his family there. They continued to farm the rest of the land, and had their cows, and we developed the backend of it into an operating sand quarry. So that's been about 10 years now, I think, since we've been operating, and some years are good, some years are bad.
Slocomb Reed: And you're operating the quarry.
Derek Dombeck: I say operating... I've leased it to an excavating company and I get a royalty.
Slocomb Reed: That makes sense.
Derek Dombeck: So... Mailbox money. I have a newfound love for dump trucks. Every time I see a dump truck, it's just some money going down the road. Yeah. The other quarry - I wish I could give you a great report, that it was super, super-positive cashflow, but it's not, at this point. It was another foreclosure scenario, started out with my acquisition person at the time, lined up a site visit... And I was driving to the property and I had no information. I was actually very annoyed with my employee at the time. I called them up and said, "What are you getting me into?" He says, "I don't know. The sellers wouldn't give me any information."
So when I met with them, they had discovered a very rare mineral that is not supposed to be found in North America. It's called nephrite jade. And jade is the green stone that the Asian markets, particularly China and Malaysia, they just absolutely love that type of stone. And we are the only licensed nephrite jade quarry in the United States. There's only one other one in British Columbia, Canada. Otherwise, most of the jade is mined in Turkey and South America; Brazil, I believe. So the downside is myself, my partners, those people that we bailed out, getting it to market has been slow going and far more expensive than what anybody projected.
We started that deal right about the time that Donald Trump came into office, and when he threw a whole lot of red tape at the Asian market, particularly China, that hurt us. Not that I was against what he did. It just didn't help our potential Chinese buyers who wanted to move forward. So we still have that, and the end is unknown at this point.
Slocomb Reed: Gotcha. Derek, I want to talk about your money lending. Let me start by saying that our Best Ever listeners are primarily apartment investors, and the majority are limited partners, passive investors, looking to invest with an operator to get a completely passive return on their capital. To draw baseline, a typical apartment syndication deal right now has a preferred cash on cash return for limited partners of 8%, with an internal rate of return or kind of global cash flow number after the sale of the asset after three to seven years 15% plus. With the hard money lending that you all are doing, primarily for people who are rehabbing single families, whether it's to sell them or keep them, what do the terms look like that you are lending on right now?
Derek Dombeck: So we land regionally, within the state boundaries of Wisconsin. We raise money nationally, so we can work with anybody. We are structured with a couple of different funds that, depending if the person is accredited or not accredited, we can work with them. But our niche, Slocomb, is -- as we were coming up, we were typically paying our investors 9% to 10% for the use of their money. And we've settled in at nine at this point, is what we do, paid out of our fund, cash on cash. There is no equity or upside when the property sells, because they're just truly passive, and they don't own the actual real estate asset. But the flip side of that is we're not leveraging our fund. And when they're into that real estate transaction with the apartment complex, I'm making the assumption that syndication is raising a certain amount of money as a down payment and then going and getting institutional financing over and above that. Is that fair to say, in most of those deals?
Slocomb Reed: It is. Derek, you're jumping the gun a bit. I think you knew where I was headed. What I was asking, Derek - treat me like a newer house flipper in Green Bay. I need a hard money loan. What do your terms look like?
Derek Dombeck: Oh, gotcha. Okay. I would tell you that throughout most of the state of Wisconsin, with the exception of Milwaukee, we're gonna charge you 12% interest and three origination points. Within Milwaukee proper and essentially a four-county area, we charged 13 and a half percent interest, and four origination points.
Slocomb Reed: Why is it higher in Milwaukee?
Derek Dombeck: Purely competition-driven. We're still undercutting our competition, but we feel like we have much, much better customer service. It's kind of fun to see the name of your show is Best Ever, and the name of our lending company is Best REI Funding. But we do a six-month term, we do allow our borrowers to get an additional three-month extension, and there will be additional fees for that extension. But our goal is really to turn and churn.
For your listeners that aren't familiar with the lending business, when you run an arbitrage business - yes, we're making a spread on the interest rate between what we pay our investors and what we charge... But the reality is, we're not really making a ton of money on that spread, because there is some downtime of money. And if I'm paying my investors 9% annualized, 365 days a year, but that money may only be in play 330 days a year, there's gonna be some downtime. I've still got to pay that off.
