Sell flip at a loss or turn it into a rental?

28 Replies

Ok, so there's a whole back story (and tons of lessons learned--see more on that below) wrapped up in this question, but it  essentially boils down to this:

I started a flip in April with a hard-money loan. It started out well but it was clear from pretty early on that the builder was going to be way behind the initial schedule. Fast forward to August and the place was finally ready to list (even though the contractor bailed before it was over I was protected because the renovation money was held in escrow and only dispersed upon completion of the different phases of work). 

I've dropped the price from $220k down to $180k over the last three months. If I sell it for the current asking price I'll break even. So, now it's November and snow will start falling and there will be even fewer buyers in that area (the prime market to sell is April to August) so I'm facing a dilemma: do I rent the place out and start getting a steady cash flow or do I hold on until spring and hope to sell it for enough to break even or earn a little profit?

More facts on the deal:

  • It's located in Maine near lakes and a ski mountain (35 mins from Portland), but houses tend to sit on the market there for a while due to a small pool of buyers.
  • I have a candidate lined up to rent the place at $1450/mo plus utilities with good income, credit, etc.
  • Only expenses are taxes ($2200/year) and insurance ($1600/year) as I now own it outright 
  • If I put it on a year lease (which is what renters want in this area) I'll be back in this position in a year from now and could extend the lease or sell it.
  • The house was extensively renovated so this is the only time it will ever be "new." 
  • I don't necessarily "need" the cash that's tied up in it but that is a big chunk of money I could potentially invest elsewhere (but without a known rate of return like I'd get on this place).
  • The property is 2 hours from where I live so I need to find a property manager.

Interested in any and all perspectives on this and happy to answer additional questions if they help paint the picture.

Updated 9 months ago

I'm $175k total investment on the deal.

How much do you have into the deal?

If you end up renting it shoot for a 18 month lease. This way you're not in the same situation when the tenants lease expires and you'll be in prime sellers season if you want to get out of it at that point.

Look at the numbers....Take what you would net on rents $1,450 minus loan costs (and make sure the loan isn't due before your lease term is up) and whatever that number is and figure out the IRR (internal rate of return) on the property. For example, lets say its $1,450 minus $700 (mortgagne), 250 taxes insurance etc, so Net Operating is $500/month. $500x12= $6,000 per year on $100,000 invested. So 7.2% per year.

Now compare that with selling at break even and taking that $100,000 back and doing another flip, possibly making $30K profit in 9 months. Whichever number is higher (assuming risks are the same...the whole bird in the hand, 2 in the bush), that would be the logical solution.

You cant win on every fix/flip, that's the game. Concentrate on making the money work the hardest for you, and it will work itself out.

Originally posted by @Daniel Klein :

Look at the numbers....Take what you would net on rents $1,450 minus loan costs (and make sure the loan isn't due before your lease term is up) and whatever that number is and figure out the IRR (internal rate of return) on the property. For example, lets say its $1,450 minus $700 (mortgagne), 250 taxes insurance etc, so Net Operating is $500/month. $500x12= $6,000 per year on $100,000 invested. So 7.2% per year.

I don't have a loan but I'm $175k in. How do I calculate the IRR on that?

@TD Wolf Ok, so you have $175,000 into the property (this is your equity). Your IRR on the rent (and I don't know the property taxes, maintenance etc, but lets say its 35% of the rents. So.

$1,450*.65 = $942.50 a month Net

$942.50X12 = $11,310 per year NET Operating income (NOI

IRR = NOI/Cash (equity)+ appreciation

$11,310/$175,000= .0646 = 6.46% Rate of Return Pre Tax

You may get 2-3% a year in appreciation ( $4,000) and could depreciate the value over 27.5 years)  $6,545 per year deduction. Based on your tax rate, that might be worth $2,160 today (whatever your tax rate is * deduction.

So true return is $11,310 Cash, $4,000 in appreciation, and $2,160 in tax savings = $17,470 So 9.98% a year return....

Or, you Sell at $175,000 and make $0. You take that $175,000 and you do another flip which you sell in a year for $220,000.

