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!

Special thanks to Junior Salters for posting this question!

## The Strategy

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.

## The Question

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.
Repairs: \$3,000-\$6,000
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.)

However…

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.”

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 – 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:

\$20,000 loan
\$1,000 HML points
\$7,000 cash you brought to closing
\$10,000 repairs
\$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 – 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.

## Important Assumptions

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 – 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 – 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!

Photo: auralninja

Brandon Turner is an active real estate investor, entrepreneur, writer, and co-host of the BiggerPockets Podcast. He began buying rental properties and flipping houses at age 21, discovering he didn’t need to work 40 years at a corporate job to have “the good life.” Today, with nearly 100 rental units and dozens of rehabs under his belt, he continues to invest in real estate while also showing others the power, and impact, of financial freedom. His writings have been featured on Forbes.com, Entrepreneur.com, FoxNews.com, Money Magazine, and numerous other publications across the web and in print media. He is the author of The Book on Investing in Real Estate with No (and Low) Money Down, The Book on Rental Property Investing, and co-author of The Book on Managing Rental Properties, which he wrote alongside his wife, Heather, and How to Invest in Real Estate, which he wrote alongside Joshua Dorkin. A life-long adventurer, Brandon (along with Heather and daughter Rosie) splits his time between his home in Washington State and various destinations around the globe.

1. Thanks again for the help, Brandon and mentioning that I should post it in the forum. I hope someone can take alot from this like I did. Definitely brought more things to reality which was needed!

• No problem Junior! I’m glad you brought this scenario to me. It’s fun to work out the hypotheticals, and it’s helpful for a lot of people!

2. john milliken on

great breakdown Brandon.

only consider flipping the house option. buy/hold/rehab/rent/hard money/refi is too much risk.

so, dusting off my Danny Johnson calculator, arv 50k *.65 = 32.5 -10k repairs = 22.5k (max offer). 25.5 is over paying already, and the extra 3k is needed when the vig is running on hard money. all based on a “IF” it sells for 50K, and quickly.

the risk for reward isn’t there, next!

• I would not do this deal, the profit is not big enough and the margins are just to tight.

• Thanks John! Yeah, I think I would agree – probably too thin. The cash flow isn’t terrible though, and the ROI might work out, but I’d still try to fight for a better deal!

3. Wow this is some great information and thanks for the break down. I dont know Junior but I dont think I would bother with this deal. The number just dont look right. Any minor mishap and you are already in the red. I am just starting and had something come to the table with very similar numbers. It just wasnt worth the risk.

• Hey Thomas, thanks for the comment! Yeah, I agree- it’s not a “great deal” and I’m a big fan of only buying great deals – not mediocre ones. Maybe once all the great deals are gone, it might be worth pursuing but not yet!

4. Yea, I never considered the deal as much as I just wanted to see the numbers in action and the process! But thanks for the heads up!

5. Great post as usual Brandon. It’s especially important that folks understand (before they put that property under contract) how hard money lenders work. You can’t go into the deal thinking you will get all the money you need, and find out later that you won’t.

I too would walk if the spread is not big enough. If there is just one big “unplanned” repair, you could be in the hole very quickly.

Sharon

• Thanks Sharon! Yeah, that’s the problem with small deals – small spreads!

6. Brandon Sturgill on

Nice work; very informative. The thing that stands out in my mind is the re-fi…if the individual rehabbing the property is using a HML on a initial flip, it suggests they have less than stellar credit; I mean, why take a huge hit on the APR of the loan if you could start out at less than half that with a traditional mortgage (or 3.5% FHA). Moreover, wouldn’t the individuals credit be a factor in the re-fi process (the final APR on the mortgage)…Am I off-base with this?

• Brandon – A lot of times banks won’t lend out a traditional mortgage on a property that needs work.

Nice analysis Brandon, I’m trying to use this method for my first deal.

• Thanks Kiz! Good luck – let us know how it goes!

• Thanks Brandon! Like Kiz said, it’s because the property is in too ugly of shape to finance conventionally. But also – with a bank loan, 20% down would be mandatory and permanent. However, with the HML, Rent, Refi option – you could get almost all your money back out again to rinse and repeat the process. Thanks for the comment!

7. Hi Brandon,

I am just about to buy my third property and I literally just got my ARV estimates from my agent, whom I worked with to purchase the last two properties. Here’s my question relating to getting ARV from two different agents.

I like my agent and will most likely work with him for the next few houses and he has no problem providing comps for me, but how would I convince a second agent to give comps for me if I know I won’t work with him? How do you do it?

Thanks!

Jason Co

• Hey Jason,

Good question. I think I would just be 100% honest with one. Just say, “I have an agent, and I’m just looking for a second opinion.” What’s the worst they could do – say no? You don’t need them to do an indepth look – an agent, in that location, should be able to ball park it within a 5 minute discussion.

That’s my thoughts anyways! What do you think?

• Hi Brandon,

I called a few agents from Zillow and got in contact with a couple of them. I told them I’m trying to get a second opinion and I’m surprised how generous they were with their time. I felt like one guy kept on trying to tell me about some quick ways to make money (or trying to close a deal with me). I never actually asked for a CMA though which was my mistake, so I didn’t confirm the ARV with another agent. I’ll be sure to mention those words in the future.

I did use a more conservative estimation for ARV in working on my max allowable offer number instead of the one my agent gave me.

Jason
Thanks Brandon.

8. Brandon – It looks like you calculated the HML monthly payment at \$210 a month using a 30 year 12% fixed rate mortgage. Do hard money lender typically use a 30 year amortization schedule?

In this scenario the hard money lender makes \$2260 for an ~11% return over 6 months.

