Buy + Rehab Financing
Member since 2023 · 21 posts · 16 votes
Buy + Rehab Financing
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Contractor · Scottsdale, AZ · Member since 2010 · 2k+ posts · 3k+ votes
2yIt's rare (and challenging) to fund a deal where you get a loan to purchase, a separate loan for rehab, and then refinance later.
The more common approach is your 2nd option. Take a hard money loan or a 203k loan to purchase and rehab. Then refinance into a conventional loan when you're done.
42 Replies
- Lender · Tampa, FL · Member since 2020 · 202 posts · 116 votes2y
Quote from @Travis Nachman:
Quote from @Barton Thomas:
If you own less than 10 properties it makes sense to have each in their own LLC. If a tenant slips and falls and sues LLC 1, all your other LLC properties are protected. After 10 or so you may want to consider groups of properties in different LLCs, just to keep things organized without being untenable.
Isn't that a lot of paperwork every year? Also, does it make the refi harder owning them in an LLC?
Travis as @Barton Thomas recommended, it's not a new LLC for every property, yes that can become expensive both accounting and filings-wise. It's only after you reach 10+ assets or a certain valuation within the LLC that you should consider creating a new LLC. Obviously, depending on where you investing, having 10 SFR properties could easily push you close to $10M in valuation for that entity, which could make it a target for the "slip-and-fall" tenant crowd. I personally use a # of assets metric OR a $ valuation rule. I will not exceed a certain # of assets inside an LLC OR I will not allow more than $X million in valuation on that LLC. Typically I keep it at 8 -10 assets per LLC, or a valuation of 2.5 - $3M max per LLC.
- Member since 2023 · 21 posts · 16 votes2y
Quote from @Edwin Epperson:
Do you mean to ask if a lender may require 20% D.P. on the entire Loan amount (purchase + rehab) instead of just the purchase? If that is your question, no. I have never seen a lender require a D.P. percentage based on the total loan amount. Almost always the lender is looking at the value of the property or the purchase amount, whichever is more, and requiring the D.P. percentage off that amount, not the full loan amount.
Yes, that's what I meant. In your example the 20% is calculated from the property price, not the entire initial loan. That was a surprise to me.
Regarding this comment: "This means the borrower's money must first be in the project before gaining access to the construction funding." ...
You can't be saying that the borrower needs to fund the construction entirely (spend $60k) in order to get access to the $60k. If that was the case there would be no purpose to borrow $60k. :)
So I am missing something. I am guessing the $60k for construction is paid out in traunches or based on phases/milestones of the project or something? So the borrower needs to front, say, $10k and then will get reimbursed (hence "arrears"), and that continues until the project is complete?
Are these arrear loan payments based on milestones? - Lender · Tampa, FL · Member since 2020 · 202 posts · 116 votes2y
Quote from @Aaron Freeman:
Quote from @Edwin Epperson:
Do you mean to ask if a lender may require 20% D.P. on the entire Loan amount (purchase + rehab) instead of just the purchase? If that is your question, no. I have never seen a lender require a D.P. percentage based on the total loan amount. Almost always the lender is looking at the value of the property or the purchase amount, whichever is more, and requiring the D.P. percentage off that amount, not the full loan amount.
Yes, that's what I meant. In your example the 20% is calculated from the property price, not the entire initial loan. That was a surprise to me.
Regarding this comment: "This means the borrower's money must first be in the project before gaining access to the construction funding." ...
You can't be saying that the borrower needs to fund the construction entirely (spend $60k) in order to get access to the $60k. If that was the case there would be no purpose to borrow $60k. :)
So I am missing something. I am guessing the $60k for construction is paid out in traunches or based on phases/milestones of the project or something? So the borrower needs to front, say, $10k and then will get reimbursed (hence "arrears"), and that continues until the project is complete?
Are these arrear loan payments based on milestones?Hey brother, you're on it! Everything you stated as an assumption is correct. These 'milestones" are explained in your draw schedule. This is a document that normally a GC or even you may provide to your lender that states, "By this date, X amount of work will be completed, and these major items will be completed" Think, demo, rough-in, finishing, final touch up etc... This draw schedule then allows you AND your lender to hold your GC accountable (get it in writing).