Slocomb Reed: And you eat the downtime in the difference between 9% and 12%.
Derek Dombeck: Correct. So where we really make our money is in the points. And the more times you could turn that money... A lot of wholesalers need that need the money for a month. That's great. Churn that money.
Slocomb Reed: Speaking of that, do you do any transactional funding?
Derek Dombeck: We do a little bit. It hasn't been all that popular... But I think that that could be changing in the next 12 to 24 months.
Slocomb Reed: That makes sense. I've used transactional funding a couple of times. Thinking about our audience, and thinking about them treating a hard money lender like an investment vehicle for that 9% return, I think the other question here with regards to your loan products is your loan to value or loan to cost, or loan to ARV, depending on how you structure it. How do you structure that?
Derek Dombeck: So we typically are going to go 70% of the after-repair value. And I do all of our in-house broker price opinions. So remember, earlier I said we don't have any institutional backing, and we're not selling our paper to institutions. I don't like hiring an appraiser, because that person has no skin in the game, and they're gonna get their $400 or $500 and put a number on paper. How do I know if they even know how to read a scope of work, or if they've ever been involved in any construction whatsoever?
Slocomb Reed: Derek, you guys land based on ARV, so never more than 70% of what it should be worth when the work is done. I assume then that you do rehab financing on draws, so that you are only dispersing rehab funding after a borrower demonstrates that the rehab has been completed... Further protecting your capital and protecting your loan. Will you go 100% loan-to-cost, meaning that you are funding the entire purchase and rehab of a project, so long as the purchase and rehab are below 70% of the ARV?
Derek Dombeck: We will. The caveat to that, and to answer your other comment - yes, we escrow the rehab funds, we release them in draws... And we will go 70% of ARV and 100% of cost, but they have to demonstrate 50% of the rehab amount in reserves. So that way, especially now, as projects are taking longer days on market to sell, or even refinances are starting to take longer, we need to know that they've got those reserves in case that loan goes along.
Slocomb Reed: That makes a lot of sense. Derek, what I'm leading to is that I kind of want to make your sales pitch for you; see how I do.
Derek Dombeck: [laughs] Feel free.
Slocomb Reed: But before I ask that, I want to ask how many of your loans - "fail" is the wrong word... But how often do you all have to take a property back from a borrower and finish the project yourself to be able to sell it and deliver on the return you need to give to your investors?
Derek Dombeck: It's almost like I asked you to ask me that question. We're different than most, because we're still in the acquisition and rehabbing stage, as far as our other company, right? We've got sister companies. But. When we interact with our clients, we're not interacting as somebody that's just selling a loan, or giving them a loan, and then forgetting about them. We truly line ourselves up as their financial partner, meaning when (not if) they have problems - and they always do - we're there to help them solve those problems. That could be as little as giving them a contractor contact, to actually stepping in and bring them a partner to help them finish a project.
So our default rate is extremely low. Our average month is about 20 loans going out the door. So at any given point, we've got 150-175 loans on the books. We have, as of this week, in the last 10 years, taken back 12 properties. That's not to say we haven't had other challenging loans, but we really do our best to work it out with people, as long as they keep communicating with us.
Recently we've had three or four where we took it away from the existing borrower, they deeded it over to another borrower of ours, and we worked a side deal, almost like a subject-to deal... And that other borrower gets the rest of the escrow and they finish the project. So we're avoiding those foreclosures, and then we don't have to go in and finish it ourselves. So it's a very low default rate.
Break: [00:15:23.22] to [00:17:23.26]
Slocomb Reed: We used to ask during the Best Ever lightning round the most money you ever lost on a deal... Do you have a loan that you've lost money on?
Derek Dombeck: Yes. And if you asked me about real estate and my own deals, I would have had to go back to 2007. But as far as the loan, and a big learning curve for us - we had a licensed real estate broker in the state of Wisconsin borrowed money from us. And back then, we didn't have people doing walkthroughs; we also weren't turning as much volume back then either. But he was sending us pictures and videos of a different project to get his escrow draws. He was committing mortgage fraud. So we ended up having to foreclose against him. And it was past demo stage, but not much past demo stage. They had put some drywall back on the walls, but not well, and had done a shingle job over the top of existing shingles; that was done poorly. Long story short, we lost about $40,000 on that loan, and he is making payments to us for the next 20 years if he wants to keep his license... Because if I go after him for fraud, he'll lose his broker's license. In the state of Wisconsin you cannot have any kind of legal action or breaking any laws and maintain your license.
