Not all flippers / rehabbers are cash buyers. Most of them are bound to the lending criteria of an asset based lender, AKA hard money lender.
A hard money lender will generally not lend more than 50% to 70% of the properties after repair value. (ARV) The total percentage they loan will be the total amount they loan, including setting aside money in an escrow account for construction purposes.
And let me tell you, those folks are not cheap. The average hard money lender charges 3 to 5 points, as well as 14% to 20% interest.
Most savvy investors factor in the cost of construction, the cost of the money, re-listing the property with a Realtor, insurance premiums, title fees, etc when buying the home so they don’t have to come with any money out of pocket as a down payment.
The formula I use when I purchase a rehab property is as follows:
1) After Repair Value (ARV) – (minus) Repairs = As-Is Value
2) As- Is Value (divided by) 2 = Offer Price
It’s funny when I was in high school I slept through algebra, but now I use it on a regular basis. 🙂
Let’s use a real life example:
$100,000 (ARV) includes stainless steel appliances, granite, ceiling fans in every room, new paint / carpet
$30,000 (Repairs) Cost to get home up to after repair value, which is top market values standards.
$70,000 (As-is Value) I simply subtract the top market value from the repairs needed
Then I divide the AS-IS figure by 2 and offer 50% of the homes AS-IS value, and that figure is:
If my hard money lender agrees to lend me 70% of the ARV, my loan amount will be for $70,000 dollars. Here are how the fees break down:
$35,000 purchase price
$30,000 repair budget
$3,500 5 points to borrow the money
$3,500 $875 dollars per month interest only payments at 15% interest x 4 months holding time for resell
(We are using 15% interest only payments as an example, which would equal $875 per month pre-paid for a $70,000 loan)
In this example, the investor would have to bring $3,000 to closing in cash.
Now, let’s say the investor fixes it up really quick and puts it on the market. Within 60 days, he gets a full price offer:
$100,000 purchase price
$73,000 loan pay off (including $3,000 cash invested at the table)
$750 title fees
$6,000 realtor commissions
$3,000 buyers closing costs (common)
$17,250 dollars net
In a nutshell, the investor had to risk $3,000 dollars, his reputation with the hard money lender, manage contractors, deal with marketing concerns, and wait 4 months to get paid back $17,250 dollars. If you break that down to NET profit, that is $14,250 dollars in 4 months. If you break that down to a monthly salary, that is $3,562.50 per month for a great deal of risk.