Last week, I talked all about the many benefits of using hard money to fund your first flip.
Although there’s lots of people who are “in the know” and completely understand hard money, there are far too many who still think the opposite.
Let me tell you why this is so wrong…
How to Estimate Rehab Costs!
Estimating rehab costs accurately can make or break your real estate business, and it takes years of experience for even the best rehabbers to master the art. However, you can expose yourself to less risk and get more accurate with your projections by learning how the pros think when estimating construction costs.
The “Big Question” and How Hard Money Can Solve It
As many of you know, I have a house flip business which I spend 95% of my time with – but I also have a blog on house flipping to help new investors.
For every new person who subscribes to my blog, I email them a question like this a few weeks after they subscribe:
Are you still interested in flipping houses?
After they say “yes”, “no” or tell me what’s their situation is, I then email them back usually asking this:
“What’s holding you back from getting started?”
Here’s why understanding hard money is SO important…
These are just a few answers (not edited at all, by the way) from the last two days back to me on email:
“Yes I am Mike, just don’t have extra cash or credit right now”
“Money a good mentor and a business partner.”
“Just hard to believe you can do re without money.”
“Mike – Time and money.”
“I am interested, but at this point I don’t have the cash flow to do it at this time……..”
“Lack of funding or knowing where to get it.”
What’s the one common element in all those answers?
You guessed it: Money. It’s the great stumbling block for nearly every new house flipper.
So how do you get “money”?
How you get it has a lot to do with the numbers and the how then comes from those numbers. Let me explain….
The 70% Rule and The Elephant In the Room
By now you probably know about the 70% Rule.
As has been discussed in this space many times, its the fundamental rule in house flipping.
So because it’s so important, lets review some of the details a little further.
The 70% Rule Fundamentals
So for example, you’ve determined with your broker that the ARV of a certain house is $200,000. There are plenty of comps in the area and you feel comfortable with that number.
So to get to the 70% Rule, you do the following:
1. Take the $200,000 and multiply it by 70%, which equals $140,000:
70% Rule: $200,000 x .70 = $140,000
2. To get the maximum amount you should pay for the house, you then deduct your renovation costs from that $140,000. In this case, let’s say your rehab expenses will be $40,000:
Subtract the $40,000 from the $140,000:
Repair costs: $40,000
70% Rule: $140,000
Maximum Allowable Offer (MAO): $100,000
In this example, you’d make an offer below $100,000, then most likely negotiate up if you need more wiggle room. When all your costs come in as expected, you will make a nice profit on this flip no doubt.
The 70% Rule Profit Breakdown Using Hard Money
Typically when we apply the 70% rule, it breaks down like this:
- 20% is projected profit of the ARV
- 10% is your projected soft costs of the ARV (this is your money cost here!)
This is the quick math you use when you “eyeball” a property when using private money or other financing sources for your flip. However you MUST know your expenses to determine how the 10% applies to your situation!
Let’s say you’re using hard money and you’re paying 12-15% and 3 or more points on your hard money loan.
If that’s the case, then your projected soft costs will be higher than the 10%!
What this means is your projected 20% profit of ARV will then have to come down. It may be more like 15% profit or even less.
This lower level of profit may be fine for you or you may need to buy at a lower price. The point is to know what your numbers will be as best as you can project.
Money Secrets Example
In our example above, you are working on a deal with an ARV of $200,000 using hard money and the 70% Rule, you might be making $25-35,000 as opposed to $40,000.
Would you like to make $25,000 profit on a house flip? I sure would.
Let’s say the house doesn’t sell for another three months and you make $15-17,000 instead? Would you STILL do this deal?
The point is that without the hard money loan, you never would have made that “worst case” profit of $15,000. AND better yet…you now have you first flip under your belt. You can now leverage this to private investors to get even better terms and then make even more on deal number two.
The idea here is really knowing the numbers when you go into the deal and understanding how they affect the 70% formula.
And if you use hard money…you need to know these numbers!
If you have the ability to buy the property for less money – less than the MAO even, do your best to get it as low as you can to add to your profits! At the same time, you don’t want to go so low that you lose the deal…so keep that in mind as well.
Hard Money IS Workable…But You Have to Know The Numbers
I hear people say all the time:
“Oh I would never pay hard money rates. That’s crazy, that’s ridiculous.”
There’s nothing wrong with hard money if it helps you make money…maybe not as much as would with private money or a loan from a bank – but you will make money.
For those who poo poo hard money, you may want to ask those people:
“In the last month, how many deals have you done?”
If they answer:
“Well, none right now”
…then you have your answer.
Action is better than no action and using hard money allows you to take that action.
Don’t worry Donald Trump…you’ll make your millions on the deals after that first one. The point is that you need to get started…and hard money allows you to do just that.
Set your profit expectations slightly lower and get in the game with hard money!
Just make sure you use the formulas enclosed here to protect your downside.
If you’ve made it this far, then please leave a comment below! I’d love to know what you think about hard money and getting money for your first flip!