House Flipping and Property Renovations for Beginners
What's up, guys?
And welcome to the most authentic, transparent and real real estate investing blog around.
At least that's my goal.
If you're new here, my name is Lili, and this is where I've been documenting my real estate investing journey and bringing you guys along with me, with all the steps from house hacking, to wholesaling, to now buying and renovating my own houses.
The question you're probably asking, is how could you get funding for your own deals?
Well, you're in the right place because I'm going to completely break down a few different methods that you could use to fund your property renovations.
We'll break down all the numbers, talk about the pros and cons, and all the things that you need to know so you can get into the house flipping game.
And if you stick with me and do the math with me, you'll see that you can actually start flipping houses a lot sooner and with a lot less money than you might think.
And if you're wondering where you can find distressed properties in the first place so that you can renovate them, I have you covered.
Propstream for House Flipping
If you don't have PropStream yet, you've got to get on that. As an investor, your focus is finding distressed properties and getting as much information on them as possible. And that's where PropStream really shines.
PropStream is an online tool and database and I genuinely use it every single day in my real estate investing business, which is why I have no problem recommending it to you guys. I've used it when driving for dollars.
I use it to pull lists of distressed properties, and I even use it to find and build relationships with people who might end up funding my deals.
So if you haven't yet, use this link to get a free seven-day trial so you can start playing around in PropStream and really see how it could take your real estate investing business to the next level.
So with that said, and a big thank you to PropStream, let's get started.
The Example Property
As we go through the following methods that you can use to fund your deals, we're going to use an imaginary property to run our numbers on so that the numbers of the deal stay the same from strategy to strategy.
That way, you can see how the strategies themselves differ. We're also not going to talk about things like holding costs or capital gains taxes, because, again, those things will be the same from strategy to strategy.
But we want to know just how do the numbers that are different from strategy to strategy work. For now, we won't worry about closing costs and realtor fees and all that stuff.
We know.
All right, so we're saying we could buy this distressed property for $100,000. And if you think $100,000 is high for your market or low for your market, just stick with me. $100,000 is a good number to do math with.
That's why we're using it.
So, $100,000 purchase. And let's say that it would take a $60,000 rehab to get this thing into the type of condition you want, and you've got an ARV of $200,000.
ARV stands for your "after repair value" which means what will this property be worth after you're done repairing it.
House Flipping vs. House Renting
And that $200,000 could be determined in two different ways. If you're going to actually flip this property and sell it when you're done, well, then $200,000 is the value that you think someone would buy it from you for.
So in that case, it's the sales price.
But on the other hand, if you're not going to sell this property and you're going to renovate it and keep it as a rental property, well, then at that point, instead of selling it, you would get something called an appraisal done.
And that's where a professional comes out and evaluates all of the things that you did to fix up this property and tells you what they think it's worth.
So either way, whether you're going to sell it or you're going to keep it as a rental and get an appraisal.
So, again: $100,000 purchase, $60,000 rehab, $200,000 after repair value.
Funding Strategy #1: Cash Purchase
Method number one is to do this deal with straight cash, the Dave Ramsey method.
I don't like his methods, because doing $160,000 cash deal is probably not realistic for most people.
But we're going to go over it, because it's going to give us a good baseline to compare all of the other methods to.
So let's get those numbers down.
Let's imagine you've got $100,000 to buy the property, $60,000 to renovate it. So you're all in for $160,000. And when you're done, the property is worth $200,000.
Now, in a perfect world, if you sell this and there's no fees or taxes involved, you'd make $40,000.
Your $200,000 ARV minus the $160,0000 that you put into it, you've got $40K left over.
So the first thing we want to do so that we understand how cash deals are different from the other methods we're going to talk about is calculate our return on investment, or what you could call your ROI.
What you want to do is take the amount of money that you're going to make from this property. If it's a flip and you're selling it, you take the amount you make on the sale.
And if it's a rental property, you take the amount that you make in cash flow per year.
So for now, let's just focus on that $40,000 as us selling the property.
So we take that 40 grand, and to get our ROI, we divide it by the amount of money we put into the deal. So in this case, that would be the $40,000 profit divided by the $160,000 we spent to purchase the property into to renovate it.
And that equals 0.25 or a 25% return on investment.
That's really not a bad investment. Most people say the stock market returns somewhere around 7% per year.