So he has been paying us, as agreed. It's not a lot of money each month, but he's been paying us for about two years now, and he's got a long way to go. So we learned from that though. Now we do require everybody to give us monthly video walkthroughs. We do have people that just randomly stop in and check on the projects, but a video walkthrough - they have to start a continuous video with the address on the front door, and then walk through the property, so we know they're not lying to us.
Slocomb Reed: That makes a lot of sense. I'm a big fan of photos and video all the time for sure, especially when it comes to progress on rehab projects in a variety of circumstances. Derek, your lending business is one of the businesses that I have brainstormed for myself several times, and every time I talk about it out loud, everyone who knows me tells me I'm too distracted with all the things I'm already doing... And your business is a business on its own, that should not be considered a side hustle by any means. So credit where credit is due; I'm not trying to say that I could do what you're doing, but I love the idea of building out the mental models for it, just to keep my brain busy.
So what my understanding - speaking again, I'm not pitching your product here, but talking about the idea of investing in a hard money lending fund in general. I am going to use your numbers of 9% and 70% though. The idea here is that for someone who wants to be invested completely passively, who invests in a hard money lending fund, there is a 9% annualized return, with a regular schedule of distributions; whatever those distributions are - monthly, quarterly annually. That money that an investor puts in the fund is then lent to other real estate investors, never for more than 70% of what their project is worth, never -- especially after having had the experiences that you've had, you've implemented this into your business, never funding rehab that has not yet occurred, to make sure that that loan-to-value gap remains, such that if anyone does default, it gives the operator of the fund the opportunity to execute on the deal, or otherwise dispose of the real estate in such a way that it protects the investor's returns.
Another way that a hard money lending fund is protecting the returns for their investors is that they're frankly charging higher interest, in the hopes of maintaining a gap for themselves. In the example of paying a 9% yield to investors, but collecting 12%, in part to bridge that gap of when money is not actively deployed, but also in the interest of maintaining a 9% return while they are not -- also in the interest of maintaining a 9% return for investors when loans are not performing... The idea being that for someone who invests in a hard money lending fund, it is made to be completely passive, and as safe as possible, while always delivering that solid return. Derek, how did I do?
Derek Dombeck: You did really well. I think I should take that recording and turn it into an infomercial.
Slocomb Reed: Well, this will be available in about six to eight weeks on our podcast, and also on YouTube. We'll get into this spiel later. But Derek, help me here... What did I miss?
Derek Dombeck: Well, you hit most of the hot buttons that most people ask about. The things that you might have missed - funds are set up differently; there's typically going to be a manager, and that's us. So in our case, the fund itself, an investor is buying units into an LLC at $1 per unit. So you put in $100,000, you have 100,000 units, a couple of years later, you want to pull it out, it's just a sale of your units. But every loan that the fund has out there at any given point in time, diversifies the number of investors in that fund. So if we do have one property that defaults, and there's 50 loans currently in that fund, it's absorbed, as you elegantly put in there, by that spread, between the 9% and 12%. Because we have to pay attorneys fees, we have to pay for other expenses, we may have to go in and secure the property, or snow removal, or lawn care; all that fun stuff. But what we do a little bit different than some lenders - and it does depend on your state, it depends on usury laws... Our commercial lending laws in Wisconsin do not give us any restrictions on usury. So we want the property -- if they fail, and if they stop communicating with us, our default rate goes into play at 24%, and on top of that, we can go retroactive to day one and charge a point per month. The whole reason for that is to absorb any equity in the property. So when we do go to sheriff's sale, we set the opening bid at what we're legitimately owed as the lender, but we've sucked all the equity out of it. So we get the property if we want the property at the sheriff's sale.
So that is to secure our investors as well, because typically, unless there was fraud, in that one case I told you about, typically we take the property back, and we're going to make more money than if they would have just performed on the note as agreed. And we want to be able to have that to go back into the coffers.