There is another document that should be signed by you AND your GC, and should contain the following:
#1: Breakdown in the phases of work
#2: Estimated Costs of each phase (Not detailed line item breakdown, thats in the line-item budget, which is a different document altogether that your GC should provide)
#3: Estimated completion date for each phase (Again this is not a hard date. If your GC has not completed phase one on exactly the day they estimated that should not throw up flags,... several weeks... yellow flags, 1 month+ red flags!)
#4: CHANGE ORDER PROCESS!! This is SOOOOO critical, that I cannot tell you how many investors DO NOT have this process detailed in this document. MAKE SURE the GC provides you with exactly how change orders should be handled, in writing and they sign it, and you sign it.... then let your lender review it. Whatever recommendations your lender makes DO THAT. The lender is looking out for their capital, and as such their cautions are also going to protect their borrower.
Now this document with these 4 main points is called the "Scope of Work" or the "Contractors Agreement". Many well-meaning investors call the Line-Item Budget the Scope of work. Thats not the case. Going back to understanding terms and definitions, this is one of those that can cause you delays if not clearly understand. If your lender asks for a Scope of Work or "SOW" and a budget, they are actually asking for two different documents. I can go on and on about the contractors and the pitfalls with contractors, but at the end of the day your lender should be helping you vet your contractors, because on a project needing construction, that they are funding, they (your lender) wants to have a successful project MORE than you do, believe me! - Member since 2023 · 21 posts · 16 votes2yThis makes total sense to me. Especially for larger (and therefore riskier) projects.
Quote from @Edwin Epperson:
#1: Breakdown in the phases of work
#2: Estimated Costs of each phase
#3: Estimated completion date for each phase.
#4: CHANGE ORDER PROCESS!!
... but at the end of the day your lender should be helping you vet your contractors, because on a project needing construction, that they are funding, they (your lender) wants to have a successful project MORE than you do, believe me!
How does this process anticipate a licensed General Contractor doing the work for their own investment property? Pretty much the same as described, just need the detailed SOW plus a line-item budget?
Also, does this loan method exclude smaller "lipstick" projects that only need, say, $10k of materials where the investor wants to do their own flooring, paint, and trim work (and that's all that's required)? - Lender · Tampa, FL · Member since 2020 · 202 posts · 116 votes2y
Quote from @Aaron Freeman:
This makes total sense to me. Especially for larger (and therefore riskier) projects.Quote from @Edwin Epperson:
#1: Breakdown in the phases of work
#2: Estimated Costs of each phase
#3: Estimated completion date for each phase.
#4: CHANGE ORDER PROCESS!!
... but at the end of the day your lender should be helping you vet your contractors, because on a project needing construction, that they are funding, they (your lender) wants to have a successful project MORE than you do, believe me!
How does this process anticipate a licensed General Contractor doing the work for their own investment property? Pretty much the same as described, just need the detailed SOW plus a line-item budget?
Also, does this loan method exclude smaller "lipstick" projects that only need, say, $10k of materials where the investor wants to do their own flooring, paint, and trim work (and that's all that's required)?Yes, a GC can do a construction project themselves, and the documents requested will be the same, obviously the SOW would not need to be signed by two individuals just the GC as the legally binding entity. This also opens up a completely different aspect of construction funding, where many investors are cautious (with obvious reasons) that if they pay their GC for phase 1, upfront, but then the GC splits. It actually happens.... a lot. Of course, the borrower can go after the GC, in civil court, and this will incur way more time, and way more expense, and at the end of the day, the borrower is still on the hook to complete the project and sell/ refi within the term of the lenders loan. On the flip side, most GC's will not pay for material and pay their sub's labor, without having a deposit from the investor, for fear of the same. They put in the labor and front the material costs, and the investor does not actually have the money. So we are at a crossroads. A way that I have answered this, and I'm sure many lenders offer the same scenario, is to step in and prove to the GC that the costs of the project is in escrow and that the lender can disburse directly to the GC, instead of to the investor, who then would pay the GC. This process actually allows the investor not to front the initial % of work needed for phase 1, and also gives confidence and peace of mind to the GC that they will get paid by the party who actually controls the money. In this case, a lender again, can provide a solution, helping their client, the RE investor, as well building trust with the GC. How many more projects do you think the GC will complete with RE Investors who are using that lender? A LOT!
