What is the best way to structure a Buy/Fix/Flip on a close friend's condo?

8 Replies

Friends of ours are going to close on a new house in approx 60 days, so they need to sell the small condo where they've been living. They've lived in this condo for 2+ years, so in order to sell it, they'd need to replace carpets at a minimum, which is a hassle for them. They're the kind of people that prefer convenience and ease, even if it costs them a few extra dollars. Other value to him includes my being flexible with timing of purchase to avoid any overlap on mortgages, and no need to fix anything or clean anything up (a big plus for them!).

Thus, my proposal: Sell me the condo at market value less cost of repairs, less realtor commissions (saving us 6%), have our RE lawyer friend do a “minimalist closing”/quit claim (saving us some closing costs), and then let me rehab, upgrade the floors and resell the condo at a higher value 60-90 days later. He gets the money he would have walked away with on a straight sale for no work whatsoever, and I get to take home the added value over cost of improvements.

I've done all the numbers (ARV, FARV, COR, etc.) and am comfortable with our margins.

Here’s what I need your help on, BP:

What is the best way to structure this deal?

My friends needs a good chunk of his net proceeds from sale of condo to pay for repairs on the new house.

I need at least some of the purchase price financed, even if only for 90-120 days (conservatively) until the time of the sale.

How can I meet both those needs as cheaply as possible? Maybe by giving my friend a lease option that explodes in 120 days with a downpayment equal to the cash he needs for the new house? What do you call that, a "deferred close with occupancy?"

Also, I’d like to minimize the transaction costs as the property is sold from him to me, because every dollar I save my friend by selling to me (vs selling to a 3rd party) reduces the price I pay for the property.

This is a true friend, so I have zero trust issues and am 100% comfortable with doing the initial sale as cheaply (even if it means unprotected, deed-wise) as possible, AS LONG as it doesn't complicate the eventual after-repair sale to a third party by me.

Hope that’s clear! Thank you BP!

This does not make a good enough deal to do a fix and flip:

Sell me the condo at market value less cost of repairs, less realtor commissions (saving us 6%), have our RE lawyer friend do a “minimalist closing”/quit claim (saving us some closing costs), and then let me rehab, upgrade the floors and resell the condo at a higher value 60-90 days later.

The rule of thumb is that your purchase plus rehab costs needs to be under 70% of ARV in order to make money. If you hit that target, use hard money to finance the deal and hold for six months from your purchase to the sale, your profit will be about 13% of ARV. This is just math.

The sellers costs don't factor into this equation because the seller pays those.  So avoiding commissions when you buy doesn't help your end of the deal.  It does put more money in your friends pocket.

Some closing costs you need, like title insurance.  Do a "hold open" so you can just update the policy and pay only the difference when you sell.

If you can reduce your money costs, that improves the results.  Hard money for six months is going to cost you about 10% of the amount you borrow.   If you buy the house subject to, you can use the existing mortgage to hold the place at a lower costs.  There is a risk of it being called, but if you in and out quickly you can sell before the lender can complete a foreclosure.  The bigger risk is the ability of your friend to qualify for the new loan while still being on the old one.  Is that a problem?

If you can keep the existing loan and fund the rehab out of pocket your threshold is now more like 75% instead of 70% because your avoiding hard money costs. You are incurring the interest on the existing loan, so you don't save the entire 10% of purchase plus rehab (which is 7% of ARV, assuming purchase plus rehab is 70% of ARV).

Where are you as far as the numbers?  There's no magic here.  Any money you make is coming from your friends pocket.   Are you able to buy it cheap enough to hit that 75% number?

You might be able to do the deal even thinner if you're willing to cut your profit. But, these numbers are telling you that if purchase plus rehab is 90% of ARV (and you have to get ARV right, its the price you get when you sell) you're going to lose money on the deal. At 85% you'll just break even, if nothing goes wrong. And things always go wrong on rehabs. So, I'd say unless you're under 80%, able to buy subject to, and willing to do this deal with a chance of no profit at all, don't do this.

Realize, too, that if you make a profit on this deal, you may lose your friend.  Anything you make is truly coming from them.  Because they could easily pay someone to fix it up and pocket that money.  They may be OK with convenience now, but they may not be so OK with it if you later wave a $10K check under their noses.

@Jeffrey Yates I agee with @Jon Holdman .  This does not sound like a good deal unless your upgrades will increase the value by many factors (that is, putting $1 in increases the value by $7). And this is unlikely. You'd be taking all sorts of risks--even on title--for almost no gain.  If you are doing it for profit forget that it is a friend and only make an offer that works for you.  Otherwise do it out of friendship and  expect to lose. 

Thanks for the responses Jon and Larry! I appreciate your challenges, too, because it makes me look harder into the deal. But I don't think I was clear enough about where the spread comes from. Once I show the numbers, I think you'll see why my question becomes how to structure the deal to maximize savings due to the fact that I'm buying from a friend, since those savings could help me get to 70-75% ARV less repairs and make this a more sound deal. It's a little tight, but that's why the structure matters to me.

Here's more info:

The repaired condo (i.e. carpets replaced, everything cleaned up) would sell at $105K. The improved condo (install wood floors, upgrade appliances) will sell "fast" at $135K and rehab costs should be about $10K (combination of sweat and hired). Those are vetted comps from a local RE broker. 70% ARV less repairs is about $85K. If I can't get there, I can get close, and here's how.

We've approached our friends with all of this full information, and they are simply not interested in improving the property themselves to get more profit -- as I stated, their time and comfort is more valuable to them, so no "friendship problems" there. They said they'd be perfectly happy to get the $105K selling price that the comps suggest the condo is worth, once repaired (NOT improved). 

