IS FLIPPING WITH LITTLE OR NO MONEY POSSIBLE?

I am often asked if flipping with little or no money is actually possible.  I use to think that it was not really possible to flip a house with no money.  I felt that it was necessary to have some of your own money invested, either during the purchase or during the rehabbing.

Recently I have been working with another flipper who frequently uses a hard money lender.  A particular hard money lender he uses did not allow second mortgages on the property being flipped.  The lender wanted to see that the flipper had some “skin in the game.”  It is not unusual for a hard money lender to write into their note/mortgage that no second mortgages are allowed.  So, when this flipper found a great house to flip, and had his money with other projects, what did he do?

Well, we figured out of way of getting 100 percent funding for the flip.   We had to provide some security without putting a second mortgage on the property.  What did we do?  We found another investor who normally funded flippers, but he also usually wanted a first mortgage with no seconds.  After showing him the past experiences and successes of my flipper friend we made him an offer that he could not refuse.  

We offered to put his LLC on the deed as part owner of the property.  The property was quitclaimed to him after the closing.  He was then 50% owner.  Now, in order to secure his funding, and put him at lower risk, a note was prepared which indicated the amount of his investment and the interest rate that he would receive.  The investor was not participating in any income or loss from the sale of the flip when it was completed.   He was getting his principal back with an agreed upon interest rate.  Since that time I have worked with flippers who have also been able to do this.  So, as you can see, finding the right investor and using this tactic can lead to flipping a house.  This shows it can be done with little or no money of your own.  As long as the numbers work, it can be worth doing.

CALCULATING OPTIONS FOR MULTI-FAMILY OWNERSHIP

There are a variety of calculations and numbers to think about when considering your options as to whether you should retain or sell a multi-family property that you are rehabbing.    It is always good to have a variety of exit strategies, and multi-family rehabs can give you that without much thought.

So, there are calculations such as cap rate, cash on cash return, rent as a percentage of purchase price, rent as a percentage of purchase price plus rehab cost and the ratio of operating expenses to operating income.  Debt service coverage ratio becomes particularly important if you are thinking of conventional financing through a lender or refinancing after some experience with renting the property.  Be aware that any multi-family less than 5 units would not be viewed as commercial property by a conventional lender.  That generally means that you will have to show the lender that you are capable of handling the debt by disclosing your personal income and source of funds.  In a commercial transaction you can usually get the lender to consider the income producing property as a stand-alone business without you having to worry about what your personal income is.

Let’s look at some of these numbers.  Cap rate (capitalization rate) is calculated by dividing the annual net operating income by the purchase price of a property.  So, if a property net operating income is $20,000 (which does not include any mortgage or debt used to finance the purchase of the building) and the building is selling for $200,000 then the cap rate is 10% or 10.  $20,000 divided by $200,000.   For smaller rentals I personally do not pay attention to cap rate.  If there are 6 or 7 units in the building I will ponder it, but if it may not be a deal killer.  In areas like Manhattan or Fairfield County in Connecticut you will find very low cap rates 2, 3 or 4 may not be uncommon.  Buyers of these properties are often looking more toward appreciation then what their return in current income is going to be.  Cap rates in less affluent areas will normally be in the double-digit ranges for good deals.  But again, it is not the only thing to consider.

I think cash on cash return should be a consideration in a multi-family buy and hold situation.  After all, if you only get a 3 or 4 percent return on your money then there are probably better secure investments for you.  I calculate the cash on cash by taking the actual cash flow on the property and dividing that by the actual cash you use to purchase the property.  So, if the net operating income (cash basis) is $20,000 in the first year and you then deduct your loan payments, let’s say $10,000 for the year, you have $10,000 of cash flow.  If you had to come up with $40,000 cash to get the building, then your cash on cash return is $10,000 divided by the $40,000 you needed to get the building, or 25%.  That looks like a pretty good use of your cash.

I consider rent as the percentage of the purchase price and purchase price plus rehab to be a “must compute” and analyze type of calculation for holding rental property.  At a minimum the monthly rent must equal or exceed 1 percent of the cost of the property.  At one percent I am not crazy about the deal, but if the current rents are too low and I think they can be raised or increased by getting new tenants I would consider the building.  If you can get a 1.5 to two percent rate in moderate income areas I think you are doing very well.  So, let’s look at the calculation.  Again, we will say the cost of the building is $200,000.  Let’s say we get $3,000 in rent each month.  The rent as a percentage of the price of the building is $3,000 divided by $200,000 or 1.5%.  This, for me, is acceptable.

