The basic strategy of a Fix and Flip loan is to help real estate investors purchase real estate properties at a discounted price. Then fix up the property to either meet conventional lending standards or renovate the property with the goal of selling for a profit. The same is true for a Fix and Hold except the investor after renovating the property gets their own conventional loan so that they can hold the property long-term as a rental or primary residence.
Whether you find the deal on your own, through a realtor or from a wholesaler, the goal of any fix and flip is to purchase the property at a discount. Remember 50% or more of your profit is going to come from the discounted price you are paying for the property. If you are not getting an unbelievable deal, then you are putting your flip at risk. It is also important to be aware of the properties flaws and be able to address those issues. Leaky roofs, water damage, fire damage, general property distress, or the need of updating are all places where a real estate investor can add value and make profit, but be aware they can also lead to other issues that are under the surface that will cost money to fix.
Finding the diamond in the ruff is the great challenge of all investors. For a flipper it is even more imperative because you will need to sell that property is a relatively short period of time. There are lots of strategies, but here are a few I have seen from our clients.
Foreclosure is the process in which a bank forces the sale of a property to repay the loan. Foreclosure sales generally require that the buyer have cash in hand. The sole purpose of a foreclosure is to have the banks’ loan repaid. If at the foreclosure auction the property sells for more than what is owed, the remainder of the funds go to the borrower. The starting bid at a foreclosure sale can be no more than what the bank is owed which creates the opportunity for an investor to purchase a property at a discounted price. In order to participate in this process, the person buying the property must have cash. If you do not have the cash then a Fix and Flip Loan from a Hard Money Lender can make up the difference as Hard Money is generally considered cash and is the loan of choice for foreclosure purchases.
If at the foreclosure sale there are no investors willing to pay the amount bid by the bank, the bank will now own the property. When a bank is forced to take a property back in lieu of a sale, the bank trades a revenue generating asset (the Loan) into a non-performing asset (a property). Properties cost money to hold and sell and banks generally don’t like that. Depending on market conditions and the banks’ balance sheet a bank may choose to hold the property for a period of time or liquidate the property quickly. The condition of the property will now determine the value of the property. It is common for a foreclosed property to be in poor condition and the bank is forced to either invest money and time to fix it up or sell the property as is. This scenario is also a great opportunity for an investor with cash or a Hard Money loan since conventional financing will commonly not lend on these properties. With less financing options this greatly reduces the pool of buyers, which in turn reduces the value of the home at that time.
Cash is king and this is certainly the case when you have a property you do not want or have one you cannot afford. If someone lists a property as a cash only sale it could mean that the property has issues that will keep it from being conventionally financeable. It could also mean that they need to sell the property fast and do not have the time for the buyer to get a conventional loan. Either way these sellers will commonly be open to a lower than asking price and can be an opportunity to pick up a property a discount if you have the cash or a Hard Money Loan which acts like cash.
Since most buyers need a conventional loan in order to purchase a property, searching for properties that do not meet conventional lending requirements are a great place to start. With the majority of buyers unable to buy, the home will not command the same market price. If a home does not have a sound roof, foundation, power meter, power panel, water heater, has been gutted or hoarded can all be scenarios in which the value of the property will need to be greatly discounted in order to generate a sale. If the real estate investor can resolve the know issues for much less than the value of the property will go up upon having resolved those issues, the opportunity for profit exists.
Many of our clients find success by focusing on a specific area in town that is being transformed. They will buy lists of hundreds or thousands of address in that area which they will send post cards or mailers to the people living in that area stating they are willing to buy homes for cash. By finding your own sellers, it enables you to offer your own discounted price and cut out the 6% relator fees the seller would otherwise have to pay if they listed the house.
An even more focused strategy is the door to door strategy. The goal in any flip is to buy the least expensive house on the block and rehab it to meet the average or slightly above average condition of the block. We have clients that will walk the same neighborhood every week or so and will find the properties that are not being maintained or look especially dilapidated in comparison to their neighbors. The idea is if they are not cutting the grass or have neglected the roof or paint, they may also want to sell. Many fix and flip investors have found great success finding people who need to sell their property this way. By finding your own sellers, it enables you to offer your own discounted price and cut out the 6% relator fees the seller would otherwise have to pay if they listed the house.
The best buying opportunities come when the seller no longer wants or is disinterested in a property. This is often the case after someone has passed away and has left real estate to their heirs. It is not uncommon for the person to have received an inherited property to be living in a different part of the state or country. This can make maintaining or keeping the property less enticing. They may have other needs for the money and may not want the property. Many times, the property is held jointly by several people some of whom do not get along which makes for owing a property together less desirable. Large inheritances can come with a tax bill. It is not uncommon that a portion of the assets will need to be sold quickly in order to pay for those taxes. In any case a relationship with a probate attorney can be a great resource for those looking to buy properties.
