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The SHOCKING Truth About Getting Money For Your First House Flip

by Michael LaCava on July 7, 2014 · 21 comments

  
The SHOCKING Truth About Getting Money For Your First House Flip

Last week, I talked all about the many benefits of using hard money to fund your first flip.

Although there’s lots of people who are “in the know” and completely understand hard money, there are far too many who still think the opposite.

Let me tell you why this is so wrong…

The “Big Question” and How Hard Money Can Solve It

As many of you know, I have a house flip business which I spend 95% of my time with – but I also have a blog on house flipping to help new investors.

For every new person who subscribes to my blog, I email them a question like this a few weeks after they subscribe:

Are you still interested in flipping houses?

After they say “yes”, “no” or tell me what’s their situation is, I then email them back usually asking this:

“What’s holding you back from getting started?”

Here’s why understanding hard money is SO important…

These are just a few answers (not edited at all, by the way) from the last two days back to me on email:

“Yes I am Mike,  just don’t have extra cash or credit right now”

“Money a good mentor  and a business partner.”

“Just hard to believe you can do re without money.” 

“Mike – Time and money.”

“I am interested, but at this point I don’t have the cash flow to do it at this time……..”

“Lack of funding or knowing where to get  it.”

What’s the one common element in all those answers?

You guessed it: Money. It’s the great stumbling block for nearly every new house flipper.

So how do you get “money”?

How you get it has a lot to do with the numbers and the how then comes from those numbers. Let me explain….

The 70% Rule and The Elephant In the Room

By now you probably know about the 70% Rule.

As has been discussed in this space many times, its the fundamental rule in house flipping.

So because it’s so important, lets review some of the details a little further.

Related: 10 Rules for Investing in Real Estate Without Looking Like an Idiot

The 70% Rule Fundamentals

So for example, you’ve determined with your broker that the ARV of a certain house is $200,000. There are plenty of comps in the area and you feel comfortable with that number.

So to get to the 70% Rule, you do the following:

1. Take the $200,000 and multiply it by 70%, which equals $140,000:

ARV: $200,000

70% Rule: $200,000 x .70 = $140,000

2. To get the maximum amount you should pay for the house, you then deduct your renovation costs from that $140,000. In this case, let’s say your rehab expenses will be $40,000:

Subtract the $40,000 from the $140,000:

Repair costs: $40,000

70% Rule: $140,000

Maximum Allowable Offer (MAO): $100,000

In this example, you’d make an offer below $100,000, then most likely negotiate up if you need more wiggle room. When all your costs come in as expected, you will make a nice profit on this flip no doubt.

The 70% Rule Profit Breakdown Using Hard Money

Typically when we apply the 70% rule, it breaks down like this:

  • 20% is projected profit of the ARV
  • 10% is your projected soft costs of the ARV (this is your money cost here!)

This is the quick math you use when you “eyeball” a property when using private money or other financing sources for your flip. However you MUST know your expenses to determine how the 10% applies to your situation!

Let’s say you’re using hard money and you’re paying 12-15% and 3 or more points on your hard money loan.

If that’s the case, then your projected soft costs will be higher than the 10%!

What this means is your projected 20% profit of ARV will then have to come down. It may be more like 15% profit or even less.

If this is the case, you may not hit a total home run on your first flip…but you will make money and a nice profit even if its an epic fail.

This lower level of profit may be fine for you or you may need to buy at a lower price. The point is to know what your numbers will be as best as you can project.

Money Secrets Example

In our example above, you are working on a deal with an ARV of $200,000  using hard money and the  70% Rule, you might be making $25-35,000 as opposed to $40,000.

Would you like to make $25,000 profit on a house flip? I sure would.

Let’s say the house doesn’t sell for another three months and you make $15-17,000 instead? Would you STILL do this deal?

Hell yeah.

Related: Why I Pay More for Fix and Flips than the 70% Rule States I Should

The point is that without the hard money loan, you never would have made that “worst case” profit of $15,000. AND better yet…you now have you first flip under your belt. You can now leverage this to private investors to get even better terms and then make even more on deal number two.

Make sense?

The idea here is really knowing the numbers when you go into the deal and understanding how they affect the 70% formula.

And if you use hard money…you need to know these numbers!

If you have the ability to buy the property for less money – less than the MAO even, do your best to get it as low as you can to add to your profits! At the same time, you don’t want to go so low that you lose the deal…so keep that in mind as well.

Hard Money IS Workable…But You Have to Know The Numbers

I hear people say all the time:

“Oh I would never pay hard money rates.  That’s crazy, that’s ridiculous.” 

There’s nothing wrong with hard money if it helps you make money…maybe not as much as would with private money or a loan from a bank – but you will make money.

For those who poo poo hard money, you may want to ask those people:

“In the last month, how many deals have you done?” 

If they answer:

“Well, none right now”

…then you have your answer.

Action is better than no action and using hard money allows you to take that action.

Don’t worry Donald Trump…you’ll make your millions on the deals after that first one. The point is that you need to get started…and hard money allows you to do just that.

Set your profit expectations slightly lower and get in the game with hard money!

Just make sure you use the formulas enclosed here to protect your downside.

If you’ve made it this far, then please leave a comment below! I’d love to know what you think about hard money and getting money for your first flip!

