Being a real estate investor (or a real estate agent working with one) is not for everyone, that’s for sure. However, one of the reasons people don’t dive into the real estate investing pool is they don’t understand how the deals are financed. Let me give you a quick breakdown of how some fix-and-flip deals are financed.
Step one: You take the acquisition price – example: $200,000; you’ll need to put down 10% – in this example: $20,000.
Step two: Determine how much will be needed in repair costs to get the home ready for appraisal and sale – example: $35,000.
Step three: The acquisition price was $200,000 with $20,000 down, so $180,000 will be needed for the home acquisition, and $35,000 will be needed for the repairs. Added together, that’s $215,000 needed from a lender.
Step four: Determine the home’s After Repair Value (ARV) – example: $375,000. The lender will lend up to 65% of the ARV – example: $375,000 X 65% = $243,750. Because 65% of the ARV is higher than $215,000 (the acquisition and repair costs), all’s well.
Step 5: The “flipper” (borrower) will be required to put together a precise list of what improvements are to be made to the home calling out specific materials. An appraiser will be called in to compare the current state of the home to the repair schedule to determine what the ARV will be. If it comes back higher than previously thought, great. If it comes back lower, it may require the buyer to bring more money to the table – example: the home’s ARV is set at $320,000 (65% of that is $208,000, and $215,000 is needed – the borrower would have to come up with an additional $7,000 over and above the $10,000 they brought in for the down payment).
Step six: Once the ARV is established, the lender moves forward with finalizing the loan and financing the project. The terms will usually be 12 months with interest only being charged. Example: on a $215,000 loan at 9.5% interest only, that would be a monthly payment of $1702.08. The lender is going to charge fees up front that usually add up to about 4-5% of the loan amount. That amount will be paid at closing along with any closing costs (about 2.5% of the loan amount).
So, let’s put this in real numbers and see how much a flipper would make:
$20,000 for down payment
$15,050 for fees and closing costs (about 7% of the loan amount)
$20,425 (12 months of interest)
$55,475 TOTAL COSTS
$375,000 house sells for this amount
$215,000 amount financed
$160,000 TOTAL CLEARED FROM SALE
$160,000 total cleared from sale
-$ 55,475 total costs
That number just north of $100K isn’t the TRUE profit because you have short-term capital gains taxes to consider, but this gives you a general idea of how such a fix-and-flip project is financed and how all the numbers are calculated.
This is just one of many different ways to finance a fix-and-flip. We also have other strategies that appeal to a “flipper” mentality but allow the flipper to avoid those short-term capital gains taxes. And for those who are leaning more toward the buy-and-hold strategy, we have ways to help them acquire properties without the need for income verification.
As an agent, by having a passing knowledge of what your lending partner can do to help finance these types of deals, you become an asset to your existing customers who are in the investor pool with both feet and to those who are nervously perched at the edge unsure of whether they should dip their toe in the water to see how it feels. Give them a splash of your insights, and you’ll be pleasantly surprised at who jumps in!