Times of transition are great opportunities to find a win/win deal. As people age they may find themselves property rich and may be looking to convert those properties into cash. It is not uncommon for people to have acquired property over a lifetime and the cost of maintaining them to become burdensome. As we age, our needs and priorities may have changed and the desire for better health, travel, or living expenses my outweigh the desire to hold and maintain real estate. This can be an opportunity to buy fix and flip properties at a discount.
Wholesaling is a strategy used by more sophisticated investors whose sole purpose is to find discounted properties in which they will quickly sell to another person. These are the people who are very familiar with foreclosure auctions or who send out mailers or knock on doors searching for people who are willing to sell their properties at a discounted price. A wholesaler has no intention to fix up the property but is in the business of finding discounted properties so they can mark up their newly acquired property just enough to be enticing to an investor who will purchase the property from them. Wholesalers commonly already have a pool of buyers waiting to purchase the newly acquired property and commonly hold the property for only days or weeks at a time.
Location, location, location is the mantra of anyone who invests in real estate. It is not uncommon for the value of fix and flip properties to vary widely based on the neighborhood and even street by street. As a basic rule it is best to purchase the worst house in the best neighborhood.
Before buying a fix and flip property, you should try to know all that you can about the issues you will have to face and overcome. A bad roof can be easily replaced, but the water damage that you cannot see can be a cost you need to account for. Foundations are expensive to replace and can cause a host of unforeseen consequences in the home if not evaluated properly. Bad wiring, bad plumbing, or a bad HVAC can be expensive to replace and should be accounted for especially if you are only planning to cosmetically fix up a home.
Although it might seem obvious, being organized, having a budget and a timeline is critical in this business. There are a ton of classes, videos, and programs on the internet that can help support you in this process, but if you are the investor flipping a property it will be on you to take the leadership role in this area.
Nothing stays the same, seasons change and so to markets. There are better times to buy and better times to sell. Most markets have peek buying times it is ideal if you can have your project completed when there are more buyers in the market to compete for your home. Conversely, seasons of bad weather, holidays, and other seasons can give you the advantage on your buy. There are also larger economic cycles (recessions and expansions) that you should be aware of as they can greatly affect your ability to sell and buy at a discount.
On a flip, time is your enemy. The longer you hold a property the more it costs you.
While not always costly in themselves, permits are often overlooked as a cost of doing a project. While it might only cost $100 to get an electrical permit, it might cost you $3,000 to have a licensed electrician to do the work correctly. Make sure you account not only for the time to get the permit but also the time it takes to get inspections. Many times, you cannot start work on another portion of your project has been completed, inspected and approved.
Credit is easy to get when you don’t need it and hard to get when you do. Before you get into the business of flipping get a Home Equity Line of Credit (HELOC) and several credit cards. It is not uncommon to run out of funds and it is always nice to have a reserve fund or additional lines of credit should you need to tap into them in an emergency.
Even the most experienced flippers have unforeseen costs and expenses. At a minimum, plan to have a 15% buffer on your rehab budget and 3-months of additional carrying costs for your loans. When you run into a snag you will be happy to have set aside an emergency fund or alternative capital sources should you run over budget or over schedule.
If you are flipping a home, you are going to need some help. Before buying a flip, it is critical that you have relationships with people that you trust and who have the time to do your work. If you do not have a general contractor who already has these relationships, you should be able to the work or have relationships with the following:
Many times, you can find people who can support several of these trades.
A portion of your cost will come in paying for licensed professionals like general contractors or realtors. On average a general contract (GC) will cost you 20% of the total rehab budget and you can also expect to pay between 5% and 6% of the after-repair value (ARV) to get your home listed and sold. That is a lot of profit to give away. Many full-time flippers take the time to get their general contractors license or real estate license so that they can do the work themselves and keep that profit for yourself.
Besides your rehab costs, realtor’s fees and General Contractor overhead, the next biggest cost to your flip is the cost of capital. Hard Money lender’s fees and interest eat into your profits. If you can save enough money to fund a project on you own, it is the encouragement of this Hard Money Lender to be your own bank whenever you can.
While there is a great profit to be made by investing in a fix and flip property it is by no means easy. You have to buy well, rehab inexpensively and do so quickly. You will also need a significant capital. Not only do you need funds to acquire the property you will also need money to rehab the property, pay your people, taxes, utilities, insurance and carry the cost of any loans you have taken out. After that you will have to pay taxes on the profits made from the sale. It has been said that you need to have money to make money and that is certainly the case if you are in the business of renovating real estate for a profit. To learn more about real estate investing check out our article Real Estate Investing.