I do not like to see operating expenses being more than fifty percent of the operating income.  I include in that calculation a reasonable estimate for vacancy loss as well as a reserve amount.  This calculation with the rent loss estimate and reserve amount included in expenses is probably too conservative for many multi-family investors, but that is a personal preference and I am always willing to consider the pros and cons of this calculation given current market considerations and longer term projections.

The last calculation I will mention is the debt service coverage ratio.  As I mentioned before, if you are looking for conventional refinancing or a bank loan this is an important calculation to a lender along with the cash flow.  Most lenders that I have talked to are looking for a 1.2 or 1.25 ratio.  Some may go with a lower ratio, but plan on a 1.2 or1.25 minimum requirement.  The debt service coverage ratio is the net operating income amount divided by the loan payment amount.  So, if we have $20,000 of net operating income, (which must consider vacancy loss, which should automatically be accounted for when using actual numbers), and our annual loan payments total $15,000 the ratio is $20,000 divided by $15,000 or 1.33, which is acceptable. Presented on a monthly basis, the monthly net operating income is $1,667 divided by $1,250 which is 1.33.  This would be considered an allowable ratio.  So, if the lender was confined to a 1.2 ratio or better, and wanted to see what the maximum monthly allowable loan payment is, the lender would take the $1667 monthly net operating income and divide that by 1.2 to say the maximum allowable loan payment allowed would be $1389 per month.  In this example the monthly loan payment of $1,250 is perfectly acceptable.

Using a spreadsheet to estimate your annual income and expenses and to analyze a deal before you acquire a multi-family property is a must.   Then calculating these rates, ratios and numbers based on your findings will help you make a more informed and intelligent decision when considering your alternatives before purchasing a multi-family property that needs work.

OPTIONS FOR MULTI-FAMILY HOUSING NEEDING REHAB

Let’s talk about multi-family housing that needs rehab work.  Obtaining a multi-family that needs work gives the investor a variety of options for both financing the property as well as deciding to flip, buy and hold or buy and hold for a period of time then flip.

METHODS OF PURCHASING MULTI-FAMILY HOUSING

You can always take the conventional route when buying multi-family properties.  By that I mean you can get a mortgage from a lender.  If the property has enough units to be considered a commercial real estate deal (generally more than four units is considered commercial) you can usually get a mortgage based on the income the property generates on its own, without having to prove your own personal income.  If you are buying the property that is in disrepair or has vacancies you will probably not be looking at conventional financing.  If you are not sure if you want to flip or buy and hold, this may not the best way to go.  The expenses of appraisal and closing costs are far too high to consider this economically feasible.  In addition, you may find that a conventional lender will insert a prepayment clause which will make a quick turnaround prohibitive.

There are some hard money lenders who will be willing to finance multi-family properties whether you decide to flip them or hold them.  Again, the rates on these loans may make it prohibitive.  The best sources of funds for buying these properties then boils down to your own cash, private lenders or OWNER FINANCING.

You can often sell your idea of owner financing by simply putting the right information in front of the current owner.  For example, you can make a cash offer at the low end of the spectrum.  You can make an offer subject to obtaining a mortgage at a little higher amount.  Finally, you can make an offer that cannot be refused, by offering asking price or higher, but that offer is on the condition that the owner finance a major portion of the purchase.  You can show the owner how the interest rate you are offering is better than most investment returns he will get elsewhere.  He will have a first position mortgage on the property that will allow him to take back the building in the event of default, and you can have the owner give you a long-term repayment schedule (say 20, 25 or 30 years) with a balloon payoff to the owner after five or ten years of payments.  Show that information to the owner on paper.  Let them see that, in fact, he or she will be making more than what the actual purchase price is because of the interest being collected over the five or ten years of repayment.  If you decide to flip the property there is nothing lost in the transaction, and you have minimized your cash outlay by getting the owner financing in place.

Of course, all of this is predicated on running numbers for both flipping and buying and holding before you even get into the idea of buying the property.  So, we have previously discussed some things about running numbers in the event of flipping.  In a future blog we will look at some numbers and calculations you must be aware of in order to make a decision on a possible buy and hold option.

There are a number of additional and traditional calculations to take into account when considering a buy and hold option on a multi-family rehab project.  I personally do not give the same amount of weight to the importance of some of these numbers as others often do, and I will try to cover that as I discuss each item and the importance of each calculation in my next blog.

You are already ahead of the game by purchasing a multi-family property below market.  The planning for this rehab should generally be a bit different than what you would do for a single-family home that you would be selling to homeowners.  Rental property generally should be viewed with a bit different perspective.  For example, do you put in granite countertops?  It is not likely that you would do that.  Likewise, you may want to use linoleum where you might otherwise tile, or use a variety of flooring instead of hardwood if the hardwood is not already there.

