How would you finance your first deal with my situation???

8 Replies

Hello all,

I've been in real estate for a few years as a project manager for a developer and Realtor on the side, but have never done my own deal. My dad is an engineer full time, and General Contractor/Mechanical Engineer on the side. He's built/rehabbed (but never participated in his own deal) almost 100 units in the past 25+ years under his license so he has a good handle on construction costs, timelines, and good subs. He, my brother, and myself are looking to rehab and flip our first home in the Los Angeles area.

We've found a few properties that pencil out to this: $700K purchase price, $150K in rehab/repair cost (adding a room in most cases), $1.05MM ARV.

The numbers seem to work out and the above numbers are conservative, but I want to know the best way to parlay our resources and situations so that we can maximize profits on our first deal.

Resources to consider: 

  • Brother: $45K in cash, Great Credit & Income, Has never purchased a property
  • Dad: ~$1.7M (I think?) between his 401K and Roth IRA, Decent Credit & Good Income
  • Parents' Primary Residence: Valued @ ~$650K, $240K Mortgage
  • Parents' Income Property: Valued @ ~$550K, $230K Mortgage
  • Me: Will be contributing the sweat equity and putting the deal together; also throwing my commissions (2.5% of PP) from buy and sell side into the deal/pot.

Knowing the above, how would you finance this first deal? Is FHA, first time home-buyer a good option? Stay away from Hard Money on this first deal? Do Conventional Loan? HELOC or Refi+CO on one of our owned properties? A combination of the above?

Thank you very much for the advice in advance!!!

@Nick Tolson why not do hard money? Depending on your fathers age if you took from his requirement you may have to pay a 10% penalty.

If you finance the purchase does it qualify for FHA and do you have the income limits to meet an FHA loan ?

If you do, then you still need the $ to Rehab which you will need to find which can be from retirement withdrawal or cash.

At $850k all in and ARV if $1M while there is a $150k delta he numbers are still tight as you most likely will have carrying costs, and if you have a buyer with an agent will you turn them down ? Throw in taxes, insurance etc and it adds up.
Still a good chunk of change to be had but a lot of risk for the $. I would rather do two $400k deals that can get me 25% after all costs to spread risk

Are you going to rehab and sell in less than a year?  Private money is a good option for short term fix and flip investments.

@Chris Seveney I was trying to avoid hard money for the first flip because of the high interest. I'm trying to take advantage of the FHA first time home buyer program. Could I pay 3.5% down with FHA and then get a hard money loan for the repair costs (and whatever the FHA loan doesn't cover)?

@Maxwell Allen The flip should take us no longer than 4 months from close to construction finish. 

Hard Money will always want to be in first position. With any investments, always bring in less money of your own. Risk your own money as little as possible.

Just do conventional no pmi 5% down and do it before interest rates go up again. Every 6months you’re losing 0.25% in interest rate assuming the fed keeps raising like it has.

Plus sounds like between all of you you’re in decent financial shape.

Plus if you plan to flip quickly not a big deal to tie up $50k for a year.

@Nick Tolson Glad to hear you're gathering all the pieces to take on your first investment project! The construction experience will definitely come in handy in this line of business. As a local investor/lender in the So Cal market, here's what I'd recommend given the info on your post:

1)  Investment deals are extremely competitive in this market. Investor buyers come in and close quickly (2 weeks or less) with little time (if any) for contingencies. With that said, buying investment property all cash with no loan is your best best for the highest returns and the quickest/cleanest closings.

2) Traditional financing (i.e. conventional, FHA, or VA) would not be the best fit for this strategy. Sure you may have a better rate, but FHA first time home buyer loans are for owner occupied use only, and requires you season the loan for at least 1 year. More than that, these loans take weeks to process and need to meet certain appraisal and physical inspection standards before close - a nightmare to deal with if your the seller of a distressed property, and reasoning as to why they would choose another cash offer.

3) If you do decide to leverage with hard money, you may be able to work the rate down with a higher down payment 20-30% or more (each lender varies on this, but it's definitely possible). 

A HELOC would serve you better than a cash out refinance because you'll be able to draw funds on an "as needed" basis rather than taking a lump sum and having the money sit and paying interest. This is your best source of financing if you decide to leverage without hard money.

There's many ways to skin the cat, but hopefully this gives you some detailed insight into the options available. 

Sorry @Nick Tolson , but this is a thin deal at best and nothing any reputable hard money lender should loan on. With a project cost of $850k ($700k purchase plus $150k rehab) at 81% of the $1.05M ARV you are approaching a break-even deal at best.

Since many on this board don't like rules of thumb, here's a detailed profit and loss estimate based on your numbers, a more realistic six-month turnaround, and typical hard money rates in LA right now.

Assuming perfect planning, you will earn about $62k or 6% of the ARV, which is way too low and easily eaten up by a small rehab overage, construction delay, or a fair counteroffer of even $1.00M. The experienced rehabbers we know initially plan on earning 10 to 12% of the ARV. It's pretty easy to show that this means your project cost can't exceed 75% of ARV. We use this for initial screening but it always works.

Using 75% of ARV as a rule of thumb, you can't pay much more than about $637.5k for this property ($637.5+$150k)/$1.05M = 75%. From our detailed analysis, this will result in a $131k profit.

The only way I see you doing this deal profitably, Nick, is if your dad funds it completely with his retirement plan, thereby eliminating the HML finance charges. One major issue is that retirement plan rules prevent any material participation by your dad in his investment. Thus, you'd have to hire a contractor. Plus, your dad is risking his retirement.

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