I have had a lot of questions lately about the ARV calculations when looking at investment properties. Specifically, why do we only go up to 65% of ARV? If you have not already done so, take a look at the previous post, “It Can’t Make Dollars if it Don’t Make Sense.” for a primer on ARV calculations.

There are a lot of reasons that the 65% rule makes sense for investors. The first, and most obvious, is that if you are able to get full ARV, you have made a tidy profit on your deal. At the end of the day, that is a goal for all investors or we wouldn’t be doing this. We want you to make money and succeed. If you are making profits, then you are doing more deals. If you are doing more deals, hopefully you are bringing them to us, and we are doing more deals. A rising tide carries all boats.

More to the point though, we look for this spread to account for all the things that new investors typically forget to roll into a deal. There are a lot of hidden costs, or at least costs that are easily overlooked. These nickels and dimes can add up to big numbers if you are not paying attention. So, let’s look at a few of these costs and how they relate to real profits.

File Fees and Closing Costs: You should always budget roughly $1500 for up-front fees on a file. Those fees cover things like AVM, processing, credit check, appraisal etc. Then, there are normal closing costs, which will run about 5% of the total loan amount. Closing costs will vary from place to place, so make sure you look into the typical costs in your area. For our calculations, I am using 5%

Points: Most hard money lenders charge points on their loans. I figure roughly 5 points as a baseline. As you work through the process, you will get a firm number through underwriting. But initially, calculate 5 points to be safe.

Realtor Commissions: Unless you are selling your property by-owner, you will have a realtor involved. I suggest finding a good realtor to work with, who can be on your team to help resell your home. A good realtor can make all the difference in reselling your home quickly. The industry standard for realtor commissions is 6% of the selling price. Sometimes this can be negotiated, but don’t count on it.

Utilities: While workers are getting your home ready to resell, they will need power at a minimum. Most likely gas and water as well. You can check with the utility providers to determine an average bill on the home so that you know what to plan for. I usually budget $200/month to be on the safe side. Also, you will need to have everything in working order to show the house. Prospective buyers will check the lights, water, and ventilation to make sure everything is working properly.

Rehab Over-runs: You may have budgeted for general rehab. However it seems there is always something that is overlooked, runs over budget, or breaks and needs repair before you can sell. The old adage of nothing getting done on-time or under-budget has been around for years, and with good reason. I suggest adding 10% to the rehab budget just to be on the safe side.

Loan Payments: While work is being done, and your home is awaiting a new owner, you are making loan payments. Most hard-money loans are interest-only payments through the term of the loan. Calculate your loan payments, and plan for making six of them. If you sell faster, you have made fewer payments and you get a better return than expected. I always plan for the worst, and then hope all surprises are pleasant ones.

Insurance: You will need to carry liability insurance on your property, especially during the remodeling process. If a worker is injured on your property, you could be liable. Better to have it and not need it, than need it and not have it. Plan on about $100/month. That is a high estimate, based on generalities. Insurance agents in your area can give you exact rates.

Permits and Licenses: Are you doing any work that requires a permit? If you use a general contractor, they can usually advise you. Most will include the cost of permits in their estimate. However, make sure before you get started. Permits are not a lot of money, but everything adds up.

HOA Fees: If your home is in an area that is part of an HOA, you will have to pay those dues while you are awaiting a buyer. HOA dues can have a huge swing, so verify this before hand. I have seen HOA fees at as little as $60/year, and reaching into the hundreds of dollars every month. Plus, if this was an REO or short sale, the previous owners may have back-dues to the HOA. Those fees become your responsibility.

Marketing: Sometimes you have to pay extra to market your home aggressively. Ads in real estate publications and newspapers can help, but as with all the other things, this can add up. Budget $100/month to be on the safe side.

So keeping these things in mind, let’s run through a practice scenario. I am a big fan of easy math, so I am going to use some round numbers to provide an example.

Let’s say you are buying a home with an ARV of $100,000. You learned your lesson, so you ran through the numbers first to make sure it was a solid project, and the numbers made sense. You got a great deal at $50.000, and it needs about $15,000 in rehab. That puts you right at 65% ARV, and you stand to make $35,000 profit. KaChing!