• Hey Kiz,

So, the \$210 comes from interest only payments, which means it’s not amortized at all. So the loan is never paid off- not in 15 years, 30 years, or 100,000 years. This is pretty typical for most HML – just interest only, no principle.

You yeah, if they made \$2260 in interest payments over 6 months, plus they made the 5% fee (which is \$1000) so they made a total of \$3260 in 6 months, which is a 16.3% return over six months – which actually computes to a 32.6% annual return on investment which is AWESOME. This is why so many real estate investors become hard money lenders!

Thanks for the comment!

9. Thank you for the post. I like looking at these.

A few thoughts locally:
Here in the Dallas Fort Worth Area, lenders will typically not write loans that are less than \$50,000. So there is a question if you could get financing at all. You might be able to get a private loan, or if you had a good relationship with a bank… you might be able to talk them into it. The typical scenario with these smaller houses that I have heard is that someone buys a few of them and does a blanket loan on all of them.

Hard money lenders here will include repairs in the 70%. If they don’t like the neighborhood, some will drop down to 65% or less. Also, I only use hard money lenders that will also help me with the refinance out the back…. mortgage broker that works with investors. They are first qualifying the refinance, and if that is OK, then the hard money loan is OK. While it is not a guarntee that things will go smooth, at least you are working with one person, and it meets all requirements at the time of purchase.

I always heard that as a rule of thumb, homes this size are best as a cash deal. Financing eats up all the profits (if you could get it). The benefit of the small house is the rent tends to be higher as a ratio to the cost of the home.

Last thoughts. 5 points seems high. I am seeing 3 points on average. I am also not sure that I have seen any seasoning requirement other than you need to have the tenant in place before the refi.

• Hey Tim,

Thanks for adding your thoughts! I agree – around here, finding small loans like that are also tough – though not impossible. This is definitely when the “private money” shines.

I like the idea of a mortgage broker who can do both the HML and a refi. I’ve never done that- but it sounds great!

And yeah, 5 might be high, but on a small loan I could see it being there. I’ve actually paid a lot higher – up to 10 points, for smaller loans. The last sub 50k HML I did, they just charged me a \$5000 flat fee.

Thanks for the comment!

• I had the same thought as @Tim that the refi might be tough.
Really I think that is the toughest part of this scenario.
I actually think it is much more likely that he could get a better HML than what you estimated then have a heck of a time getting out of it.

Seen the same thing where they don’t like to write loans for under \$50K, which means the place would need to be \$62.5K (If you can get a loan with 20% down, often see 25-30% on these small ones).

On the other hand I could see him getting a HML for less points (Though that isn’t a bad interest rate). I could also see it not being hard to get more cash from the lender either.
Most HML I know will fully fund the repairs and only have you bring some amount of the purchase price and closing costs.
The idea is:
1) Paying the closing costs is money in their pocket immediately. Even if everything else goes to hell they at least got the points and fees already.
2) Bringing purchase money increases the initial equity. Presumably you will be buying it at some discount of As Is value to give them a spread from the start, but every dollar you put in at closing is another dollar they have as a spread if you Tweak out on day 1.
3) They don’t want the final value of their collateral to be dependent on you being able to find the money for the repairs (aside from the typical small float between you paying and the draw). Presumably you are increasing the value of the house by more than a 1:1 ratio (In this case with a \$5K budget you would increase the value almost \$5 for each \$1 spent), the ARV is dependent on the work getting done so they want to make sure it gets done!
3a) Often they will allow for a small buffer as well because they want to make sure that small overruns won’t risk the final value and because they will get the points and fees on the extra money even if you never use it.

10. BTW I agree with others that this is not a great deal as presented.
I could be good as an all cash deal.

Basically if you had \$30K burning a hole in your pocket and wanted to buy a 2% property in an area where they are hard to find that isn’t a bad deal at all.
Presumably to get the value up to \$50K with such a small amount of work I assume that typically \$45-50K properties will be the ones renting for \$625.

Great deal if you have a bunch of unproductive cash that you want to get into an investment that makes a much better return (And liquidity is of no real concern).

11. Very informative post for new investors looking for a way to be able to turn their money.

The one thing that stood out to me was the three months to complete an estimated \$5000 rehab (or \$10,000 for some unexpected repairs). Were you assuming they would do the work themselves? I would consider a month a fairly conservative estimate if you were using a half way decent contractor. If it takes them three months, look for a new one, lol.

12. I’m new here at BiggerPockets community. I just started reading some of your articles today and I must say that you really are an ASSET to RE field in general (I need to brag about it). I already learned a lot from the articles I read and will continue to learn because I am planning to read all of it. I got RE courses from UCLA extension, I just wish I know this site back then to advise them all to visit and use this website. This site is just awesome with real experience from real people and their actual transactions. Anyway, I attended your Webinar last week and I also learned a lot for it – Thank you for educating me Brandon!

13. Does it really take 6-12 months before a refi can happen? I heard that you can refi couple weeks after the closing is done.

14. Thanks for the breakdown, Brandon. I am still struggling with the math. How would this work if one wanted to buy a cheap home to live in for two years, then make it a rental? Would it still be a good idea to go to a HML ?

15. This was very well written! Thank you! I was looking hard into hard money especially considering I’m very new. I love that you touched on hypotheticals as well that way I can mentally prep for the worst instead of going in reactive. Thank you for sharing!

16. I did not see any other carry cost in your numbers. What about utilities (water, sewer, trash, electric, etc). Those too can make a difference in these tighter deals. I am in the process of calculating cost for a rehab and flip right now. I found a lender who charges a 3.5% point minimum and 12%. I’m looking at a 100k ARV with 30k to 35k in repairs. Meeting with contractors next week to confirm. Hopefully I have overestimated and they come in under 30k. Asking price is 45k, but my goal is 35k.

Thanks