Factors in evaluating flip (rehab) deal for hard money financing
FlipFunds SW and our advisers and associates will consider a number of factors in evaluating a flip (rehab) deal for hard money financing. These factors largely overlap with the elements that make a profitable deal for the investor. So consideration of these factors benefits both FlipFunds SW and our investor/customers. Here is a list of some of the more important factors we consider.
Loan-to-value ratio
What is the value of the property relative to the loan amount? The property is the collateral securing the lender’s payment. So loan-to-value drives the decision of whether to lend hard money. FlipFunds SW looks for deals where the amount of the loan will not exceed 65-70% of the property value. For properties needing significant repairs or remodeling, lender and borrower can sometimes maintain the required loan-to-value ratio by staging release of funds. For example, a reasonable estimate of the property value at closing may be $200,000, while the anticipated value of the property after repairs might be $250,000. To maintain the loan-to-value ratio, FlipFunds and the investor may structure the loan to fund $135,000 at closing and another $33,500 in a series of draws as repairs are completed. Each draw will fund only after professional inspection of repairs to make sure they are properly completed. This process can allow the lender to maintain loan-to-value ratio while still allowing the investor to fund and complete repairs needed to maximize return on the property.
Insurance
FlipFunds SW will require the investor to provide proof of hazard insurance at closing. The investor will need to maintain that insurance as long as the loan is outstanding. Obviously, covering the property against catastrophic loss benefits both investor and lender.
Investor liquidity
A hard-money lender funds most of the investment in the property and repairs, but not all of it. In most deals, the investor will contribute some cash at closing to pay the equity portion of the purchase price and closing costs. The investor will also fund part of the repairs, pay insurance premiums and utilities, make interest payments on the loan, and pay other day-to-day costs. If the property is held past a property-tax deadline, the investor will also pay property taxes. The investor must be able to show enough liquidity to contribute some cash at closing and pay expenses until the property is ready for resale.
Property taxes and first-lien position
FlipFunds SW will require a first-lien position at all times while the loan is outstanding. This means the investor will have to pay property taxes within a reasonable time after assessment to avoid property-tax liens. And property-tax loans from other lenders are forbidden. Property-tax loans jeopardize the lender’s first-lien position and violate the loan documents. This factor intertwines with the investor-liquidity factor. Investor and lender should ascertain from the outset that with the proceeds of the hard-money loan and the investor’s own resources, the investor will have the funds to see the investment through without turning to other funding sources. This inquiry benefits not only the lender, but also the investor. A property overburdened by debt is likely to cost the investor its profit opportunity and perhaps its equity as well.
Repair difficulty
Some repairs are more difficult than others–extensive foundation work, for example. Logically, the more difficult the repair, the more likely cost overruns, and the more expensive they may be. For more difficult repairs, investor and lender may both benefit from building slack into the budget to leave room for cost overruns. If the budget cannot tolerate the slack and still leave room for a nice profit, investor and lender may decide to move on and look for a safer deal.
Restrictions
Federal and State regulations and other factors prevent hard-money lenders like FlipFunds SW from making loans on owner-occupied properties or other properties purchased for “personal, family or household use.” We make loans only for commercial purposes to investors buying for profit. As a condition to the loan, the investor will be required to sign an affidavit at closing affirming that the investor is taking the loan for commercial purposes. The affidavit will confirm that the investor will not live in the property, declare it a homestead or use it for “personal, family or household” purposes. (Disclaimer: This is a layman’s description; the legal document will include different and additional language and the language of the legal agreement will be binding.) The deed of trust (Texas mortgage document) will also affirm that the property will not be a homestead. FlipFunds SW takes these restrictions seriously and will not abide their violation.
Hopefully, the factors we consider in evaluating a flip (rehab) deal for hard money financing will provide some investors with a new perspective on some of the deals they see. If you have any questions or want to discuss a specific deal further, please contact us.