So 25%, that's a really good flip.
You make 40 grand.
Now, of course, you're going to pay taxes and closing costs and stuff on that, but. But for now, let's ignore all that stuff. And obviously coming out of pocket $160,000 in cash is not realistic for most people.
Funding Strategy #2: Conventional Mortgage Loan
So another thing that you could do is instead of paying 100% of the cost out of pocket cash, you could go to a bank and get a mortgage loan for this property.
And let's say you put down 20% and have the bank put down the rest of that 80%.
So this means on that purchase price of $100,000, you put down 20%, which is 20 grand. And then you take a loan from the bank for $80,000.
Now, you still have to pay $60,000 to renovate the property.
So you get 20% down, the 80% mortgage loan, and then you put another $60,000 into the deal.
So you've got 80 grand yourself in and 80 grand from the bank in.
Now, an $80,000 mortgage from the bank at a 4% interest rate, is going to cost you somewhere around $550 a month or $3,300 for a six month project.
When you sell, you'll still make the same $40,000. But this time your numbers are going to look a little bit different. So let's break it down. You sell and make that 40 grand.
Remember, you had $3,300 of mortgage costs involved, so you'll actually come out with $36,700, ignoring stuff like the capital gains taxes and closing costs.
And this time you didn't put 160 grand into the deal. You put 80 grand into the deal and borrowed 80 grand from the bank. So you take that $36,700 you made and divide it by the $80,000 that you put into the deal.
That gives you a 0.458 return or a 45.8% return, which is a lot higher than that 25% because you leverage the bank's debt to give yourself a higher return even though you made $3,300 less than you would have if you put 160 grand of your own money into the deal.
We won't go too much into the concept of leverage in this video, but this is a perfect example of why people say that real estate investing, and particularly borrowing money to invest in real estate, is good debt.
Paying that $3,300 in mortgage cost takes your 25% return to a 46% return. It also means that instead of needing $160,000 of your own money to do this, you only need $80,000 of your own money to do this. So you can see that leverage is super helpful.
Funding Strategy #3: Hard Money Lender
Most people probably also don't have 80 grand sitting around. So let's go on to the next method, which is using a hard money lender. Hard money lenders are companies that work almost exclusively with real estate investors to purchase distressed properties.
Where a bank will give you a long-term low-interest loan, a hard money lender is going to give you a short-term high-interest loan.
So for our last example, we said that the bank is going to give you a 30-year mortgage at 4%.
A hard money lender is going to give you a six-month mortgage at 12%.
So at first, it doesn't make sense why anyone would use a hard money loan because they are way more expensive and you have a time crunch for how soon you have to get your project done.
But the benefit is they're created for real estate investors to get a higher return and they give you more flexibility in the strategies that you want to use.
First, let's talk about the numbers. Then we'll talk about the different strategies that you can use with a hard money loan.
Similar to a bank, a hard money lender will give you about 80% of the purchase price you need to get a property.
So, same deal, you put down about $20,000 to purchase this $100,000 property. But unlike a lot of banks, most hard money lenders will also fund 80% to 100% of the renovation costs for your project as well.
One of the properties that I'm flipping this summer is being funded by a local hard money lender who's lending me 80% of the purchase price that I need and 100% of the money I need to rehab the loan.
So for our example on this $100,000 house, that means that you only have to pay $20,000 at closing to buy this $100,000 house and then you'll also be getting $60,000 additionally lent to you by the hard money lender to do the renovation.
Before we get more into the numbers, I'll just pause here and say that this is why I'm so glad I started wholesaling first, because wholesaling is a very low risk way of getting involved in real estate investing.
I find the property, I hand it off to an investor for a fee, and I get to learn so much about that process.
But if after I hand that deal off to the investor, the roof collapses or they find something wrong with the plumbing, that's not on me, because I've already sold that property.
So it's very low risk.
But many wholesalers, myself included, are making $5,000 to $20,000 per deal.
So just a couple of wholesale deals can get you not only the experience and connections you need, but also the money so that you can make your down payment and then use something like a hard money lender to fund 80% of the purchase price and up to 100% of the rehab you need.
Back to our example.
The hard money lender is going to give us most of the money we need to get this project done. But they usually charge 10-12% interest, plus one to two percentage points in fees.
For example, say they're lending us $80,000 for the purchase, and $60,000 for the renovation, so a total of $140,000 at 12% interest.