But let’s make sure:

Purchase Price $50,000
Rehab Estimate $15,000
File Fees $ 1,500
Closing Costs (est. 5% of loan) $ 3,250
Points (est. 5 pts) $ 3,250
Realtor Commission (plan 6% of sale price) $ 6,000
Utilities (6mo @ $200 / mo.) $ 1,200
Rehab Over-run Contingency $ 1,500
Loan Payments (est. 6mo @ $800/mo) $ 4,800
Insurance $ 600
Permits $ 200
HOA Fees $ 400
Marketing $ 600

TOTAL COST $88,300

PROFIT IF SOLD @ $100,000 =  $11,700

As you can see, the $35,000 bonanza we expected wound up being less than 1/3 of that. Plus, if the home was having a hard time moving, so you discounted it, you ate into that margin even more.

Granted, I figured on paying for a lot of things you may not. However, it’s better to think about all these potential expenses and allocate for them, than to be surprised later on.

Now you can see why we look for that 65% or better ARV deal. We want to protect your profits, and make sure that you are investing wisely. If we do our jobs right, you should be working on deals that make financial sense, and begin growing your real estate business. We all want the same thing here: For you to succeed.

With that said, all of these things may not apply to your specific circumstance. But of all the extra costs that can crop up, these are the ones that novice investors tend to most frequently overlook. It could be that you have only one or two of these items. But as I have said a few times – you have to mind the pennies, and the dollars will take care of themselves.

Thanks for checking in with us. If you have suggestions for more articles you would like to see, be sure to let us know.

Good luck and happy hunting!

What is a Hard Money Real Estate Loan?

A hard money real estate loan is a loan that is usually acquired through a private party. Because these are private loans, it is generally easier for an individual to qualify. Loan decisions are heavily-weighted on the property, its collateral or value, and the borrower’s exit strategy. These loans are appealing to private investors as they will carry a higher interest payment than what a traditional bank loan charges.

These loans are typically short-term; six months to a year for a resale property, and up to five years for a long-term rental project. Loans usually cover the acquisition of property as well as the costs to make it ready for the retail market.

Current Market Conditions:

Recent dynamic changes in the marketplace have prompted investors to seek new investment avenues. For many investors, the stock market offers troubled waters for a hard-fought nest egg. Traditional savings accounts, CD’s and bonds don’t offer the returns many need to grow their funds sufficiently to provide for them after retirement. This has lead many to look to other markets, such as real estate.

Right now, with foreclosures at an all-time high, real estate investors are finding opportunities like never before. These investors seek out properties the may be acquired through bank REO’s, tax lien sales, short sales and pre-foreclosure direct sales. By purchasing properties this way, the investors are able to buy significantly below fair-market value. They will then remodel and repair as needed and either resell the property for a profit, or convert it to a long-term rental.

But, what if you are in an area where these properties are not readily available, or a good investment? What if the properties are available, but you do not want to take on the project of finding, repairing and reselling? Can you still profit in this market? Yes.

Often, investors who undertake these projects typically have few options when it comes to funding the purchase and cost of the remodel. They can use their own cash, which drastically limits the number and scope of investments available. Conventional bank financing is typically not an option of properties that are not move-in ready. So, many of these investors seek out a hard money lender.

How You Can Capitalize On This Scenario:

If you want to take advantage of this real estate market, you are able to offer your funds via a hard money lender to finance these projects. In doing so, you are able to receive a high rate of interest, typically from 8-18%, and determine the length of the time you would like to invest. Usually short-term loans (six months) will demand higher interest. While a longer-term loan may have a lower rate, but longer, steady returns. Your loan is backed and secured by the subject property.

First, you will typically earn a higher rate of return on your investment than through traditional means. Rather than leave your money in a low-return savings account, you are able to ask for higher rates and make your money work smarter for you. As mentioned earlier, hard money loans typically return 8-18% depending on the amount of the loan and term of the loan.