After sales commissions etc, you may net $204,600 on your $175,000 investment for a gain of $29,600. That NOI is $16,9% and when you sell in a year, there is no "appreciation" as its already baked into the sales price, and no depreciation, as you have no holdings. So if you can find a flip, where you can spend $175,000 and sell for $206,950 ($175,000 + $17,470)/.93 you will break even. (the .93 is the % you would net after escrow, sales commissions etc). So find something where you can sell for more than $204,000 and the better solution would be to sell current property, and make the money up on the next flip.

Is the hard money loan still financing the property? If so, the interest rate is probably too high for it to make sense to keep as a rental without first getting a conventional loan on it. I would say it wouldn't be a bad idea to rent it out until the market is hot then sell it to another investor. Definitely ask a local agent to see if they think selling the property with a tenant in place is a good idea.

Originally posted by @Rob Beardsley :

Is the hard money loan still financing the property? If so, the interest rate is probably too high for it to make sense to keep as a rental without first getting a conventional loan on it. I would say it wouldn't be a bad idea to rent it out until the market is hot then sell it to another investor. Definitely ask a local agent to see if they think selling the property with a tenant in place is a good idea.

 I paid off the entire balance before the ballon payment was due. So I don't have a mortgage.

@TD Wolf Sounds like a solid BRRRR candidate (Buy, Rehab, Rent, Refi, Repeat)! But with 'Rent to Own' instead of rent. If you're going to rent it, but want to sell, consider offering it as a lease w/ option to purchase. Get 3-5% down from a tenant buyer at full market rent with a 1-2 year option to purchase at full market value. Wait until you meet your lender's seasoning requirements and cash out refi 75-80% LTV out.. then keep it as a rental until the tenant-buyers get financing. Good luck!

Originally posted by @Lloyd Stanton :

@TD Wolf Sounds like a solid BRRRR candidate (Buy, Rehab, Rent, Refi, Repeat)! But with 'Rent to Own' instead of rent. If you're going to rent it, but want to sell, consider offering it as a lease w/ option to purchase. Get 3-5% down from a tenant buyer at full market rent with a 1-2 year option to purchase at full market value. Wait until you meet your lender's seasoning requirements and cash out refi 75-80% LTV out.. then keep it as a rental until the tenant-buyers get financing. Good luck!

I agree I think a BRRRR would work well for this property assuming you don't mind having some money stuck in it.

At 75% LTV on a $180k appraisal you'll get $135k minus fees so let's say $130k net to back into your pocket.

Granted you'll still have $45k "tied up" into this deal but you'll have $130k to go buy more properties.

Meanwhile this one will still be cash flowing based on a $135k mortgage and $1450 rent.

Originally posted by @Lloyd Stanton :

@TD Wolf Sounds like a solid BRRRR candidate (Buy, Rehab, Rent, Refi, Repeat)! But with 'Rent to Own' instead of rent. If you're going to rent it, but want to sell, consider offering it as a lease w/ option to purchase. Get 3-5% down from a tenant buyer at full market rent with a 1-2 year option to purchase at full market value. Wait until you meet your lender's seasoning requirements and cash out refi 75-80% LTV out.. then keep it as a rental until the tenant-buyers get financing. Good luck!

 @lloyd Stanton That's very interesting, it hadn't occurred to me before. Can you say more about how the lease w/option to purchase works? Are you saying get 3-5% down of the market value of the property?

Also, I don't have a seasoning period to deal with since I own it outright. Can you cash out refinance if you don't have a mortgage?

One option: lease it with a cancellation clause. That way, if buyer wants to hold as a rental they can. If not, tenant gets a 60 day notice to vacate.

Originally posted by @John Thedford :

One option: lease it with a cancellation clause. That way, if buyer wants to hold as a rental they can. If not, tenant gets a 60 day notice to vacate.

Good suggestion John and yes to the OP you can cash-out refinance without having a mortgage.

Howdy @TD Wolf

Agree with the BRRRR strategy. You can basically consider it a long Flip (A Brandon Turner term). Especially if you want the higher $220K price. Hold it, collect rent, and wait for the right sell price.

  • I have a candidate lined up to rent the place at $1450/mo plus utilities with good income, credit, etc.

Get rental references, though.

  • Only expenses are taxes ($2200/year) and insurance ($1600/year) as I now own it outright

There will be more expenses.

