buying a duplex with hard money

Thinking about borrowing hard money to buy rentals? Whether that’s a good idea really depends on your goals, your cash on hand and how good of a deal you’re getting.

You’re looking at properties for long term rental income, but what happens when you find one that’s vacant and your bank won’t finance the purchase? If your lender can refinance a rental property for you at 80% LTV, but not until it’s been leased for ~6 months, a hard money loan could be the bridge financing you need.

Understand Property Value and Budget

First, be sure your hard money lender will agree with your current as-is value. We tend to be conservative, so it’s best for you to be conservative here as well. Hard money lenders analyze your property based on the 30-day liquidation price, not the highest possible price.

Always use at least 3 similar, recent and – most importantly – sold properties. If you’re not a real estate agent, you need to be sure you’re working with someone experienced and diligent with comps. It doesn’t pay to be optimistic here.

We recommend doubling your repair budget at this stage of analysis because you should be extra conservative on your “napkin math.” Don’t learn the hard way – making more than you expect to is the goal, but it’s also rare, despite what you see on HGTV.

Hard Money Loan Rental Pro Forma

Let’s look at an example – a duplex that rents for $2,700/side or $5,400 total rent/month.

Deal Numbers

  • $600,000 current as-is value
  • $420,000 max hard money loan (70% of current value)
  • $15,000 repairs needed

Now, let’s be a bit pessimistic and assume you can get a hard money loan for 70% and 4 points. At Little City Investments we often provide Austin and Houston hard money loans at lower rates and higher loan to value. Contact us for more info.

$420,000 (70%) Hard Money Loan Costs

  • $16,800 points (4) to hard money lender
  • $650 legal fee to have the documents prepared by our attorney
  • $350 escrow fee to the closing office
  • $17,800 total loan costs to be paid at closing

Then figure holding costs for the hard cash loan term. The minimum you should assume for a rental property is six months:

6 Months of Holding Costs on $420,000 Hard Money Loan

  • $27,300 interest for 6 months
  • $8,100 property tax estimate
  • $1,500 utilities/lawn/maintenance estimate
  • $0 HOA
  • 6 months at $6,150 per month total expense = $36,900
  • $5,400 rent/month with 5 months leased = $27,000 income
  • Estimated net holding costs (6 months) with hard money loan: $9,900

Then plug in better terms for the future bank refinance loan which will “take out” the hard money loan:

Refinance – Long Term Rental Pro-Forma

  • Refinancing $480,000 (80% LTV) into a new loan at 5% with 2 points and average closing costs should net you $54,700 cash out at closing
  • 30-year amortizing loan payments: $2,576.74
  • Estimated taxes and insurance/month: $1,600
  • Total expense/month: $4,176.74
  • Net pro-forma income/month: $1,223.26
  • Net pro-forma income/1st year: $14,679.12

Consider Different Purchase Price Points

Now model your return on investment based on different purchase prices:

Purchase for $500,000

  • $517,800 total cost to purchase with hard money closing costs
  • +plus anything else you agreed to pay in the contract such as title policy, survey, etc.
  • Cash to close: $97,800 + $15,000 repair budget = $112,800 cash needed
  • Estimated net holding costs (6 months) with hard money: $9,900
  • Total cash on hand required: $122,700 plus contingencies, $54,700 returned at refi
  • Cash on cash return: 22% before depreciation or taxes

In this example, you need $120,000 to make it happen, but you get about $55,000 of your cash back once you refinance. Still, by using a hard money lender, you’re able to acquire a long term income property with 22% ROI before depreciation or taxes. This example doesn’t consider the opportunity cost of the money between the purchase and refinance.

As usual, the key to bringing less money to the table is to get a good deal going into it. If you can negotiate the price down to $400,000 (67% of the value), things get more interesting…

Purchase for $400,000

  • $417,800 total cost to purchase with hard money closing costs
  • +plus anything else you agreed to pay in the contract such as title policy, survey, etc.
  • Cash FROM closing: $2,200 + $15,000 repair budget = $12,800 cash needed
  • Estimated net holding costs (6 months) with hard money: $9,900
  • Total cash on hand required: $22,700, returned at refi
  • Cash on cash return: Infinity! You got paid to buy this cash machine!

In this scenario, you put in about $22,000 cash at purchase, mostly in holding costs paid monthly. Once you refinance you get back ALL of your cash AND $32,000 more. You could reduce the loan amount and increase your cash flow or use that $32,000 toward your next deal. As usual, it works out much better when you make your money when you BUY the property instead of creating value after you buy it.

Key Points for Purchasing Rental Properties with Hard Money

  • If you want to use hard money, be sure about the accuracy of your current value.
  • Know how much cash you have access to and if it is enough to do the deal.
  • Be confident you can get the refinance you’re expecting.
  • Have multiple exit strategies – always.
  • Be sure you can sell it for more than you have into it, at any point in the process.

Considering a real estate investment project in Austin or Houston? We’d love to hear from you; click here or give us a call at 512-577-6049. We make Houston and Austin hard cash loans, and we’ll get your deal done!

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