Second, you are able to take advantage of a growing real estate investment market, without having to do all the hard work. There are thousands of investors who are able to find, plan and execute these projects – but they need backing. By providing that backing, you are able to profit from someone else’s expertise and ground-work. They are happy to have the funding, and will pay a premium rate for it

Loan amounts are often restricted to, and determined by, a percentage of the home’s after-repair value (ARV). Most purchases are structured at 65% – 75% of the home’s ARV. By only lending up to 65% – 75% of the ARV (depending on the structure of the deal), there is enough profit to allow for the borrower to resell the home. If necessary, he is able to reduce the price for a quick-sale to repay the loan, and move the house, and still make a profit.

You are able to take advantage of investment opportunities outside your geographic area. There may be some incredible opportunities in Florida, but you are in Montana. By using a hard money lender to find investments for you, you are able to profit by investing in hot markets no matter where you are.

You are able to choose projects that fit your comfort level. If you want faster returns, you can request only short-term rehab/resale projects. If you prefer longer-term investments, you can only back those projects. By working with a hard money lender to place your investment, you are able to select only those projects that appeal to you.

Why Use A Hard Money Lender For This Process:

A hard money lender will have established procedures and processes in place to evaluate every deal. There are several steps to the process to ensure that every project has the best chance of success. The lender will also underwrite each file or property and check the viability of the real estate investor purchasing and remodeling the property. Deals that do not pass the lender’s strict guidelines will be rejected. You are assured that when a deal is presented for your consideration it has been thoroughly reviewed.

Some Of The Things The Hard Money Lender Will Look For Include:

• Comparable Sales (comps) – properties similar in age and design to the subject property. These comps must be within a small geographic radius, and have been recently sold. In looking at these comps, the lender is able to determine approximately what the property will be worth, at retail, upon completion (ARV). The lender will calculate the maximum amount of the loan based on an average of these comps.
• Qualified Rehab Estimates – The lender will request a detailed estimate from a licensed contractor, specifying the nature and expense of repairs needed to the home. Some homes only need cosmetic work such as carpet, landscaping and paint. Some will need more extensive repairs.
• Exit Strategy – the lender will need to know how and when the borrower will have the loan completely repaid. For most projects, the exit strategy will be to repair the home and have it back on the market as soon as possible. For some, the borrower will complete the repairs, and then take out conventional financing to ‘cash out’ the hard money loan.
• Stability of the Borrower – the lender will verify that the borrower has the ability to make the payments on the loan. The borrower will usually need to have some money in reserve to support the payments. The lender may also check credit to verify that the borrower has no federal tax liens or encumbrances that may attach to real property. Borrowers who do not meet specific guidelines may have to come to the investment with a higher down payment, or may secure an investment partner to back the project along with them.

Once a project has been reviewed and initially accepted, it will be sent through underwriting. In the underwriting process, all information is thoroughly checked and verified again. An appraisal of the property will usually be ordered to verify the value of the property (ARV). The purchase is always transacted through a title company, attorney or closing agent.

Lenders usually have an established base of clients with verified, viable projects. By having this base, you will have multiple opportunities to invest. This means a greater variety, of projects and potential returns. You are not limited by your geography or experience level.
The lender will also have contingencies in place should problems arise. If a project stalls, or the borrower in unable to complete, the lender will have people in place to assume and complete the home. The lender will be in contact with the borrower to verify the progress of the project, and step in when necessary to see that it is completed.

In Summary:

By working with a hard money lender, your investment dollars are collateralized by real estate. Should the project stall for any reason, the hard money lender will often step in and take over the project. They will either complete the repairs and resell, or offer the property to another investor as-is. Either way, it is in their best interest to assume the project, get it off the books, and repay your loan.