Slocomb Reed: Derek, that makes a lot of sense. Are you ready for the Best Ever lightning round?
Derek Dombeck: I'm very nervous, but yes, I'm ready.
Slocomb Reed: Well, I will say, we're going to skip the question of the biggest mistake and the best ever lesson learned, because you already answered that. We have also a special announcement with the following question... What is the best ever book you recently read?
Derek Dombeck: I love the author Oren Klaff, and he has two books. First one was Pitch Anything; the follow-up book was Flip the Script. And to me, those books are the backbone of how I talk to people, how I negotiate, how I just socially interact with people. And I love them. I've read them for the first time years ago, but I reread those books over and over again. Usually, I listen to them on audiobook. So I love those books. Oren Klaff, hands down.
Slocomb Reed: I understand you're releasing a book here soon as well, and you want to make an offer to our Best Ever listeners...
Derek Dombeck: Yeah. It was fun for me, because you didn't have any idea what I'm writing this book about... It's going to be published early next year, so depending on when this is released, it might be right at that time... But the book I am writing is "Start to finish, A to Z, how anybody can be a private lender." And it goes from how do you find clients, to taking in an application, through underwriting, through scope of work, and BPO, valuation, closing, then servicing a loan, right through to defaults... 100%. So you're gonna love that book, and you absolutely need to get a copy.
Slocomb Reed: I absolutely do, for sure. Let's discuss that after this interview.
Derek Dombeck: And I'd love to give that book away to your listeners for free, the electronic version, if they just simply reach out to me and let me know they heard me on the Best Ever podcast. As soon as it's released, I'll send it out.
Slocomb Reed: Awesome. Derek, what is your best ever way to give back?
Derek Dombeck: For me, my wife and I spend a lot of time educating. So we're speaking at local REIAs, we're speaking on a national level... And I actually host a conference that we do once a year as well... And it's not a free conference, but for us, it's a break-even type of an event to put it on. It's called The Generations of Wealth. It's an advanced strategies and networking conference. But what I love about it and why I'm super-proud is I encourage people to bring their kids; we don't charge anything extra for their kids, they get to come there and hang out and be involved in as much or as little of the conference as they want... But its real design is not for them to learn these advanced real estate strategies, it's for them to meet other kids who have parents that are freaks like us. That just don't conform. Because my biggest mistake in my first half of my career was I was a closet investor; I didn't build a network, I didn't have people to turn to when the markets crashed, and my wife and I got set back... And whether our kids go into real estate or some other business is immaterial; just for them to build a network, and have that in their teenage years - it's huge. So that's what we're really passionate about.
Slocomb Reed: That's awesome. Derek, what is your best ever advice?
Derek Dombeck: This may not go over really well with your group, because I believe they probably use a lot of bank financing, but I do not like banks,. I have nothing against banks, I just don't like the control that we give banks over our businesses. And it's one of the main reasons that we only deal, at least for right now, with individuals and people, that we can have real conversations with in our lending business and our real estate business... Every property I buy, I don't fund with banks. And I learned that lesson the hard way when the bankers that I did business with in the 2000s were escorted out the door, and I was just a file.
So I'm not saying that there's anything wrong with using them, I would just say buyer beware; and balloons come up fast, and lines of credit get called due... Things happen really quick when markets shift, and it's happening again, right now.
Slocomb Reed: Last question, Derek, and especially for those of our listeners who are interested in your book - where can they get in touch with you?
Derek Dombeck: Simply send an email to my personal email address, Derek [at] bestreifunding.com. And if anybody wanted to check out what we do with our conference, it's Generations of Wealth, which is GOWvoyage.com. And that conference is coming up in Cancun, Mexico, February 26th of 2023.
Slocomb Reed: Excellent. Those links are available in our show notes. Derek, thank you. Best Ever listeners, thank you as well for tuning in. If you've gained value from this conversation, primarily about hard money lending and the opportunities available with it, please do subscribe to our show, leave us a five-star review and share this with a friend that you know we can add value to through our conversation today. Thank you, and have a best ever day.
Derek Dombeck: Thank you.
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