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{ 21 comments… read them below or add one }

jim July 7, 2014 at 6:49 am

Great article. As they say…50%(or whatever percentage you make) of something is better than 100% of nothing. Do a couple deals with hard money and then perhaps you can get a bank LOC or come across a private lender.

Reply

Michael July 8, 2014 at 5:46 am

Exactly Jim – I constantly work on the cost of money. It is something all business owners should do. Like you said 50% of something is better than 100% of nothing. New investors need to think more like that especially when getting started.
How are you funding your deals?
thanks for your comments.

Reply

jim July 9, 2014 at 2:31 pm

Two of the homes I’m working on are private sales as I was doing houses on the street and simply walked over one day and the other two I actually bought off the MLS.

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Michael July 16, 2014 at 4:07 pm

Did you fund them privately as well?
I think you thought I said finding and I said funding. LOL.
Good job though finding them that way!

Maurice July 7, 2014 at 7:04 am

Michael, when you’re right you’re right. Short money is better than no money. I am inspired by your article. Thanks!

Reply

Michael July 8, 2014 at 5:47 am

Thanks Maurice
Happy to inspire. How are you funding your deals or are you new to investing?

Reply

Maurice August 4, 2014 at 7:57 pm

I’m not new to investing but it’s been a while since I’ve been in the thick of it. I’m a little rusty but I have a private investor. However, I am always looking for sources of cash and hard money is an arrow in my quiver. Sorry I didn’t reply sooner but for some reason I wasn’t aware of your response. P

Reply

Chinua Rhodes July 7, 2014 at 1:15 pm

I think this is great info. I was just having a convo with a few business partners yesterday about what way we wanted to go with financing our first property/properties. I’m interested in multi family homes and flipping houses. I think the combination would be ideal. I wanted to start off by flipping a house. The thought of hard money was scary but with your info (that I will share) makes it more realistic for me. Thanks sir

Reply

Michael July 8, 2014 at 5:50 am

Thanks Chinua
Let me know how you make out with your business partners. Holding for long term wealth and rental income is a great strategy. There are some great deals out there right now.
How were you originally thinking of financing them?

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Walt Payne July 8, 2014 at 12:47 am

Good point, that if you have no money you should evaluate all potential sources. But there are additional things that need to be considered. Take that $15,000 “profit” example and consider the extra taxes involved in flipping. Add the 6% listing fee if not an agent or broker, and the other seller side closing costs. It may still be worth doing, to build up starting funds, but people need to be aware of all of the costs when evaluating a deal.

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Michael July 8, 2014 at 5:54 am

Yes they do Wayne that is why the 70% rule is the quick math and we explain in this short article you must do your math & know your cost of money for example and how it effects the 70% rule.
Typically for us the 10% of ARV covers our real estate commission and soft cost on average.
Once you know all your costs you can apply it to a % of ARV so you get your offers at your MAO.
You are right that you have taxes to pay as well and that is the case in any venture when you make profits. You must be prepared to pay what you owe and a good CPA will help you prepare for that. Thanks for reminding everyone on that.
What types of real estate investing are you doing?

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Albert A. July 10, 2014 at 12:13 pm

Hi Michael,
As always excellent and concise info! Thanks for taking the time to write all these very helpful articles. We’ve all read many on the 70% rule but I finally FINALLY got it with this one. My block had been realizing that soft and acquisition costs are already built in the 20% part of the 30% whole. So thanks for specifying that in the comments. Questions:
1.- Does the 20% also account for selling costs?
2.- I plan to use HML for my second flip and want to gather a fund of equity investors, mainly family and business owners friends, to help me come up with the usual 10% down and construction start up. Would paying them a 6% on their individual money be advisable? Have you or any of your readers done this before?

Thanks and Cheers!!

Albert in San Antonio Texas.

Reply

Michael July 16, 2014 at 4:05 pm

Thanks Albert
10% is for soft costs including all selling cost and commissions
This may be higher depending on your cost of money and how long you hold the property
The % interest you pay will be important and different to people. I would come up with a reasonable amount and offer it the same to all.

Just make sure you don’t break any SEC rules or regs. if you are combing funds. I don’t do it this way. I am not an attorney so this is just my opinion.

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Albert A. July 16, 2014 at 6:51 pm

Thank you Michael! It’s all coming together now! LOL =)

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Maurice #2 July 15, 2014 at 7:35 pm

Michael,

This article just hit a nerve with me… Awesome! Been on the fence for a while nervous to use a hard money lender I have been in talks with. I just set a goal to do my first flip within the next 60 days!!

Thanks a ton!!

Reply

Michael July 16, 2014 at 4:06 pm

That’s is great Maurice. Let me know how you make out!
Where are you looking and what price range?

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Maurice #2 July 17, 2014 at 4:59 am

I am in Minneapolis and want to be in the 75k – 125k price range, preferably a single family. Will keep you updated, thanks again!

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Michael August 4, 2014 at 5:20 pm

Your welcome Maurice.

Shelly Swanzy August 4, 2014 at 1:37 pm

Thanks for the great information. You’ve addressed all my concerns about hard money except for one. The hml’s ask if it is under contract as part of your initial submission-how can i get it under contract if i dont know if i can get the hard money to actually purchase the property?

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jim August 4, 2014 at 3:42 pm

Get a hold of a couple hard money people and get approved. Find out what their requirements are so that you can go and bid on some deals.

Reply

Shelly Swanzy August 4, 2014 at 7:42 pm

Thanks m will do.

Reply

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