I would say for smaller renovations it does not exclude this type of loan, but it may cause the lender to become suspect of the borrower's ability to handle a project when they cannot from the cash for a $10K project. That being said I have loaned smaller amounts $10K the min., with the expectation set forth to my investor, that they must complete the entire project and then be reimbursed. This leads to your first question "Why would someone borrow money that they don't even get access to until the project is complete? " Several Reasons:
#1: Leverage: By borrowing all the capital a lender will confidently loan you, allowing you to put that capital to better use, ie marketing (finding more deals) making monthly payments etc..
#2: Timeframe: A sub $25K project should not take longer than 45 days. So it's not that you would spend that money and have to wait until you sold/ refi'ed the asset before being reimbursed. It's only a few weeks, a month at most, until the construction is completed and then you are reimbursed. In these smaller projects, LOC and CC can be an option, knowing that once the work is completed you will be reimbursed.
I must point out a caveat though. At the end of the day its all up to the lender. I know for myself, if someone wants to borrow the construction funds on a lipstick, say less than $25K, I'm OK with that as long as they actually have reserves and could take on the project without me. At the end of the day, I will NOT do a loan to an investor, who literally has ONLY the D.P. and closing costs... that's a recipe for disaster, both in terms of the loan success and the borrowers' success. In these cases, I have denied making a loan, and investors have gotten mad at me... one even going as far as calling me racist, and misogynist. I kid you not. At the end of the day, I WANT and NEED my investors to have a successful project, I don't "Lend to Own", that's unethical and predatory. I lend to build relationships. Long-term, highly profitable, and storm-weathering relationships. Find a lender like that and you won't go wrong. - Member since 2023 · 21 posts · 16 votes2y
Quote from @Edwin Epperson:
In these cases, I have denied making a loan, and investors have gotten mad at me... one even going as far as calling me racist, and misogynist. I kid you not.Yikes!
I completely understand and the lender's position makes complete sense as described.
I'm sure there will be a lot more questions to follow as I continue modeling the BRRRR process. - Member since 2023 · 21 posts · 16 votes2y
Quote from @Edwin Epperson:
At the end of the day, I WANT and NEED my investors to have a successful project, I don't "Lend to Own", that's unethical and predatory. I lend to build relationships. Long-term, highly profitable, and storm-weathering relationships. Find a lender like that and you won't go wrong.
With your equity holdback loan, is the closing cost calculated against the entire amount of the loan ($177,750), or just the purchase price of the home ($100k), or something else? (I'd expect slightly higher closing costs due to larger loan?)
Also, I assume the monthly payment on the loan would be against the entire loan, not just the $140k, so we would have a bit higher carrying costs while doing rehab? - Lender · Tampa, FL · Member since 2020 · 202 posts · 116 votes2yAgain, you're thinking through the scenario fully. The answer to your first question is yes, the answer to the 2nd question is "YO" (Yes and No).
Quote from @Aaron Freeman:
Quote from @Edwin Epperson:
At the end of the day, I WANT and NEED my investors to have a successful project, I don't "Lend to Own", that's unethical and predatory. I lend to build relationships. Long-term, highly profitable, and storm-weathering relationships. Find a lender like that and you won't go wrong.
With your equity holdback loan, is the closing cost calculated against the entire amount of the loan ($177,750), or just the purchase price of the home ($100k), or something else? (I'd expect slightly higher closing costs due to larger loan?)
Also, I assume the monthly payment on the loan would be against the entire loan, not just the $140k, so we would have a bit higher carrying costs while doing rehab?
