Tell me why this is a bad idea

16 Replies

Disclaimer: I'm still pretty new to all this...

So, I've been reading up on HUD and how the properties that it sells work for investors. I had a thought that seems pretty simple (which makes me immediately think that I'm missing something).

A hypothetical scenario: Let's say I find a SFR on the homestore site that I want to make an offer on. I do my math and figure my offer price based on ARV and an intentionally inflated repair estimate (seeing as I haven't seen the inside in person). Now, let's also say that I have almost none of my own money to use -- I could pay the $1000 earnest money deposit out of pocket though.

So if my offer gets accepted is there anything wrong with taking out a hard money loan for the purchase price and repairs, then retailing the house once the rehab is done? I mean, it's all about the numbers right?

If I could find a deal that was discounted enough for me to be able to afford the 14% plus 6 points the lender will charge me, plus cost to sell, and still walk away with a profit, is there anything wrong with that? Are there factors I'm not considering? The way I see it, the biggest hurdle -- and maybe an insurmountable one -- is going to be finding a deal that's discounted enough for the numbers to work.

What do you think?

Thanks in advance!

(PS. I've also been considering the same scenario I described above, except instead of HUD I'd be buying from wholesalers.

@Jason Pachomski  Egad, are hard money lenders really charging 14% and 6 points in Van Nuys, CA?  Here in New Hampshire it's more like 12% and 2 points. 

I think I may have found a problem with your plan. Here in NH I (and the other HMLs that I am familiar with) will lend a total of 65% of ARV, but you don't get the 65% of ARV all at the closing table when you buy the place. You only get 65% of your purchase price at the closing table. Then you get the rest in 3 or 4 construction draws.

So you really have to make an extensive spreadsheet and plan out your cash flow MONTH BY MONTH, making sure to include all the carrying costs, including loan interest, utilities, property taxes, insurance, etc.  And add in a big fudge factor on your rehab estimate.  I've hardly ever seen a rehab perform under budget - they almost all go over by a significant amount.

Even if you have enough cash overall to do the deal, unless you plan out your cash flow month by month you could get caught short in one or more months.

@Matt Taylor  is right. I'll make it easy on you. Do everything you said up to the hard money part. Instead get it under contract and wholesale it in 30 days. As long as your arv and rehab costs are close (trust me every single person that says they rehab, has a different view on rehab costs) and you get it under contract 65-70% below market minus rehab it'll sell. Just make sure you sell it cheaper than anything else in the area (short sales/foreclosures).

Make 5-6k rinse repeat enough for a down payment for a loan and badabing.

I wouldn't take a hard money loan on my first deal, especially not a flip. The money is simply too expensive to give you the room you need for the mistakes you are going to have to make to learn the trade.

I'd take a two pronged approach. Work at building up some capital. What @Nathan Paisley  suggests is an excellent way if you can find the deals that make sense. Make sure you run the numbers up and down each deal. It's good practice and will increase the chance that you wont get caught with your pants down.

Once you have some capital, and some experience wholesaling for example, see if you can put together a deal that would attract private, not hard, money. 

I have been looking at HUD sales in my area also and almost all of them have some kind of huge expense that makes the numbers so close they scare me. HUD seems simple but it is a government program so nothing is going to be simple. For example your earnest money or payoff must be in your bank account for 60 days or more at closing. If you pull it out the day before that's a deal breaker. Why? I don't know. When does the government make sense?

@Jason Pachomski  2 things.

First:  Never overestimate your analysis.  Why would you?  The deal either works or it doesn't based on your offer and the assumed rehab.  If, after you win the bid, and you inspect the property,  it doesn't, you pass on it.  If you overestimate, and you didn't need to, and the deal doesn't work with the overestimate...but would have with the actual numbers, you just screwed yourself out a good deal.  If the deal doesn't work after inspection due to higher rehab costs, then you back out during your inspection period.  You don't need to overestimate the rehab at analysis.

Second: HML isn't a loan, in the same sense as a mortgage. A mortgage stays with the house and effects your CF. The HML is dumped with the mortgage and should be thought of as another cost of a floor, kitchen, doors, etc... How much of a cost depends on how long the rehab will take. Estimate the length/time of rehab, factor in the interest payments for that many months (here is where you need to add in a month or 2 to be safe), and if the numbers still work with the HML cost included in your rehab cost, then you're good to go. If not,'re still good to go. To a different deal,

Agree with the above, plus your offer won't be accepted without a POF or a preapproval. HML's may lend up to 65% of ARV, but usually only 80% max of actual purchase and rehab. There are very few deals where you'll get them using an inflated repair budget.

@Wayne Brooks What you say about most HML is true, but there are the exceptions. My HML bases his % on the appraisal, not the cost. I can get the entire cost to buy and rehab from him if it is under 70% ARV (future value...not current).

@Joe Villeneuve  Agreed, some but they usually require some experience on the borrower's part?

Hi Jason:

First of all, as @Chris Syrett mentioned above, this is a government program so you know right off the bat it's not going to be as easy as it looks. Unfortunately. 

Remember, these homes have been offered to end users first, meaning there's a reason the property didn't sell on the retail market and the government is offering it to investors (condition, location, price?).

Don't buy anything without having an inspection, especially when you're new. There are problems with the home you don't see - an assumption you should always make when you buy. You must buy discounted enough to do all the repairs and still sell below market value to get it sold.

And, your numbers need to work if you to continue to hold it as a rental. Why? Because it might not sell after you've spent money to fix it - that's a concerns whether it's HUD or not, and hard money is not the way to go on a property you're going to hold long term - way too expensive. I gasp with @Matt Taylor at the price you're talking about paying for money. I would do that only for very short term borrowing and I wish I could get that when I lend! But perhaps that's another reason I'm thankful I don't invest in California...

