Today’s REI Classroom Lesson

Lex Levinrad discusses why you should take advantage of hard money when working on fix and flips.

REI Classroom Summary

Lex explains how it can be hard to get a loan from a bank when working with distressed properties that need repairs.

Listen to this REI Classroom Lesson

Real Estate Investing Classroom Show Transcripts:

Mike: Welcome back to the REI Classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Lex: Hi guys. Lex Levinrad, founder of the Distressed Real Estate Institute. And today we’re gonna be doing another REI Classroom and on this show we’re gonna be talking about fixing and flipping, specifically using hard money and why someone would do that.
Mike: This show was sponsored by
Lex: A lot of you, if you have never borrowed money before on a hard money loan, you would think that paying 13%, 14%, 15% on a fix and flip is ludicrous compared to bank rates of 4% or 5%, but what I want to point is a couple of things. First of all, number one: banks don’t loan money on damaged properties. And the reason they don’t loan money on damaged properties is because you cannot get insurance on a damaged property. So that means any REO that’s boarded up, any short sale, any bank-owned property, any property that’s got major damage has to be a cash buy.
Now, if you’ve got the cash, yes, by all means. If you’ve got 100,000 sitting in your checking account, don’t come to someone like me and borrow money at 13% or 14%. But let’s say you don’t have the money. [inaudible 00:01:20] on a deal that was recently done. Okay, so he came to me and he had a property he wanted to buy in West Palm Beach. And it was a property that he was purchasing for $89,000. I agreed to give him a hard money loan for $80,000. I charged him 15%, relatively high interest rate. So his out-of-pocket cost so far is $10,000. Right? Well, actually $9,000. He put $9,000 down and I loaned him the $80,000.
Now he went and he fixed up this property. The property needed a lot of work. I actually helped him with the contractor for the property, did the work, cost about $21,000 to fix it up. So now his cost is the $89,000 plus the $21,000, plus there were some fees: our charger, 3 points, plus about $1,200 in fees, plus closing costs. So by the time he got into the loan, he spent some money.
He is a licensed real estate agent so he listed that property on the MLS himself. He sold it for $163,000. When he sold it, he paid back the $80,000 loan. And what we did then is we put it down on a spreadsheet and we looked at his numbers. And what it turned out, is his profit was almost $40,000 left, $39,700. So in his case, he came out-of-pocket the $9,000, plus the $21,000, about $30,000, plus some fees. So he came out about $34,000, $35,000 that he had to use of his own cash. But his return was almost $40,000.
Now compare that to if he had utilized his own cash. Let’s say he had the $110,000 or so sitting in his account, and he had used it. He would have made the same profit, minus a little bit of those fees, but a leverage factor would have been substantially less.
So if you’ve got the cash, absolutely use it. But if you don’t, sometimes hard money can be very beneficial, because it allows you to buy more properties. And there’s many business models out there, companies like myself, where we’ll choose to close on three, four, five properties in a week. And some of those properties we’re closing with borrowed funds.
Now, we might not pay 15%. We might only pay 8% or 9% or 10%, but it allows us to close on a property and re-market that property for another two or three weeks and then move it at a higher price point. So if we flip a property for $10,000 or $11,000 and it cost us $2,000 in fees, that’s a lot better than giving up the property.
Okay, so there’s a lot of reasons why you would use hard money, for fix and flip obviously it works very well. A couple of points is if you’re gonna try and do a fix and flip using hard money, I like to use the 30-30 rule. Make sure you can make at least 30% on your money and make sure you can make at least $30,000. Because remember, the costs can add up very, very quickly. You’ve got closing costs when you buy, you’ve got to put insurance on the property, you’ve gotta pay for the repairs. Typically, it’s going to take you five or six months to sell a property, so you’ll have about a half a year of interest to pay. Then you’ve got all the fees getting into the loan, the points and the fees. Right?
Now, when you go to sell, you’re gonna have to pay your 6% commission if you’re not an agent. And in addition to that, you’re gonna have to pay probably around 2% in closing costs, and if you’re selling to a first-time home buyer with an FHA loan, you might have to pay even more, because FHA loans typically are a little higher. So when you factor in all those costs, the 30-30 rule is a great way to keep yourself out of trouble because if you get into a real skinny deal, sometimes you think you’re gonna make $30,000. By the time you add up all your fees you might only make $18,000.
So pay attention to important things, like after repair value. That’s another thing about hard money: when you use your own cash, you can overpay, there’s no one stopping you. But when you come to me and say, “Hey Lex, will you loan me [inaudible 00:04:51]?”, you’ll see very quick whether I think it’s a good deal or not. Because if I’m not willing to loan you the money, then your deal probably’s not as good as you think it is. So make sure you understand the ARV formula, 30-30 rule, try to make at least $30,000 profit, 30% return. So once again, this is Lex Levinrad with some hard money tips on REI Classroom.
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