So that's $16,800 a year, which is $1,400 a month. And if this deal takes us six months to complete, that's $8,400 that we're going to pay to the hard money lender to get the deal done.
But remember, we also have to pay them two percentage points, which is basically an upfront fee for them to lend us this money. So that $140,000 that they're lending us, we take 2% of that.
That's $2,800 on top of the $8,400 we're gonna pay them in interest. Ouch.
But we can't stop there. What does this mean for our return on investment?
Let's say we sell for $200,000, so we've got a profit of $40,000, but we have to pay back that $8,400 of interest.
So that puts us at $31,600. Then we also have to pay our two points, which was $2,800.
So now, out of that $40,000 sale, after we pay our hard money fees, we're left with $28,800, but we only had to put $20,000 in.
So we take that $28,800 that we make, divide it by just the $20,000 we had to put in because the hard money lender lent us the rest, and that gives us a 1.44 or 144% return on investment.
With this one deal, we've made more than we actually had to put into the deal, that 12% doesn't seem so bad, right?
To compare it to our original all cash deal where we made $40,000 but had to put in $160 thousand, versus this case, we made less.
We made $28,800, but we only had to put in 20 grand. Which one seems more realistic for most people?
To take it a step further, using a hard money lender lets you use something called the BRRRR method, which is something I talked more in depth.
The basic idea is that instead of using bank financing to purchase the distressed property and then renovate it, you use a hard money loan to purchase the distressed property and renovate it.
And then when you're done, you don't sell the property. Instead, you now get bank financing. Use the hard money loan first, and then you go to the bank and ask for something called a cash out refinance so that you can take the bank's money and pay off your short-term hard money loan.
And now you have that long-term, low-interest rate, 30 year mortgage. You rent out the property. The rent from the property covers that mortgage. You've paid off your hard money loan and now you're cash flowing each month.
That might sound a little complicated.
But to keep on track with the methods that you can use to fund your deals, we've talked about cash, which is maybe not that realistic.
Conventional loans.
Hard money, which is made for real estate investors to purchase distressed properties.
So once you have a few wholesale deals under your belt, you've got some experience and some capital to put down on the property, it's not that hard to find a hard money lender to work with you. That's what they do.
Funding Strategy #4: Private Money Lender
This next method gets even better: working with a private money lender.
Whereas a hard money loan comes from a company that works with investors, a private money loan comes from a wealthy individual.
You might think these people are hard to find, and I did too. But when I started out wholesaling, I found that I was making so many connections with local investors that they could also connect me with their private money lenders.
And some of the investors that you're going to be selling deals to also do private lending as well, because it's a way to stay involved in real estate investing that's not as active as actually being out there making all of the decisions.
They can just loan the money to you.
You go do the rehab and they still get paid in the form of interest.
Two of my purchases this summer are being funded by a private money loan from a person that I met during my house hacking and wholesaling journey, stayed in contact with, and built a relationship with.
Since private money loans are between two individuals and not necessarily official companies, the terms of those loans are completely negotiable and up to the people involved.
A standard agreement might be something like 10% interest with no fees or points.
So for our example, let's say the private money lender will fund the same amount as the hard money lender: 80% of the purchase and 100% of the rehab, or $140,000.
So we're paying 10% on that $140,000, which is $14,000 a year, or $1,167 a month.
And for the length of our six month project, we're going to pay $7,000 in interest.
So when we sell the property for $200,000, we pay back our hard money lender the $140,000, we pay back ourselves the $20,000, and we've got 40 grand left over.
But we still have to pay the hard money lender back their interest. So we subtract $7,000. We've made a $33,000 profit to get our return. We divide that profit by the $20,000 we had to put into the deal, and that gives us a 1.65 or 165% return on investment.
That's even better than the 144% return we got with the hard money lender because generally, private money loans don't have as many fees and points attached.
That's why private money is generally referred to as "cheap money."
And if you can build relationships with the investors and lenders in your market, private money is going to save you a lot and help help you get a higher return on your deals.
Funding Strategy #5: The BRRRR Method
Now, this method is the one that I'm really excited to talk to you about. So if you've stuck with me this whole way, this is a true treat because it's something that I did not learn until very, very recently.