The question indicates that it's too soon for you to jump into this without guidance. Attend local investor meetings and follow someone there successfully doing what you want to do. If it was as easy as you're hoping, there would be so many investors in your area doing it that, chances are, you wouldn't be able to get into the dance.

Before you lay down funds study, learn, then go for it! Let us know how it works out.

I just thought of this amazing new flavor for ice cream, I call it Vanilla...

Reason you don't hear anyone talking about this is because it is pretty much the most straight forward introductory path to rehabbing.

As pointed out if you truly don't have any more money than fronting the $1,000 EMD then you might have trouble getting funding. You would most likely have to borrow the rest from another source. One good thing about HML though is that they don't typically agonize over every little financial issue like a bank grilling you on a $5.25 cash deposit you made 2 months ago or something ridiculous. So you CAN do things like take $50,000 in credit card cash advances or max out a HELOC on your house or get your parents to give you a $30,000 gift for the downpayment 2 days before closing or whatever to make up the difference. Now if you SHOULD do anything like this is a different question...

It is possible to get closer to 100% financing for sure.  But you usually will need a fair amount of experience if it is your first deal with the lender, a long term relationship with the lender and even with one of those things it will usually have to be an absolute killer deal.

Like it blows 65% ARV less repairs out of the water! Try less than 50% ARV less repairs so the As Is value is a fair bit higher than what you are paying.

Nothing special about HUDs really.  I actually would say they are one of the easier buying methods to deal with UNTIL they accept your offer.  You just have that one page online form to fill out and nothing else until they accept it.  Now once that happens it is like dealing with the government, but you won't get very many to that point.  :)

That's besides the point since I don't think a respectable HML would lend to you anyhow...

Thanks everyone for the responses. This is why I love these forums..

@Nathan Paisley wholesaling them was definitely my first thought as well. As far as I know you can't assign the contract on a HUD deal though, right? I suppose I could do a simultaneous close, but wouldn't I still have to have a POF in order to make it that far?

@Ben Leybovich  Wait, so, Vinny The Knee Surgeon isn't a reputable lender? :-P No, I totally get that. I wouldn't give myself a HM loan either. I am however in a position (maybe should have mentioned this) where I'm working with another very seasoned and successful Los Angeles investor who has her team in place (HM lenders included) who I am able to use, as she'll partner with me on anything I bring in. This all is, of course, contingent on the deal being good and feasible. I love working with her because her forté is transaction engineering and I trust that if something is a **** deal she's not gonna allow me to pursue it. 

@Shaun Reilly  as a fellow Masshole, I appreciate your sarcasm.

@Jason Pachomski there's nothing wrong with considering a HML as a source for financing your investment purchase.

HMLs will usually lend off the ARV (after repair value) and there will be a LTV on that so be sure you understand the LTV of the ARV the lender you are considering will be at.

Hard money, private money, call it what you want the point is it's different (and more expensive) than conventional lending. The key is most conventional lenders don't do rehab loans unless you already have a relationship with the lender. 

Whatever financing you ultimately choose I doubt you'll be able to get 100% of the purchase and rehab. You'll like have to have some skin in the game more than the earnest money. Experience might be considered but EXIT strategy is key. 

Personally I think HUD homes are hard to wholesale unless you plan each closing stands alone and then you'll need a loan anyway.

The earnest money (EM) as an investor on HUD homes I believe is non-refundable you want to be sure to check on that.

You can calculate until the cows come home. At the end of the day you're looking to make some money. If you have to borrow and get a loan in order to do so then you have to decide on whether or not using OPM is worth it.

Good luck!

@Jason Pachomski Some information for you on HUD; unless the rules have changes since our last purchase:

  • Earnest money for HUD deals is non-refundable. If you don't close, bye bye $1K.
  • You're bidding against a computer on the HUD deals.
  • Like many investors we bid on MLS properties, including HUD, sight unseen. If your intent is to use a HML to fund the deal you must get someone in to the property quickly to provide you w/ the info required for a renovation. You can't turn in your site unseen repair estimate to an HML. When our bids accepted we have someone @ the property within 24 to 48 hours to provide us w/ the renovation details. We also use those details to help decide whether we stay in a deal or kill it.
  • Cash or Finance offer to HUD- Need to decide before you put in your bid whether it will be cash or Finance (i.e. HML finance).
  • Last factor then I'm off my soap box- Take a close look @ the Days on Market for the sold comparables. If it's long then don't use an HML w/o an alternative exit strategy.

Thanks again everyone. This is exactly what I was hoping for: to find out what I didn't know... I knew the scenario I initially laid out was too easy (otherwise everyone would be doing it). I think I'm just frustrated by the lack of prospects I have. Los Angeles, I'm discovering, is a tough market as it is and I'm coming into it (this past year) at a time when houses are selling mere days after they're listed and at prices higher than asking. There's no inventory and it seems like everyone I talk to -- usually someone responding to a piece of marketing just to tell me that they don't want to sell and to take them off my list -- thinks their house is worth way more than it actually is. One offer I made on a probate lead recently was overbid by another investor who came in at a number that baffles me as to how they're going to make any money. On top of that, evvvvveryone thinks they're a wholesaler. You can't drive 100 yards in Los Angeles without seeing a bandit sign. So much so that I haven't even bothered putting them up (until I figure out a way to make mine stand out from the saturation).

This all is what's got me frustrated and looking for different ways to find properties to make offers on. Hence, the HUD exploration. I appreciate everyone's responses though and I'm going to look into it all some more. Thanks so much!

Keep pushing @Jason Pachomski  like the saying goes if it was easy everyone would be doing it. Good info here and even more in other threads. 

Good luck 

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