When investing in a luxury item, say a vintage 1954 Rolex Submariner with a few dings and scratches, you're thinking of how much value it's going to have once it has been restored to its former glory.
The same thing goes when you're scouting for an investment property.
You're not really looking at how it appears right now. In fact, the uglier the property, the healthier the profit margins! With your vision, you can transform it into a rental that could generate revenue for years to come, or resell it for a higher price!
However, unless you have substantial cash reserves, chances are you're going to need financing. The challenge is finding a lender who will provide financing for both the acquisition and the renovation. Fixer uppers are a riskier prospect for the lender compared to move-in ready homes, as in the event of default, they'll be stuck with a property that they can't sell, and worse, one that needs costly repairs before they are able to unload them.
Enter hard money lenders: unlike other lenders where you have to provide a ton of documentation and where your approval is contingent on your credit score (among several factors), the loan they provide is simply secured by the property that you're buying and its after repair value. In other words, an ARV loan.
In this article, we're going to walk you through hard money loans and why they are a financing option of choice for many house flippers.
Hard money loans, also known as bridge loans, are an innovative financing tool that provides investors with instant cash that would allow them to grab real estate opportunities as they come. Hard money loans come with a lot of benefits for real estate investors looking to flip properties and then resell them within a year or so, among them:
Most hard money lenders offer interest only loans. This results in lower and manageable monthly payments for the borrower, with the principal only needing to be paid at an agreed-upon date in the future, usually once the flipped property has been sold.
In contrast to traditional lenders where you have to wait for weeks or months before you get approved, hard money lenders can give you the funding you need in just a matter of days. In real estate investing, time is always of the essence, so lenders who can provide lightning-fast funding are favored by aggressive investors.
In obtaining hard money loans, your personal credit doesn't matter as much as the profitability of the deal itself. Since the loan is secured by the property being purchased, you don't have to undergo credit checks and submit a ton of financial documents to increase your chances of getting approved.
The only drawback is that hard money loans generally cost more, owing to higher interest rates, and a lower loan to value ratio. However, this higher cost is generally offset by paying the loan amount off very quickly--usually in less than three years.
The loan to value ratio (LTV) determines the maximum loan amount you can get based on the current value of the property you are pledging as a collateral. In the case of hard money loans, LTV ratios range between 50-75%, versus 80% for regular mortgages.
Fortunately, experienced house flippers can get higher LTVs, so just work on earning your stripes in the real estate market!
The After Repair Value (ARV) is the property value after repairs, upgrades, and renovations have been made. Simply put, the ARV formula goes like this:
After Repair Value (ARV) = Property's Purchase Price + Value gained from the Renovation Process
Do note that the price you paid isn't necessarily equal to the property's current value. Similarly, the repair costs isn't the same as the value it adds, as you'll see below:
Calculating ARV is simply getting the property's current value and then adding the repair value. That should provide you with a nice rough estimate.
However, if you're looking to get a more nuanced answer so you don't accidentally pass up a worthwhile investment property, you can do the following:
Before you sign the purchase agreement, the first thing you should do is schedule an inspection. This would give you a clear snapshot of the property's condition: exactly the amount of work it needs and how much you'd likely spend in its restoration.
After the inspection, you must then get the appraised value to have a starting point in calculating the financial benefit of such an undertaking. You can either spend a few hundred dollars by hiring a professional appraiser, or you can...
To establish the current value of the property you're eyeing, you can evaluate it against real estate comps in a comparative market analysis (CMA). Comps are similar properties in the same neighborhood, which means these are properties with roughly the same square footage, features, age, architectural style, and condition.
Comps can easily be found on the multiple listing service, which can be accessed if you're working with a real estate agent, but if you'd like to save on realtor commissions, you can totally DIY this process!
To get a reliable estimated value from your CMA, it is recommended to look at around 5 comps recently sold nearby and get their average purchase price. Once you complete the upgrades on your fix and flip property, you could probably sell it at around the same price.
The inspection report would tell you what needs to be done to improve for property's current state. It also gives you an idea regarding future repairs. You can then shop around for contractors and get quotes from them.
