We often get asked by real estate investment professionals about when it makes sense to get a hard money loan on real estate investment property. Also, they want to know the maximum an investor should pay for a property they want to fix and flip in a 4 to 6 month time frame?
The Southern California real estate market has suffered some of the most significant declines in the past several years and there has never been a more opportune time to buy investment property. However, it’s not as easy as the TV shows make it to be. When buying investment real estate, there are many factors to take into consideration. The cost of the repairs is only part of the picture. While there are no guarantees as to what the bottom line will look like when the project is complete, there certainly is a checklist that you should go through in determining your maximum offer. In reality, sometimes you will make less than projected and other times you will make more than projected. The bottom line is, the more experience you have, the better your projections will be.
The first step is to determine the ARV (after repair value) or what we also call the QSP (quick sale price). You need to analyze the market area and look at the comparable properties that have sold over the last year. Don’t give much value to what the current listings show; they can be way off any realistic value for a variety of reasons. Take into consideration whether values are going up or down. You also want to assume that you are going to price the property on the lower end of the comps so that you can move the property quickly. Holding time can be costly. Don't be too conservative with your estimates because your offer does need to be competitive with the other offers/bidders. The input you receive from local realtors that know your target areas can be invaluable in this effort.
When you have determined what you think you will sell the property for, you simply need to subtract your projected costs and your desired profit. The equation will look something like this:
|Projected QSP (Quick Sale Price)||$200,000|
|Minus Eviction Costs||$0|
|Minus Cost of Repairs||$10,000|
|Minus Unpaid Taxes/Liens||$0|
|Minus Sales Costs (3% to 6%)||$10,000|
|Minus Closing Costs (1%)||$2,000|
|Minus Holding Costs (utilities)||$1,000|
|Minus Loan Costs $3.5% +1% mo.)||$11,400|
|Minus Target Profit (10%)||$20,000|
Obviously, the more creative you can get at minimizing costs, the greater profit you can achieve. Also, by reducing your costs, the more you can offer for the property which will allow you to capture more deals while still hitting your target profits. We have found that the real pros get very good at negotiating their costs.
Now, let’s assume that your private money lender agrees with your after repair value of $200,000 and agrees to lend you 60% of the ARV or $120,000. Your total out of pocket expenses in this example, using a down payment of $25,600, would be $60,000. So, given the assumptions we have made, you would have made $20,000 on your total out of pocket expenses of $60,000 or a return of 33.3%. If you did not get a loan for this transaction your gain would have been $31,400. However, your out of pocket expenses would have been $168,600 which would have given you a return of 18.6%. So you can see that leveraging your money can net you a higher ROI (return on investment).
In summary, using private money on your fix and flip real estate investment property transactions can be a smart way to deploy your cash over multiple properties and increase your net return. This formula gives you the guidance that can assist you in making good business decisions. You will be able to apply your particular situation to the formula in figuring out ways to reduce your costs. Soon you be doing this stuff in your sleep. Press on and good luck.
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