Doing a rehab with hard money isn’t always as great as it sounds. We’d like to tell you we fund every hard money loan that comes through our application process, but it’s just not true. Lots of new real estate investors get excited and overly optimistic when they find a deal, and that’s especially true when they’ve put up non-refundable option money to get the contract. Remember, just because the purchase is competitive doesn’t necessarily mean you’re getting a good deal. Sometimes not doing a deal can be more profitable than doing the deal.
Here’s one where we said no to financing this investor’s deal, and in the end, the investor actually thanked us for it. It’s much better to lose your option money after a few hours of research than to lose $25k after 6+ months of work and stress. (If you don’t know what option money is yet, then start here with Texas real estate contract basics.)
Buy a rehab with hard money for 195k, put 55k of work into it, sell for 285k, sounds great, right? Make 35k on that deal, right? Not even close. Here’s why that math doesn’t work with a hard money loan, or at all actually.
Contract price: $195,000
1,092 sf house, 3 bedroom, 1 bath
Rehab needed: $55,000
Remodel comps came in as high as $320,000, but this house was in a less favorable part of the neighborhood. Our after-repaired value (ARV) for this property came in at $285,000. Here’s why, even if you’re confident with that ARV, you shouldn’t do this deal. (If you want to learn more about ARV and investment property valuations – head right this way.)
$200,000 loan offer from Little City, 70% of $285,000 ARV
$195,000 contract purchase price
Purchase costs: $10,700
- $8,000 origination fee (4%) to Little City
- $300 document prep fee to attorney
- $1,000 builder’s risk insurance for 1 year
- $500 closing fee to closing office
- $400 survey
- $500 inspection
Remodel costs: $55,000
Holding costs: $2,583.33 per month / $15,500 for 6 months
- $12,000 interest on $200k loan for 6 months
- $3,000 for 6 months of property taxes
- $500 for 6 months of utilities & lawn maintenance
Total investment: $276,200
$2,583.33 per month “burn rate” at completion
Selling costs: $14,250
- $285,000 sale price
- 1% to listing agent *typical listing fee is 3% – note that you may also have to pay separately for photography if you’re paying a discounted commission
- 3% to buyers agent
- 1% for seller-paid title policy and closing fees
Net proceeds from closing: $270,750
You’d have to finish the remodel and get the sale closed in less than 4 months just to break even. In our experience, that’s very difficult to do with $55,000 worth of renovations to execute on. Keep in mind that even once it’s under contract to sell, the average time from contract to closing is over 45 days. We think a more realistic time-frame for a typical rehab with hard money is 6 months.
Projected LOSS if sold in 6 months: $6,450
Projected LOSS if sold in 9 months: $14,200
So if everything goes as planned (which never happens with a rehab, by the way), then the investor PAYS $6,450 for the experience of managing this rehab. If it takes 7 months, that number goes up to almost $9,000. It’s easy to see how this deal sinks quickly.
What if you don’t need a hard money lender though? Is this even a good deal then? If you have $280,000 cash, then you could do this deal without borrowing the money, saving over $20,000. You might have a chance at eking out a profit that way, but assuming you can stay on budget, if it takes 9 months to remodel and sell it, you’re looking at taking a ton of risk for less than $6,000 profit. 11 months and you’re breaking even. You could have made $21,000 on your $280,000 by investing in a hard money loan for 9 months at 10% – and saved yourself a ton of time and stress.
The worst way to get started flipping is to lose money on your first deal. Your first deal should be a no-brainer, total slam dunk deal, so you can make sure you’re able to do your second deal. Don’t settle for a marginal deal because you’re optimistic and excited. Trust a hard money lender who is willing to tell you “no” when a deal doesn’t make sense. Doing a rehab with hard money is an easy choice when there is plenty of equity, meat on the bone as they say. Go into the deal with a strong margin, and you can handle the inevitable surprises involved in a rehab flip project without losing money.
If you’re interested in financing a Texas investment property with a reliable and honest hard money lender, please contact us today. If putting your cash to work without the hassle of running a rehab sounds interesting, learn more about investing in our rehab hard money loans here, and please reach out if our loans sound like a fit for your investment portfolio.