Hi Samantha,
Before calculating the profit on a flip using a hard money loan, the best thing, I think, is to calculate the profit on the flip as if you were buying the property with 100% of your own capital and then paying for all the rehab and carrying costs yourself as well. There are probably some posts here on BP that show all of the costs involved with that. The profit is calculated as the sales price minus sales commission minus rehab costs minus carrying costs (property taxes, utilities, etc) minus purchase price minus any title company charges (recording, title policy etc).
Once you have all of that down, and the profit margin looks good, then I’d go ahead and calculate the profit margin net of the hard money loan. Each lender is going to have their own particular costs, but I think generally speaking just take the points and interest on the loan and subtract that from the equation above. Then you have your net profit on a property using a hard money loan.
Regarding being unable to sell a property:
Yes, this is one of the risks to your profit margin. If you cannot sell a property before the loan comes due (usually around six months), it will probably be necessary to roll the hard money loan into another hard money loan which will mean another set of points. That gets expensive.
If I can, let me add a couple of items here from my own experience.
I’ve been lucky enough to have been flipping properties for a few years now and coincidentally I also now run a hard money lending business. I’ve seen both the debt and the equity side of this business.
From my own experience originally as a borrower, here are 3 key items to remember.
1) The deal must be good enough upfront that you can bring the property to market for a little bit less than what other properties are currently selling for in the subdivision. This means I wouldn’t use hard money to try to upscale a property. By upscaling I mean adding lots of expensive improvements and then trying to sell the house at the high end of what properties go for in the subdivision.
2) I would plan at the start to get the property out the door in less than 6 months. This means the rehab must get done fast, fast, fast because I’d want the property on the market quickly, usually no more than three weeks after I took out the hard money loan. I always have to remember that the buyer is going to need about a month to close, so even if the property is under contract in 4 months there’s another month before it can close.
3) I always want to make sure to call the banks that provide pre-approval letters to make sure that a potential buyer is really going to be able to close if I let them put the property under contract. There’s nothing worse than having a property fall out of contract because the buyer couldn’t actually get the financing. In this sense I became like a banker myself. I got actually got into the kung-fu of what the banks do to underwrite both a property and a borrower so I could make sure that the borrower and the property were going to actually qualify for the loan before I let the borrower put it under contract.
Lastly, I would say to anyone working on their first flip: Do not use hard money for your first flip. The learning curve in dealing with new contractors etc is most likely going to be too steep to get the property done and out the door in 6 months.
Therefore, for a first flip, I would suggest finding an equity partner. An equity partner will fund the whole deal for 50% of the profit at the end, and if you go over six months there’s no penalty. Getting all the learning done with an equity partner first is safer and easier in my opinion. Then once you have the system down you’ll be ready to try it with hard money.
The great advantage of hard money is that once you have an efficient flipping system in place, the cost of capital for a hard money loan is less than the cost of capital for a full equity partner.
That’s pretty much it! I hope this helps!
Best, Bobby
