Quote from
@Randall Alan:
@Joshua Nuss
Hi Joshua,
Welcome to Bigger Pockets!
It looks like you are looking at both rentals and flips. I'm going to offer up a few words of caution, as well as the way I like to approach flips.... but to answer your up front question on financing, the typical heloc is going in the 9% range. That's really expensive for any type of hold (rental property) - but maybe feasible for a short term flip. Long term it would pretty hard to make a descent profit on a rental that was carrying a 9% loan. The numbers usually just don't work after you factor in principle, interest, taxes, property insurance, as well as a maintenance reserve unless you somehow found a steal of a deal on the purchase price.
A refi is simply a new loan where you are keeping your same house. So you start from scratch on the loan, but there are no real estate agents involved on a refi, so you have no commissions to pay them. Most of the other regular costs associated with the loan apply... appraisal, doc fees, county taxes, etc. You probably won't have survey requirement because you can re-use your old one, and usually you get a credit for title insurance if refinancing within 2-3 years of your original purchase. Refi's typically have a slightly higher interest rate than a new home purchase. Probably 1/4 to 1/2 point as I recall. The refinance loan pays off and replaces the original loan.
Since you are probably looking to get cash out of your paid off house, that is called a cash-out refinance. Usually you have to leave 25% of the equity in your house - so you can borrow about 75% of the equity. But know that your interest rate on a cash out refi is usually higher than a typical interest rate. So if a new purchase loan was 7%, a cash out refi would probably be 7.5-7.75%.
Flips are certainly possible to do - BUT - it takes a REALLY great spread between your purchase price and ARV for it to be worth the effort in today's market. The cost of money in today's market doesn't help the situation either. I've done 6 flips, and own 37 rentals since starting in real estate in 2018 (just to give you touch on my background).
Today, on a daily basis I get 10-20 texts and emails offering me purchase opportunities that are mostly homes to BRRRR. The problem with 95+ percent of those is that the math doesn't work.
There are a lot of ways to approach BRRRRs.. for me, I tend to work the equation "backwards". I start off by saying, "How much money do I need to make to make a flip worth my time and effort?" This is really a great short-cut to analyzing deals, because I can easily look at the ARV spread (which you should seldom trust, by the way) and see if it is even feasible to make how much I want to make. I tend to operate in the $50-300K house price range (between buying price and selling price). For me, I don't want to take on a project where I will NET less than $50,000 after I sell the house. You might say, "That's a lot of profit to expect." My response to that would be, "Yes, but do you realize the time, effort, and risk I am having to take to pull off this deal?" Maybe it's a $100,000 buy and a $200,000 ARV, with $40,000 in renovations, plus holding costs, closing costs, unexpected expenses, etc in between". You have to ask yourself, what's it all worth to you? How much are you willing to risk up front to make what your net profit will be? Once you have done your first flip, you will have such a greater appreciation for this statement! Because renovations are a time consuming and frustrating processes - especially if you are hiring outside labor for the majority of your repairs. Just finding quality help is tough, much less getting them to show up, do the job to a competent level, and actually stay on task to finish before their mind is off to the next job. Usually you are one of multiple jobs they are working on, so you start off not even having their full attention.
I see so many deals where the purchase price is $50,000 below the ARV market price. So the implied proposition is, "Buy this run-down house... pay ALL the closing costs (often both sides of the transaction) to buy it, invest a significant amount of money, sweat and tears to bring it up to market condition, then sell it while covering your typical closing costs as well, and your spread to do this is max $50,000 according to their ARV. For me, this imaginary house is a non-starter. I want/need to net what you are telling me the entire spread is. Move on to the next house.
Why do I want that type of spread? It's all in the numbers...Lets do some imaginary math on a $100,000 purchase with a $50k ARV spread...
Say closing costs to buy are $3,000, and to sell the house once finished your closing costs are $7,000 with commissions and fees presuming you are paying a realtor on at least 1 side of the sale. Your profit margin is now $40,000 and you haven't done 'thing one' to the house yet. Let's say going in you think the house needs a roof, an AC, and some paint & general repairs for $10k, 5k, and 3k respectively. So repair costs are $18,000. Your profit margin is now $22,000 (44% of the 50K). But flips seldom go exactly as planned. So maybe along the way you run into cost overruns... This can be anything, and everything you never even thought about. You start finding evidence of termites ($2,000 to tent the house). There were 3 cracked window panes ($200 to repair, or $1000 to replace). The bathroom tub faucet isn't working right and needs a new valve ($450)... and the list goes on and on. So let's just stop there with the list and say it took an extra $5,000 to ultimately fix everything else you found as you did the Reno. Repair costs are now $23,000 and your profit margin is $17,000 (34% of the $50k).
You might be thinking, OK, $17,000 - not bad?! But don't forget your money costs. Let's say it was a 6 month project from buy to sell, and your interest rate was 8.5% on $96,000 (You put down $30k, but needed 73k more to buy the house with closing costs, plus $23,000 to fix it... so you ultimately borrowed $96k). Principle & interest on a $96,000 loan was $738/month, and let's call property insurance $125/month, plus utilities of $100/month. So holding costs were $963/month... times six months is $5,778 to hold the property. Ok, so your profit margin is $11,222. Maybe you are stilling thinking, "Well, it's something!"
Did you remember to factor in short term capital gains into your thinking? If you hold the property for under 1 year, the difference between what you paid and sold it for is taxed at your regular income rate. The way you describe your situation, I'm going to say you fall into the 22% tax rate bracket (single over $47k, or married over $94k in taxable income). While you probably can't write off every expense listed above, let's just say you can and use your final net profit for tax purposes. So $11,222 times 22% is $2,468 - leaving you a true profit on the house of $8,754 for an all encompassing 6 month intensive project that you will likely feel lucky to get out of with that profit, because you did your very best to minimize expenses along the way.
How do you quantify this number? How about the value of your time? Let's say you spent 15 hours a week on your flip (beyond your 9-5 job). That's 360 hours across 6 months, or $24/hour in profit. How about percentage profit on your investment? From the $30k you invested, it looks brighter - 29% ROI. But really you risked $123,000 when you factor in the borrowed money to net your $8,754 in profit... that's a 7.1% return on what you would likely agree is a pretty high risk endeavor.
I hope some of this helps!
all the best!
Randy