  • If I put it on a year lease (which is what renters want in this area) I'll be back in this position in a year from now and could extend the lease or sell it.

Not sure if the ski season affects this, but in winter I like 6 or 18 month leases, and then renewing for 12 month periods in spring, which is also a better time to sell. You can even have 18 months with a step up in rent written in at 6 or 12 months in.

  • The house was extensively renovated so this is the only time it will ever be "new."

"Newer" is good, too.

  • I don't necessarily "need" the cash that's tied up in it but that is a big chunk of money I could potentially invest elsewhere (but without a known rate of return like I'd get on this place).

I'd rent it, but I love cash flow, and that beats would could be a loss considering all of the time you've put in.

  • The property is 2 hours from where I live so I need to find a property manager.

Check with them on the rent and the candidate. Also, you get what you pay for. Go for the 2 interior inspections a year. If you have a qualified tenant, you shouldn't have to pay a leasing fee.

@TD Wolf Thats correct. If you get 3.5% down, it would count as their down payment with an FHA loan (once they get approved for financing). Don't take an 'unreasonable' amount, to avoid 'equitable interest' issues down the road.

You can offer seller concessions to cover their closing costs in lieu of offering 'rent credits' which can be viewed as a 'financing agreement', and subject to lots of fun rules.

Keep the lease completely independent of the option; don't tie performance of the lease to the performance of the option. 

Take potential tenant-buyers to a RMLO to get pre-screened to establish their ability to get financing in a reasonable amount of time

As far as seasoning goes, my lender requires 12 months of being on title before they'll cash out refi, whether its leveraged or not. Some do 6 months, definitely check with yours.

if you are trying to flip more sell it and move on, if you are trying to build a rental portfolio and it is where you want rent it. 

Here is my two cents. I would definitely refinance. There are investor friendly sources that should allow you out sooner. If you attempt lease option be mindful of Dodd Frank regulations. I have found temporary renters from real estate agents who have clients waiting on a house closing and need real short term housing. They often will only move in the necessities and bring little wear and tear. Keep in mind houses sell all times in the year. Find the highest producing agent in the area and get his or her advice. Take a step back and really analyze what went wrong so you don’t repeat it. It should be very rare that you don’t make money.

@ed  can you say more about why you would refinance in this situation and what you mean by "there are investor friendly sources that should allow you out sooner"? I like your tip about the short-term renters, too, by the way.

It's still too early to say if this deal is a "failure" but I've already identified two things that I would do different: 1) I made the classic mistake of not knowing the market well enough and therefore might have unrealistic expectations about sales price 2) I might be being too impatient. The house still could sell at or above my break even but I'm clearly getting antsy. But on the flip-side, we haven't had any offers so that tells me it's priced too high. My realtor is an expert in this area and says it's very common for properties to sit a while since the pool of buyers is much smaller...

@Ed Emmons undefined

Another thought: will the decision to rent in any way conflict with my agreement with the current listing agent?

@TD Wolf I really like the idea of renting it out and refinancing when you need the cash for another flip/investment. 

I would definitely do a credit/background check on any tenant no matter how good you think they are. If anything for peace of mind. 

How far is the property from Lewiston/Auburn?

I have a few multi's and a single family that I rent out (the single family is almost ready to rent :) ) located in the Lewiston/Auburn area and since I started using the checks my tenant quality has risen a lot. Also the interview process is faster as we get less applicants who see we do checks and don't bother coming or calling.

@Carl Hebert : it's in Sebago and very close to Bridgton. That's a little under an hour from Lewiston. Do you happen to know any property managers in my area?

@daniel Klein now that’s bigger pockets helping with breakdown. Good stuff

Replying to your question-

Hard money is in of itself risky unless you really no what your doing and have a large margin. It is also important that you know your market and are sure it will be a quick sale. In 25 yrs I am yet to use hard money although I could have on some of them. If you refinance you buy yourself time. You can get up to 75% of appraised value back which will increase your rate of return. With a reasonable mortgage rate you should have a positive cash flow until you do sell it. Consider using hard money only as a last resort and be very sure of the od the deal.

air b n b until spring and lost it for sale 

Or if you rather not bother just wait til spring and list it your self for $149 on MLS or for $7/day on listing spark

Save the commission and you may actually make money.   It worked for me 

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