And since you're flipping houses, you definitely want to get the most bang for your buck. Therefore, focus on repairs and upgrades that can add to your property value.
Upgrades with high returns include:
Add a home office: hybrid office setups are commonplace in the post-pandemic world. Converting one of the bedrooms into a home office can definitely attract working professionals looking for their new home, and doing so adds around $10,000 to the property's market value.
Replace the garage door: Not only does it boost your curb appeal and makes it stand out in the neighborhood, it adds an average of $3,000 to the estimated value. And since garage doors usually cost around $1,200, that investment has a stunning 133% return!
Revamp your façade by giving it a fresh coat of paint: Repainting your whole exterior not only makes your house look like new, it adds about $7,000 in resale value!
Consider an open plan layout: If Pinterest boards are anything to go by, an open floor layout is really trendy! Knocking down the walls not only gives your interiors an airy feel, your house can sell for 15% more than its comparable properties.
No matter how diligent you are in preparing everything beforehand, planned repairs rarely happen as they were set out to be. More often than not, issues are uncovered while the renovation plan is being carried out, driving up the total cost of repairs.
So, in order to avoid cost overruns and to give you some wiggle room as a real estate investor, the 70% rule of real estate is there to ensure profitability on your investments.
Basically, this rule sets a cap on the maximum amount you have to spend in acquiring the property: in this case, 70% of the After Repair value (ARV) net of repairs. This gives a price that is lower than the market value, but still competitive and acceptable enough for the seller.
For instance, if the estimated ARV of a certain fixer upper is $250,000 and repairs amount to $50,000, the purchase price should be $140,000 at most (70% of $200,000). The anticipated ARV would net you around $60,000 in profits less closing and other costs associated with the sale, as well as other monies owed to your lender which largely depends on the interest rate.
To help you find the best lender fit for your needs, we sifted through plenty of hard money lenders so you don't have to.
Check them out below:
If you're a borrower plagued with bad credit, it can be extremely difficult to get financing.
Fret not, as CoreVest is a rare breed of lender that doesn't look at your credit score. Instead, they place emphasis on the profitability of a deal. Loan amounts range from $75,000 to $5 million at rates starting from 8%.
Interest only payments can be made for up to 24 months with the lump sum payment thereafter, although extensions can be negotiated.
Funding can take up to 21 days, and CoreVest recommends that you have at least 3 completed flips for higher chances of getting approved.
If you're a newbie looking to break into the scene, Kiavi offers a wide range of products to help get you started.
With a credit score of 660 or better, the amount you can loan starts at $75,000 up to $1.5 million, and you can choose from 12-, 18-, and 24-month interest only loan terms.
They can finance up to 90% of the property price and up to 75% ARV. Kiavi offers the highest loan to ARV ratio, as other providers max out at 70% ARV.
Closing time is relatively quick too, as you can get funding within 10 days.
With rates starting at 6.5%, Groundfloor has one of the friendliest offerings in the market.
They can give you 80-100% of the purchase price and up to 75% in ARV, depending on your credit score. No prior investing experience is required, but they do have upfront fees, which include:
In a competitive housing market, you have to act fast or else risk losing a deal. New Silver caters to aggressive investors, extending loans ranging from $100,000 to $5 million in as little as 5 business days! Their process is fully online and you can instantly get proof of funds letter so you can quickly seal the deal.
Interest rates range from 10-12.5%, with loan terms up to 24 months.
A minimum credit score of 650 is required, and you have to pay an origination fee of 1.875% of the principal.
That's not the case with Do Hard Money.
They offer loans with little to no down payment, allowing you to get 100% funding for purchase and rehab as long as you have a minimum credit score of 660.
They have flexible terms of 5-12 months for properties with a minimum after repair value of $70,000.
Whether you're an experienced investor or a first-timer looking to get your feet wet in the field of real estate investing, getting an accurate ARV estimate for a property you're buying is essential. Calculating ARV shows whether the investment can provide a worthwhile financial gain for the amount of work and money you're required to put in.
To finance the work required, hard money lenders can be an indispensable partner. Although rates and fees tend to be higher, the convenience and ease of funding access offsets this many times over.
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