First Q = Yes. Why? Simply because the loan amount is now more and at the end of the day, once all the funds are drawn down, and disbursed, the lender will require interest to be charged on the whole amount. Therefore it will be written into the original mortgage as such. Now that being said, large development projects which have a long runway, and typically have leveraged capital from institutional markets, may have draw-down clauses, or even mortgage modifications throughout the draw process, simply because the total loan is so large and the draws are significant, but that's not we are discussing here.
Second Q = YO. Why? Yes because for private lenders (let's categorize this group of lenders as small, local businesses, not national lending firms that try and hold hostage the term "private", and without access to 2nd-ary market capital, nor warehouse LOC's). In this case, a private lender has committed to funding the $177,750. This means they must keep those funds available for you to draw down on whenever you request your draw. (Evidence of a lender's non-liquidity can be seen when a draw for paid work takes longer than 1.5 weeks.). So they are not able to earn money on that money with creative financing techniques, such as Large national HML have the ability to do, or even banks and financial institutions. Therefore they will charge on the entire loaned amount even if held in escrow. This process of charging interest on the entire loan amount including borrowed funds in escrow is called "Dutch Interest". Ask your lender if they charge Dutch interest or not. If they say yes then this is the case, if they say no, see below.
Also, NO. Why? Well, it depends on the lender. Again the reason a PL WILL charge interest on the entire amount is the issues stated above. However, a large national HML and especially financial institutions (ie banks, credit unions) may offer the borrower the ability to only pay interest on money drawn down. How can they do this? Because they have federal regulations that protect them from taking money "allocated" toward your loan, and creatively investing it so that they can earn a return on "lazy" capital. There is a trade-off for this ability. The investor must be credit-worthy, and meet the financial requirements of that institution, ie X months of interest payments, + X% of contingency funds. Due to these more personal underwriting requirements, these type of lenders cannot close in short time frames, and many of them change their requirements even up to the day before closing, so it can be frustrating to work with this style of HML or institutional lenders, but the trade-off can be quite a bit of saving especially on larger projects that take a long time, think a 2 Million SFR development that would take 2+ yrs... You would not want to us a PL that charges Dutch Interest. - Member since 2023 · 21 posts · 16 votes2yBased on quick number crunching, even with a yes and a yes (increased closing costs and increased carrying costs), the 79% LTV with equity holdback easily outperforms the 75% LTV typical scenario regardless whether it's a 4 month rehab or a 9 month rehab.
Quote from @Edwin Epperson:
The answer to your first question is yes, the answer to the 2nd question is "YO" (Yes and No).
Can you shed light on the expectation for a lower interest rate in the Rate & Term option? If a Cash Out refinance is say, 8%, would 7% be a reasonable guess for the refinance in a R&T refinance? Is there some rule of thumb/back-of-napkin easy way to guesstimate typical the difference? - Lender · Tampa, FL · Member since 2020 · 202 posts · 116 votes2y
Quote from @Aaron Freeman:
Based on quick number crunching, even with a yes and a yes (increased closing costs and increased carrying costs), the 79% LTV with equity holdback easily outperforms the 75% LTV typical scenario regardless whether it's a 4 month rehab or a 9 month rehab.Quote from @Edwin Epperson:
The answer to your first question is yes, the answer to the 2nd question is "YO" (Yes and No).
Can you shed light on the expectation for a lower interest rate in the Rate & Term option? If a Cash Out refinance is say, 8%, would 7% be a reasonable guess for the refinance in a R&T refinance? Is there some rule of thumb/back-of-napkin easy way to guesstimate typical the difference?
There is no "rule of thumb" in relation to the general difference in spread between the two. I do know the DSCR lender, I broker for, when offering the refinance of my BRRRR Strategy Loans, has about a .45 - .85% difference when calculating the ARP between the two. But remember the goal is to gain access to as much of that liquidity as possible on that refinance, not get caught up in 1/10th of a percentage difference, especially when R&T refis are always going to be less than a Cash-Out anyway. - Member since 2023 · 21 posts · 16 votes2y
Quote from @Edwin Epperson:
There is no "rule of thumb" in relation to the general difference in spread between the two. I do know the DSCR lender, I broker for, when offering the refinance of my BRRRR Strategy Loans, has about a .45 - .85% difference when calculating the ARP between the two. But remember the goal is to gain access to as much of that liquidity as possible on that refinance, not get caught up in 1/10th of a percentage difference, especially when R&T refis are always going to be less than a Cash-Out anyway.
