House Flipping as a Business
Experienced house flippers will tell you there is much more to flipping a house than what is glamorized on television. Seasoned real estate investors understand the risks and rewards of flipping and have learned to minimize potential pitfalls to generate a meaningful profit. Renovation costs for a house flip can be unpredictable and expensive for inexperienced flippers, which is why most private lenders shy away from these investors.
The fix and flip business is not the get-rich-quick scenario laid out on HGTV with minimal setbacks and a hefty profit. Inexperienced newbies looking for a get-rich-quick rehab deal often end up losing money or break even if they are lucky. Still, some novice investors might be fortunate enough to walk away with a slim margin. On the other hand, experienced investors who see it as a serious business and apply vital due diligence can turn a nice profit.
Veteran investors often use customized financial modeling techniques to establish the profitability of a particular property. These models incorporate the purchase price, estimated rehab costs (including labor), and after repair value to decide the potential sale price and estimate their return on investment. Financing costs, closing costs, realtor commissions, and neighborhood comps should also be considered in a robust investment portfolio. Most lenders will require a prepared scope of work that includes this information along with a projected timeline. This collective project management information is used to accurately assess loan risk and loan costs for the borrower.
Savvy investors know their numbers, collect all the necessary information, and have a well-planned exit strategy. Most hard money lenders prefer to work with experienced borrowers and will avoid the newbies
Getting a Loan to Flip a House
When real estate investors seek out a loan for a flip project, they want to make sure the terms of the loan work for each specific deal. Is the loan consistent with the deal? Will there be enough margin to make the deal work? An experienced investor, looking at cost-to-capital, will calculate points, percentages, and closing costs to evaluate the profit margin and whether a lender’s terms will conform to the rest of the deal.
Even the most experienced investors shop around for lenders and loan options, always looking for a great referral. Consequently, it is wise to develop a network of other investors and industry-related connections to draw on as a possible resource.
Some lending options:
Traditional bank financing for a rehab property requires a good credit history, along with a successful track record of renovating properties. In this scenario, the bank will lend the funds according to the estimated timeline to complete the project. Then the borrower completes the down payment, pays closing costs, and so forth, and waits for the loan to be reviewed and processed for the funds to be released. This method could take up to 45 days.
It is also possible to get a home equity loan for a flip, provided there is enough equity built up into the property. These lines of credit typically offer a variable rate. However, the greatest gamble with this loan is that the investor’s home is tied to the flip project. If things go south, the borrower could lose the rehab property and their personal home.
Hard money loans have become the desired option for many real estate investors. The process is quick and simple and designed for people with credit issues. While the interest rates are more expensive, an experienced investor can complete the renovation project and pay back the loan within a short timeframe. For an investor with multiple rehabs occurring at a rapid pace, hard money loans can be utilized to great effect.
What are the benefits of a hard money loan?
While these types of loans might not be for everyone, there are a lot of benefits to using a hard money lender.
· Easy application: The application process is simple and requires a lot less paperwork than a traditional bank loan.
· Faster funding: Once approved, funds are usually released within 2-5 days. This allows an investor to jump on that prime property and begin the rehab right away.
· Cash deals: Getting access to funds immediately allows the investor to make a cash offer to the seller, which is rarely turned down and shuts out some of the competition for a property.
· Lower credit criteria: Hard money lending more heavily weights the value of the asset and experience of the borrower as opposed to not-so-stellar credit history. Many times, a lender will not even pull a credit report.
· Loan negotiation: Hard money lenders might be more flexible with their deals. It is possible for some lenders to get creative with loan terms to accommodate an investor’s project that might not fit the traditional criteria.
· Multiple projects: Traditional banks have a limit on the number of loans allowed by a borrower. Veteran investors who have a strong relationship with their lender can leverage additional capital to fund and manage multiple rehab projects.
How to qualify for a loan to flip a house?
Fix-and-flip loans are designed to cover the entire cost of a rehab project. Investors should have a strong grasp on the numbers before shopping for a loan. Compiling the purchase price, renovation costs, and after repair value of the asset helps determine the loan-to-value (LTV), or the amount required for a down payment, mortgage rates, and liability to the lender. Generally, lenders base the loan amount on an LTV at or around 65% of the appraised property value. If the “hard asset” or property is valued at around $200k, the loan offered might be in the $130k to $145k range.
Once the asset’s value is established, it is time for paperwork. Some examples of required documentation, in addition to the loan application might be:
· Scope of work, including a timeline
· A driver’s license or official form of identification
· LLC bank statements or other company financials
· The LLC operating agreement, if applicable
· An executed sales agreement for the property
· Contractor bids and estimates
· Personal tax returns
· Documented examples of prior rehab projects
It is important to make certain your documents are verified and well-organized before approaching the lender.
Some Positive Outcomes
Honest real estate investors can turn a profit while also impacting their communities.
· Investors with a strong and active business model provide jobs for contractors, plumbers, electricians, landscapers, realtors, etc.
· Local businesses benefit from the need for supplies, such as lumber yards, tile and flooring stores, paint, light fixtures, and so forth.
· Rehabbing distressed properties normally result in increased property values for other homes in the neighborhood.
· Neighborhood beautification makes residents happier and encourages others to maintain their properties.
· Impact on crime. Neighborhoods fraught with foreclosures, vacant properties, and other distressed assets increase the likelihood of crime. Studies have shown that investing in and renovating these kinds of communities creates a positive impact and reduces the criminal element.
Neighborhood revitalization might be as rewarding as it is profitable for knowledgeable investors who operate a successful real estate investment business.