40% Net Reasonable If I Am PM on a Flip?

Question

H All,

If I fund the purchase, close, & carry of a property ($40K-80K) is it reasonable to expect 40% of net proceeds? I want to be mostly hands off other than approving the project and am easy to work with. I am assuming the rehabber's time and material costs are coming off the top-line.

Example:

$60K purchase, $4K carry and closings, $20K rehab time and material, $99K sale... I would expect 25% of net, or $6,000. The rehabber would fund material costs and delay moderate fees for labor.

I hope to understand if I am high or low with my 40%. What have others done? Is there a thread someone can't point me to that better lays out what I am hoping to achieve by becoming a PML? I understand the experience of the rehabber will have a lot to do with the percentage split.

Thanks for reading

J Scott · Answer

It really depends on what types of returns you're looking for...

Some basic math:

-  It's not tough to find experienced investors who will borrow just a portion of their costs (up to 80%) and give you first lien position on the property (for security) and in return, pay you 10-12% annualized interest.  If 10-12% return on your money is interesting to you, you should be able to get that at very little risk or work.

-  Less experienced investors will often pay up to 15% (and maybe a couple points) for loans at 75% of the value of their property and will give you first lien position.  Risk is higher because the investors generally have less experience and less of their own case, but your investment is secured, and as long as the investor isn't a completely idiot, doesn't try to screw you and as long as values don't drop significantly, your money should be reasonably safe.

-  Some investors are willing to pay up to 50% of the profits from a deal if you bring all the cash.  As mentioned above, there is a good bit more risk, but the returns can be pretty substantial.  If a typical rehabber generates a 15-20% return in 3-4 months, that's 45-80% annualized returns.  If you're getting 50% of those returns, that's 23-40% annualized returns.  Pretty darn good.

So, while there's no path to ridiculously high returns in exchange for essentially no risk, as a real estate lender, you can generally generate pretty decent returns for the amount of risk involved.  As long as your goals are reasonable, of course...

Paul Jamgotch · Answer

@J  Scott

Thanks for the feedback and the points you made. Looking like putting our cash to work in RE is going to be harder than I initially thought.

J Scott · Answer

Agreed with Jon on everything...

As far building minimums into your agreement, you certainly can if the rehabber agrees.  Of course, most inexperienced rehabbers who require 100% of the costs to be funded aren't going to have $5K to give you should the deal go south.  And experienced rehabbers aren't likely to need 100% financing.

Paul Jamgotch · Answer

@Jon Holdman

Thank you, Jon. That all makes sense. I would hope that a sale would take place closer to three months than six, of course. I wouldn't want to take something on for potential less than $5k/3 months. Can I build that minimum into the agreement?

Jon Holdman · Answer

50% would be more typical unless you have a long standing relationship with an experienced rehabber.

That deal is too thin for me.  A sales price of $99K will net about $92K after commissions and sales closing costs.  Purchase closing costs will be perhaps $1000.  Insurance and utilities perhaps $1000 during a flip, depending on the time required to sell.  That looks like $9000 profit.

Sounds like you have another person doing the active part of the rehab.  They get NOTHING for their labor during the project.  If they hire contractors, yes, they get paid.  But the active partner's pay is their cut of the profit.

You say the rehabber funds material. So, is that not in your numbers?  I assumed that was in the $20K.  How much are you actually lending?   I prefer a straight loan with a deed of trust (or mortgage) on the property.  At, say, 12% interest you make about $5000 on an $84K loan if the deal takes six months.