When I first started learning about real estate investing four or five years ago, I thought that residential loans were for properties one to four units (such as house hacking using an FHA loan for a triplex or a fourplex).
I thought that anything above five units was going to be a commercial loan, and I was like, I can't even think about that yet. I'm still at this level, let me think about my options with residential loans.
And that's what we talked about earlier, putting 20% down.
If we don't want to go that route, we could talk to a hard money lender or a private money lender.
But I recently found out about a commercial loan that is made for the BRRRR method.
And remember, BRRRR-ing means that we're not going to sell the property at the end of the renovation. We're going to rent it out and do something called a cash out refinance. So keep that in mind.
But generally, these commercial loans will still fund the same amount as our hard money in our private money lender, 80% of the purchase and 100% of the renovation.
So we still put in the same 20% to purchase the property.
But here's where things differ.
The commercial loan is set up as a six-month interest-only period while you're renovating the property.
And then it automatically converts to a long-term, low-interest rate mortgage that you would typically get when you go to the bank to buy a property.
But the interest rate is the same that entire time.
So let's break it down because I think this is pretty cool.
We're borrowing that same $140,000 that we got from the hard money lender and from the private money lender.
But this time, it's at the same interest rate as our eventual long-term mortgage. Let's call it four and a half percent. So instead of 10% with private money, 12% with hard money, we've got 4.5% with our commercial loan.
And four and a half percent on that $140,000 loan is $6,300 a year, or $525 a month. And for the six-month period of our project it's $3,150.
And remember, instead of selling this property for $200,000 and making 40 grand, the bank is going to send out an appraiser and hopefully say that the property is worth that $200,000.
Now, in this case, the bank usually gives you 80% plus fees. So that means that of the $200,000, they're going to give us 80% of that in what's called a cash out refinance.
So 80% of $200,000 is $160,000. We borrowed $140,000 during that six-month interest-only period. So we pay that back, and we pay ourselves back for the $20,000 of our own money from the down payment.
That's done with.
Plus, we've now got the $3,150 of fees that we have in interest. We also get that back because it's generally 80% plus fees covered by the bank.
And so now we have an infinite return. What do I mean by that?
Here's how the infinite return works. The bank looked at the property. It's worth $200,000. They give us 80% of that in the form of a cash out refinance.
So we get that 160 grand to pay off the short term money. That $160,000 cash out now becomes the amount of our mortgage to payback back over the next 30 years. And so that mortgage payment will be somewhere around $1,000 a month.
Let's say we rent out the property for $1,500 a month. Now, we have a cash flowing rental property.
We can still set aside $200 or so a month for future vacancy or repairs. So now we have a cash flowing rental property that's paying off our mortgage, making us, let's say, $300 a month or $3,600 a year.
And $3,600 might at first be like, well, I could have been making, you know, 40 grand if I sold it, but $3,600 a year divided by what we have left in the deal, which remember, is zero.
When we got out our cash out refinance, it was 160 grand. We paid back the 140 grand we took as a short term loan from the bank, and we paid back ourselves the 20 grand that we put in as a down payment.
So what is our investment left in the deal? Zero.
I remember from math class that you cannot divide by zero. And so in this case, that cash flow we're making every year is an infinite return because we have none of our money left in the deal.
And once you really get into all this stuff, you'll find that there's some really cool ways to combine some of these methods.
You can use a hard money loan or commercial funding to pay most of the money you need to purchase and renovate the property.
And then you could take a small private loan to pay the down payment portion you need. And that's why people are able to get 100% funding, because they're combining different creative strategies.
But you've got to know about them first, and you've got to work the math out so that you understand how leverage works and how these returns are working.
The options truly are endless.
It is 100% possible, and that's what I hope this blog post is showing you guys. I'm giving you everything.
I'm just showing you what I'm doing and how I'm putting these pieces together from house hacking, to wholesaling, to now renovating and BRRRR-ing properties.
Because you can figure it out and you can make it happen. But it's not easy.
START YOUR REAL ESTATE INVESTING JOURNEY TODAY!
So, now that you've gotten an intro to house flipping, are you ready to start?
If so, you can use my Free Resource Pack to help get your real estate investing journey off the ground. It includes:
- My Offer Sheet Template
- My Phone Scripts for Calling Real Estate Agents
- The Wholesaling Deal Tracker
So what are you waiting for?
Start your real estate investing journey towards financial freedom today!