A good hard money lender will also put several filters or levels of assurance in place to protect the property, and your investment. Some things to look for include:

• Loans which are secured by a first mortgage or trust deed;
• Third party independent appraisals are ordered to ensure credibility of anticipated ARV;
• Experience and qualification of contractors are validated;
• Title insurance is bought, and paid for by the borrower, to protect against defective title;
• Casualty insurance is bought in the name of the lender or investor, and paid for by the borrower;
• Promissory note and mortgage are, or if a purchase with a lease, prepared by an attorney;
• Investor funds are under the control of a title company;
• Investors have access to the borrowers’ file by providing written request;

If you want to utilize this method of investing in real estate, look for a lender who thoroughly investigates every project. The lender should have a depth and breadth of experience to recognize potential trouble areas, and potential opportunities that may otherwise go overlooked. The lender should have a system in place that protects your investment, and plans for every possible contingency.

To learn more about investing in real estate with a hard money lender, please contact me for a personal discussion. I will be happy to discuss our opportunities, your goals, and the best ways to bring them together.

Edy Eddins – Business Development Manager
Blazevic Funding Group
7579 E. Main St, suite 200
Scottsdale, AZ 85251
775-825-2121
Edy.eddins@gmail.com

“Going Green” – it’s the popular term of our times, and one you should be aware of. Consumers are looking for more and more green products; whether it’s because they are environmentally conscious, or just looking for ways to trim their power bills. Savvy real estate investors know this, and can take advantage of programs to “Go Green” without increasing their rehab budgets.

Jim Simcoe of Simcoe Consulting works with these investors. I have come across many green consultants, but I was surprised by the investor-friendly approach Jim takes to his business. His approach shows investors how to turn their rehab projects into green projects without increasing the budget, which is good news. The better news is that when the project is complete, the homes typically appraise 10-15% higher, and generate higher cash flow as rentals.

For most investors, the decision to go green is uncharted territory. Its not that they don’t want to turn their projects green; rather it is a matter of educating, and shifting the thought process slightly. For example, if you have to replace a hot water heater, it’s a matter of knowing which one to buy. Things you would normally replace in a rehab have green alternatives that can actually make you money in the long run. According to Jim, it can be as simple as installing rubber gaskets behind wall sockets and light switches to prevent air flow, thereby reducing heating and cooling bills.

And it’s not just about your cost on the rehab. A detailed, documented green plan on your rehab is a valuable selling tool. Make sure to keep records of every green item installed, and show the buyer how your home will actually have a lower power bill than the one across the street. Show them that they are moving into a home with environmentally-friendly carpet, paint, and appliances for a healthier lifestyle. And, to make it even sweeter, new appraisal guidelines for green houses mean that your home will actually show a10-15% increase in value.

If your project is a rental, you will be able to get higher monthly rent on a green home as opposed to one that is not. By showing renters their savings in power and water bills, you are able to ask for a slightly higher rent. For example, let’s say your home would normally rent at $1000/month, but have a $200/month power bill. However, your home is green now. So that power bill may only be $75 per month. You can increase the rent to $1100, getting you better cash flow. The renter is paying $25 per month less, but your cash flow has increased by $100. Plus, they have the peace of mind to know that their home is a less toxic environment for their family.

Can it get any better than that? Why, yes. Yes it can.

Green projects qualify for numerous rebates, incentives and tax credits. Knowing how and where to apply for these programs can actually save you money on the total rehab as well. Jim points out the example of buying a hot water heater that may cost slightly more on the purchase. However, due to multiple government programs, after rebates the hot water heater is actually a fraction of the cost of other alternatives.

Now how cool is that? Your rehab budget stays about the same. Your home appraises higher. Rents increase. Utility bills decrease. The project is environmentally conscious. And to top it all off, rebates and incentives bring the total cost down.

Jim was kind enough to forward me a case study of a green project he completed in Michigan. The results are impressive, and prompted me to start thinking green when looking at rehab projects.

If you would like a copy of this case study, let me know. I will be happy to email it to anyone who is interested. Email me at edy.eddins@gmail.com or contact Jim Simcoe at Simcoe Consulting (760.271.7128 or jim@jimsimcoe.com)

So there you have it friends. Going green is making a lot more sense these days. As long as you are doing a rehab on a project any way, look at it from a green alternative. You will find that it’s just as easy, and can net better results when completed.

A phenomenon I have noticed with new investors is the almost feverish desire to jump into a high-dollar property as their first rehab/resale project. I have had many people call me, new to this business, because they found a “great deal” on a high-dollar home. Many have only limited experience, and for some this would be their very first project. But is that “great deal” really a good idea?