 

TO FLIP OR RETAIN MULTI-FAMILY PROPERTIES FOR INCOME

 

 It is becoming more and more apparent that knowing the ins and outs of house flipping allows the investor to increase his or her possibilities for making the most out of an investment.  A perfect example of what I am talking about is when an investor, who is familiar with house flipping and the costs associated with that process, purchases a multi-family property with the original intention to flip.

Not so fast!  Before you decide to flip that property, I suggest that you review the benefits of possibly retaining the property.  Before we examine what you must know to make an informed decision about keeping the property or flipping it, let’s consider some alternative methods of purchasing the property that may or may not be available to you if you are dealing with a single-family flip.

Generally, if you are flipping a single-family home, you can finance the purchase and rehab of that home by using your own funds, using private money or using hard money.  You may be able to convince the owner to finance the property while it is being upgraded, but I would say that would be rare.  Most houses that will be worth flipping for a good profit are houses where the seller is quite motivated and is looking to cash out more quickly.  The original owner may not be willing to wait for you to fix the house and then sell it, which can take a number of months, and has an unknown end date for both you and the original seller.

Other problems can be created by the original owner waiting.  If they have any idea of the profit you may make you can find yourself at odds with them.  This could jeopardize the project and lead to the entire project becoming a bone of contention. Will there be profit sharing?  If so, how will that be determined?  If not profit sharing will the original purchase price need to be adjusted?  What happens if the profit is somewhat different than what you anticipated, (either more or less) as a result of you running the project?  Also, would the original owner be willing to deed the house to you before getting paid-in-full?  Would they be willing to allow you to tear the house apart and rehab if they do not turn the deed over to you, or they are not sure that you will finish the job or pay them the remainder?  Will you leave the house half done and walk away with less to lose then what they may lose?   Owner financing for a single-family home that is being flipped is difficult to come by, to say the least.

Our next blog will move into the discussion of multi-family housing that needs rehab work.  Obtaining a multi-family that needs work gives the investor a variety of options for both financing the property as well as deciding to flip, buy and hold or buy and hold for a period of time and then flip.

Rehabbing a Bathroom

Rehabbing a bathroom is an important step in a fix and flip situation.  Generally, if you want to get the best results you will find yourself replacing toilets, sinks, bathtubs, tile, flooring, tubs and showers.  You have to be careful about how much you spend in a bathroom makeover.

Prices for tubs, showers, sinks, tile and toilets vary tremendously.  When flipping you want the bathroom to look great.  You also do not want to use products that look cheap.  You need to find decent materials that will look great and will last for a reasonable amount of time.

Kitchens and bathrooms are probably the two rooms that need the most attention when flipping.  Sometimes you will find a bathroom with porcelain tubs and tile that may look worn but really doesn’t have anything wrong with it.    These items may even be a better quality,  when originally installed ,then the products that you intend to use for the flip.  Instead of ripping it out the old items consider refurbishing the tub and tile through a glazing process.  Redoing the coloring and glazing in a tub and on tile will make the bathroom look as new as replacing those items.  You can also change the colors.  There are a number of people who do this, and a good job could save you some cash, which means more money in your pocket.

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Rehab Spreadsheet

This is a rehab spreadsheet that does it all.  You can analyze with it, budget, track expenses, do some accounting and use forms from it.  You can get into great detail with it or alter it for your particular needs.

 

Curb Appeal

Curb Appeal is important in any real estate sales transaction.  That continues to be true when flipping a house.  It is important to have the exterior of the house as neat and clean looking when selling a house.  If you went on a job interview you would be sure to dress appropriately and look your best.  This is the same thing you have to  do for a house that you are flipping.

Be sure that the lawn is cut and the yard is well groomed.  If there is a particular problem growing grass in one spot consider an island of shrubs, flowers and a small tree or two.

Paint the house if necessary.  Redo or add siding if it increases the value and improves the look of the house.  If the house already has vinyl siding it can be painted with a good acrylic based paint.  Match the color if you only need to spot paint.  This can easily be done by taking a sample of the siding to a paint store.  I have used Sherwin-Williams with great success.  Sherwin-Williams and others have products now designed for painting vinyl siding.   If neither painting or adding siding to the house is practical, then at a minimum power wash the house.  Be sure the driveway looks good too.  If it is asphalt and you don’t redo the paving then you should seal the driveway to create a new and clean look.  If the driveway is gravel be sure it looks good and get new gravel dropped in if it is too thin.

Having curb appeal will allow you to sell the house quicker.  It can also add money to your profit by enabling you to get a better offer.