Got it. Wasn't sure if there was a significant enough spread to consider it or not, but sounds like it's just a "safe bet" that it's lower so it's gravy but not worth focusing on.
- Member since 2023 · 21 posts · 16 votes2y
Quote from @Edwin Epperson:
In this case, a private lender has committed to funding the $177,750.I have a question about ARV! The $177,750 in your example is based on an ARV for a project that currently is on the market. Since success of the equity holdback loan hinges on the future ARV, how does the lender determine that number?
- Lender · Tampa, FL · Member since 2020 · 202 posts · 116 votes2yExcellent question. Remember in the case of Blue Bay Capital making a loan (now) for $177,750, base on future value, the ARV of $225K, we get what's called a "Full Property Valuation". I personally have decided that I do not require a formal appraisal, normally called a 1004. This is for several reasons. A 1004 takes longer, typically it can be as little as 1 week but more often than not it takes 2 weeks+. This can severely eat into the timeline to close for the investor. 2nd, and just as important, a formal 1004 can cost upwards of $700+ depending on appraisal availability, and local market conditions, fewer appraisers in the area drive up costs, as well as increase the time it takes to get the appraisal.
Quote from @Aaron Freeman:
Quote from @Edwin Epperson:
In this case, a private lender has committed to funding the $177,750.I have a question about ARV! The $177,750 in your example is based on an ARV for a project that currently is on the market. Since success of the equity holdback loan hinges on the future ARV, how does the lender determine that number?
So I opt to go with my company's internal "Full Property Valuation" which provides As-Is value as well as THREE ARVs based on potential rehab costs, and their corresponding ARVs. For instance, in our report there may be an ARV of $200K with a renovation amount of $40K, a $225K with a reno of $60K, and an ARV of $250K with a reno of 90K. So based on the highest best use of proposed funds to renovate and which ARV returns the best value for the reno, we will suggest the investor have a budget that correlates to the best ARV. In this case, the budget of $90 may get the investor to the highest ARV, but as a percentage of costs, the $60K reno would be the highest best use of funds, returning the best ARV.
Another question that you did not ask, but is of note, what happens, if after the reno is complete and the property has been seasoned, the market shift and the ARV is not as high as when we first made the loan? This is the risk, and like all good lenders, I shift that risk to the borrower. It's the name of the game in lending. Based on our metric of a total loan to ARV being 79%, we would not release the full equity holdback if that release meant our loan would now be above 79%. This ensures that the investor is able to get the full refinance available to them from the DSCR lender.
Example: In the video, the equity holdback was $37,750 based on the ARV being $225K. If the ARV when the investor qualifies for the refi is $215K, then the amount of the equity holdback released would be 27,750. The remaining $10K would be used to reduce our loan amount so that the refinance could happen. If I released the full holdback, $37,750 then that means the amount needing refinance would actually be 82.67% which would not qualify for the refi lenders take out loan, therefore the refi would not be viable. This is the risk. - Member since 2023 · 21 posts · 16 votes2y
Quote from @Edwin Epperson:
Another question that you did not ask, but is of note, what happens, if after the reno is complete and the property has been seasoned, the market shift and the ARV is not as high as when we first made the loan?Ha, yes that was going to be my next question, but since you answered it I will ask another: Is it possible for the actual ARV to come back _higher_ instead of lower, or will the estimate? For example could it come back at $245k? Does the borrower get to take out more cash in this case or does the lender cap it at the guesstimated ARV?