But what that really means is they'd be happy with net proceeds from a $105K sale. IF I can match their net proceeds from a $105K sale price - i.e., what they take home after a straight sale to to a third party (which includes all kinds of RE agent, legal, closing and ancillary costs designed to protect each party) - that's all that matters. 

So let's take the $105K selling price to a third party, and say that

after repairs to get in listing condition, ( - $3K) (carpet, misc fixing)

closing costs to seller, (estimated at 3%, or about - $3k)

and realtor commissions, (6%, or about $6K)

they walk away with $93K ($105K - 3K -3K -6K)

But if they sell to me, they immediately save $9K in repairs and RE commissions, making my purchase price $96K (105K -9K). I'm now $11K away from the 70% ARV mark, but only about $5K away from 75%, which is worth it to me. If I look at it another way, using J Scott's formula: Max Purchase Price = Sales Price - Fixed Costs - Profit - Repairs, I'm trying to get the condo for about $92K (= 135K sales price - 13.5K fixed (estimated) - 15K profit - 15K repairs (padded for a 5K disaster)), giving me $15K on the deal. I'm about $4k over my max purchase price...

So now, every dollar I can save my friend by selling to me instead of a third party means I PAY less on top of the net proceeds of sale, effectively reducing the purchase price of the property for myself - -so yes, the seller's costs DO in fact carry over to benefit me in a way. 

**HERE is my question, and why I am asking about it: 

Is there a deal structure whereas I pay them some cash (to give them $$ for  in exchange for title to the house and 120 days to deliver the full balance of the purchase price AFTER I rehab and sell the house? And what's the cheapest way to accomplish that?

Normally, this may not matter and there should be enough cushion in a deal not to have to do acrobatics for closings, but saving a few thousand by being clever here makes this deal all the safer, and my profit better. 

As you can see, the deal is tight, so hard money costs and paying extra closing costs might make the difference between whether it's worth my time and risk.

Thanks for all the thoughtful responses, it's helpful!

You're describing a sub2 deal.

You give them the difference between what's owed and the sales price (or less if they're game).  You make the pays, do the improvements, pay the light bill, etc.  market the house and pay the loan off when it sells.

You can cheat on 70% in a hot market and/or if your money costs are low.  Just know your numbers and additional risk involved.  

@Jon Holdman

I definitely agree with you that these should be my goals: (not sure how to quote, sorry!)

  • "If you can reduce your money costs, that improves the results."
  • "If you can keep the existing loan and fund the rehab out of pocket your threshold is now more like 75% instead of 70% because your avoiding hard money costs."

So maybe I should focus more on how to find an arrangement that give my friend the cash he needs to do repairs/downpayment on this new house, but buy myself 3-4 months (6 to be safe) to sell it after repair.

And I would like to show them the profit we expect to make after all the calculations to be extra sure that they're going into this with eyes wide open -- great advice all around! thank you!

@Darrell Shepherd

Awesome, I knew that what I was describing had to fit some sort of mold, just wasn't sure which.  Now I can better research and communicate it!  Knew I wasn't reinventing the wheel (or hoped, rather) so thanks.

70% and 2% would be nice, but I haven't seen them but once in a blue moon in South Florida.  But I won't cheat too much, that's for sure.

How much do they currently owe on this property?  The cash you actually hand over would be the differnece between what you're paying and what they owe.  To hit their numbers, I think you're going to pay $96K for this property, so cash would be $96K less the loan balance.   Some of that goes to the costs, though, so I'd estimate the cash in their pocket as $93K less the loan balance.  Is that enough to make them happy?

If you go with a 75% deal, which is pretty feasible if you're buying with a combination of subject 2 and your own cash, your maximum price is $91K.  Your friend will still pay the closing costs, so they would net $88K.  You could pay those costs, which would put them at $91K net.  Kick in another $2K and they're at what they would get on a normal sale. 

That puts you into the deal at $91K + $3K closing costs (that's probably a bit high) plus the $2K extra = $96K.

I'll assume you pay 6% interest on the loan balance (which I don't know) for six months.  I'll guess that at $3K.  You have your $10K rehab costs.  Then when you sell you have commissions (about $8K), your closing costs (say $2K, doing a hold open on the title insurance will be a big savings).  So, it looks like this:

Selling price: $135K

Commissions: $8K

Costs: $2K

Rehab $10K

Interest: $3K

Return initial investment: $96K (loan payoff is a big chunk of this)

Net profit: $16K

You'll have some additional costs in there, such as utilities and HOA dues.

Not too bad of a deal, though the numbers are so small any big hiccup on the rehab will really hurt.  You can bet you'll have a small hiccup or two and this will be $2-3K more expensive than you think now.

@Jon Holdman

You're great, and your numbers are spot on. Thanks for the breakdown! Done this before?  :) 

They owe $58K at something like 3%.  Which would mean the cash to them would be $38K.  Getting them the full net proceeds amount of 38k would definitely make them happy, but I'd ask if they could make do with slightly less (maybe $25K), depending on what they need to do to ensure their financing goes through on their new home (they were approved for 400 and bought one at about 300, so i think they should be okay). That would free up my cash for rehab.

I see your $96K as being the exactly right number.  It's the straight proceeds of the sale without nickel-and-diming my friends, which is good business and good practice.  

The amount needed to bridge the gap between my minimum purchase price ([email protected] 75%) and their minimum net proceeds ($96K or 79% ARV) is no small amount, but my wife is a RE agent and so that's $4K of commission at sale. That preserves our "imagined" 16K profit, but add in minor catastrophes and sacrifices to the RE gods, and we're at 10K or so. We only expect that much, and would just hope to do better.

So next up is really nailing down the cost of the wood floors (no pun intended) and trying to cut our holding period way down.

Thank you so much for helping us think through this one!

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