Let’s Walk Through an Analysis: The Hard Money Fix, Rent, and Refi
I’m kinda a math nerd, so when opportunities arise in the BiggerPockets Forums to analyze a deal, I love to jump into the conversation and help people look at the deal. I understand that the math can be complicated, and it’s taken a long time for me to wrap my small mind around it (and I still mess numbers up often!)
So yesterday, I spent some time analyzing a deal and when I finished, I thought “Well… I bet a lot of other people might be wondering the same thing – I’ll put it on the Blog.”
So here it is!
If you’d like to read the whole thread, click here, but I’ll sum up the question below.
Special thanks to Junior Salters for posting this question!
Essentially, Junior wanted to know more about the strategy that is often talked about around BiggerPockets where an individual:
- Uses a Hard Money Lender to buy a cheap house;
- Remodels the property;
- Rents the property out;
- and Refinances the property, through a bank, into a fixed rate, long term mortgage.
I have personally used this strategy a few times, and am in the middle of using it on a four-plex (soon to be 5-plex) that I bought several months ago – which you can read about in my (super long winded) article “How to Buy a Small MultiFamily Property: A Step by Step Case Study.” I am a large fan of this strategy – though there are definitely some major precautions a person needs to take – which I’ll go over below.
Junior posed the following hypothetical question, based on a real-life property:
“If i had a rental that I wanted to purchase for $25,500 cash and the After-Repair-Value (ARV) was $50K; and the HML would give me 70% of ARV and it only needed 3-5K in repairs (turnkey with tenant – rent at 625), how much money would I need to bring to the table?”
Do you have a guess on how this situation would play out in real life? Take a guess, and then follow along my analysis below and let me know if you agree or disagree!
How to Analyze a Fix, Rent, and Refi
First, let me re-cap the numbers presented in the question:
Purchase Price: $25,500.
After Repair Value: $50,000.
First, I want to make some minor changes to the numbers above – because I believe it’s important, especially for new investors, to double your repair budget when calculating the numbers. You can always reduce later and try to save money, but when analyzing, I always recommend doubling your budget.
So, $3,000 – $6,000 in repairs I’m going to turn into $10,000 for repairs.
Therefore, a $25,500 purchase + $10,000 repairs would be $35,500. Add $1500 in closing costs and you’ll be at $37,000.00 into the deal.
Now – a quick note on the “After Repair Value.”
Remember, hard money lenders are going to be ULTRA conservative. So you might think it’s worth $50k and they might say $39k. So I believe the #1 most important step in this whole thing is being 100% absolutely positive in the final ARV amount, confirmed by at least 2 different real estate agents and supported by at least 3 comparable SALES, sold within 3 months and within half a mile. It might seem like overkill, but as I’ve outlined in my article “How NOT to Flip a House: An Embarrassing Story of Wasted Time, Money, and Opportunity” – over estimating the ARV is a recipe for disaster.
So let's assume the $50,000 number is a solid, good number to use. So, if $50k is the After Repair Value, a hard money lender, as suggested in the question, will fund 70% of that deal, or $35,000, which means you'd be "technically" expected to come to the deal with $2,000 worth of repairs (because the total deal was going to cost $37,000.)
Most hard money lenders are not going to fund all the purchase price AND most of the repairs on your first deal. Most likely, the repairs will be 100% the responsibility of you, even if the 70% and the ARV support it. You might find a lender to do it – but it’s unlikely on your first deal. The 4-plex (soon to be 5-plex) that I am working on right now was funded almost 100% by my lender, but that is because I have the experience and financial backing to support the added risk – plus the relationship I’ve built with the lender was very important as well. However, don’t assume this will be easy to find.
So, I’d say most likely, the lender would say:
“Since this is your first deal, I will fund $20,000 of the deal. You will come to closing with the remainder, and the repair costs will be on you.”
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The hard money lender will then charge you their points as well, and add it to the loan. Let's say the HML will charge 5 points and 12% interest. So the total loan is going to be $21,000 ($20,000 + $1,000 for the "points") and you'll come to closing with $7,000 to cover closing costs and the rest of the purchase. Then, you'll pay the $10,000 for repairs (hopefully it's less than that Ã¢ÂÂ and if it is, awesome but don't expect it,) close on the deal, and begin work.
Keep in mind also – you’ll pay the lender $210 per month for the mortgage payment plus another estimated $100 for taxes and insurance, so $310 per month in holding costs. Assuming it will take 3 months to clean it up, and get a renter in it (probably less, but always double your timeline), this is going to add another $1000 or so to your bottom line.
SO in the end, you’ll have spent:
$1,000 HML points
$7,000 cash you brought to closing
$1,000 holding costs
Total cost: $39,000
Cash Flow Analysis
At this point, you get the house rented out for $625 per month. Using the 50% rule, figure $300ish goes out to expenses, and the remained pays the mortgage ($210 per month). So, while using the HML, you are getting around $100 per month in cash flow. Not too shabby, but with the short term hard money loan, you don't have a lot of time either. As soon as the "seasoning" period is up (banks will typically require you to wait 6-12 months before you can refinance) you can start the refinance process.
At that point, the bank will do the appraisal and it comes in (hopefully) at $50,000. The bank agrees to do an 80% loan to value mortgage, on a "Cash Out Refi" (which means you get the original HML loan paid back, plus cash to pay yourself back) so they will loan $40,000 â which covers everything you've put into it. However, the bank is also going to charge a couple thousand in fees and closing costs because they all suck like that. So you may be a couple grand short in the end, but nothing is free in life!
The new mortgage of $40,000 at 5.5% for 30 years is $227 per month (just the principle and interest.)
Now, using the 50% rule again, and assuming a rental price of $625 per month, you, you are left with around $90 or so per month for cash flow.
Sure, that cash flow is not amazing, but knowing that you have no money into this thing, it isn’t a bad thing either.
As I mentioned earlier, there are a number of important considerations and assumptions to consider when using this strategy. This section is going to cover a few of those. This is very important – so be sure to read carefully through this section.
So, this whole deal hinges on a few important things:
1.) The property really being worth $50k. This is a big deal. We talked about this above.
2.) Having the, roughly, $18,000 of your own money needed to do the deal. Or finding a partner with the $18,000. For more information on investing without cash, check out “How to Invest in Real Estate with No Money.”
3.) Finding a HML that will fund 70%. Most will only do up to 60-65%. Maybe less on a first deal – so be sure to look around. For the internet’s most comprehensive list of hard money lenders, check out the BiggerPockets Hard Money Lender Directory.
4.) Being able to get the refinance from the bank. This is vitally important if you are going to use this strategy. Lending practices could change â so be sure to have multiple exit strategies. At the end, you'd only have $39,000 into the deal. Could you quickly sell it for $45,000 if you had to unload it fast? Are properties in that price range selling quickly in that neighborhood? Having multiple exit strategies planned is very important â and will also help you secure better terms from a hard money lender.
Conclusion- What do YOU think?
Anyways – that’s my analysis of such a hypothetical deal. Hope that all made sense to everyone! Feel free to post your questions or comments below if I didn’t explain something clear enough or if I messed up in my math anywhere!
Also let me know … would you do this deal? Why or why not? Share your thoughts below, or on the forum post itself!