- Lender · Tampa, FL · Member since 2020 · 202 posts · 116 votes2yHahaha I like where you are thinking, but that also goes along with the risk right? As of right now the short answer is no. The maximum of our loan is the maximum of the loan, however.... that's the benefit of working with a private lender. There are always creative ways to work out situations like this to best maximize the investors cash position. I would say I'm not willing to divulge what that would look like here, but for loyal clients, I'm always willing to strategize and work out solutions
Quote from @Aaron Freeman:
Quote from @Edwin Epperson:
Another question that you did not ask, but is of note, what happens, if after the reno is complete and the property has been seasoned, the market shift and the ARV is not as high as when we first made the loan?Ha, yes that was going to be my next question, but since you answered it I will ask another: Is it possible for the actual ARV to come back _higher_ instead of lower, or will the estimate? For example could it come back at $245k? Does the borrower get to take out more cash in this case or does the lender cap it at the guesstimated ARV?
- Lender · Houston, Tx. · Member since 2023 · 91 posts · 60 votes2y
Quote from @Aaron Freeman:
Quote from @Edwin Epperson:
Happy to share, I also created a video that goes into detail why this is the case, but I cannot post video links here. 50,000 ft view for the purchase + reno side, the most that you will be able to get access to is 75% of ARV, though in today's environment the norm seems to be 70% Max LTARV.
...
So this means you will always have 25% - 30% equity in your deal, and you will always have 5 - 10% of tappable equity untapped.Dumb question time!
In your video you show that a property purchased for $100k that requires $60k in renovations would only require a $20k down payment (20% of the purchase price). So that means typically we do not have to make a down payment on the rehab portion of an initial loan?Aaron, as a lender of both HML and the 30 Year DSCR refi i can answer your question here.
The most common Hard Money product we have is 90 & 100 up to 70% of ARV. So, Let's say the Appraisal (this is where we get the ARV number comes from, we don't just agree on it) comes in at $200,000 - Our Max is going to be 70% ($140,000)
Let's say you bought this property for $110,000 and have a scope of work for $40,000
Our loan is 90% of the purchase price ($99,000) + 100% of the rehab ($40,000) Totaling $139,000
Total Hard Money loan is $139,000 you have 10% of the purchase price and closing costs as "Skin in the game".
Back of napkin math, with ALL of these factors considered, title/closing costs etc. you would be bringing around $20,000 to get these deal funded at close.
Now - once you have owned it for 90 days (best to season a little for rates) you would use a commerical loan (dscr) which yes is going to be a commercial loan and would need to be within an LLC. It is much easier to get than a 30 Year conventional, but keep in mind the most important number on this is NOT the value of the property, but rather the rent...or the ability for the rent to cover the debt service (Principle, Interest, Tax, Insurance) monthly.
- 2yDevin PetersonBusiness MemberLender · Sarasota, FL · Member since 2022 · 2k+ posts · 667 votes
Quote from @Aaron Freeman:
There are so many loan options out there, that I need help focusing my education to the most important ones, and that raises the first question I am having a hard time understanding.
For the experienced BRRRR investors, are there typically three loans in play or just two?
1) Loan to purchase the property
2) Loan to rehab the property
3) Refinance loan
Or are the experienced investors typically seeking to combine steps 1 and 2 into a single loan (e.g. fix-and-flip, or some alternative)?1) Loan to purchase and rehab the property
2) Refinance loanFor BRRRR strategy there is actually two options here (reno to rent) and (fix and flip) both, under the same category and loan product its just a difference of exit strategy from the hard money loan. Hard money loans will provide you with the funds to purchase (LTC) 75-90 LTC based on experience, and then 100% of the reno budget usually. Most lenders do this in arrears which means the work is done and then you request a draw for inspection and disbursement to be compensated for the labor and materials.
Post renovation, if you are buying, renovating, and holding the asset you would seek a DSCR refinance. You can do a cash-out up to 75% of the ARV or a standard rate and term refi with a lower rate. Each lender has their own rules and overlays concerning seasoning and max leverage for cash out. This is the loan product you would be seeking to stabilize the asset to start generating cash flow.
Any other specific questions happy to help!
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