One thing I often promote is the value of staying in the shallow end of the pool. I encourage investors to work on projects in the low- to middle-price strata for their area, and only get into a high-dollar home after they have had a lot of experience, and built up the reserves to manage a bigger project. In my never-to-be-humble opinion, I believe there is a lot more potential in the smaller projects than the bigger ones for a number of reasons.

As a side note, when I refer to lower-end homes, I am not referring to the run down homes in the less than desirable neighborhoods. I am referring to homes that are affordable to the middle class for your area, in good neighborhoods. Sure, there are buys in the low income sections, but most of the time these would be better converted to rentals, not flips.

First, there are a lot more buyers in the lower end than the top-end. Looking purely at demographics, there are a lot more people able to buy in the middle to low price as compared to the high price. Therefore, in most markets, you are able to make a faster flip on the project, and move on to the next investment.

Homes in this sector usually do not take as long to rehab as the higher end properties. For example, let’s think about a 1500sf. project as compared to a 4000sf project. When it comes time for flooring, which one is completed faster? How long will it take to paint the small house as compared to the larger one? How much time will be spent with contractors making the small project ready, as compared to the larger one? Generally speaking, the smaller projects can be done much faster than the newer ones, and back on market a lot quicker. This means a faster return on your investment and the opportunity to move on to the next project.

Buyer expectations on the lower end properties are lower than the buyers of the upper tier. I am not suggesting shortcutting the process or using cheap materials by any means. I am, however, saying that buyers of high end properties expect high-end amenities. The appliances you put in a $150k home would not be acceptable to the buyer of a $1M home. Stock cabinets are just fine in a cheaper home, while the more expensive home should have better cabinetry. Flooring, moldings, even the faucets and doorknobs are expected to be better than you would find in the lower end homes. And they should be. Therefore buyers in that higher strata expect a lot more, notice more, and will be a lot pickier than your lower strata buyers.

You will have a lot more expenses, and headaches, with the expensive property too. Sure, if you buy right the rehab costs are included in the loan, so that part is covered. But there are a lot of expenses that you will need to pay out of pocket. You will need insurance on the property while it is in rehab. You will need to cover electricity and water for the home while the workers are getting it ready. Unforeseen problems can crop up on either project, but the potential for more, and costlier, problems is greater on the bigger and more expensive home.

Then there’s the loan payments. You will need to cover the monthly loan payments until the home is sold. Obviously that payment is much higher on a $1M than a $100k home. And, since the more expensive home will typically be on market longer, that means more cash going out every month. No thanks!

Lastly, if you are looking at one of these high-dollar homes as a first project, do you really have the people in place to make it ready? As I said before, the buyer for this property will be a lot more particular. So your flooring contractor, painter, landscaper and every other sub needs to be up to the task of providing quality results. If you have never worked with these guys, can you be sure that their skill is up to the standards needed for this project? Take your bumps and bruises in the small end of the pool while you build your team of trusted subs. Then when that million dollar opportunity makes sense, you know you have the right people to get it done right.

I had a new investor call me last week, looking to get started on his very first project. He had found a home selling at $1.8M that he was certain could bring close to $4M when finished. That potential $2M profit on a deal was all he looked at, and never considered all the things I mentioned here. As much as I want us all to make seven-figures in this business, I have to say that I would rather make it on ten, $100k homes than lie awake at night worrying about all my eggs in a $1,000,000 basket!

So consider these things when looking for your projects. Staying in the shallow end typically means more buyers, faster turns, lower expenses, less headaches and more opportunity. You may start in these projects and build up to that front-page home, or realize that you prefer dealing in the faster paced environment that comes with the smaller homes. Either way, I suggest making the first few projects cheaper homes for a great education and a foundation on which to build.

Until next time, good luck and happy hunting!

New members and old have heard me chant this time and again. Yes, I know the grammar is terrible. I grew up in the deep south, and homespun witticisms are hallmarks of our culture. But why do I keep saying this?

One of the most frequent stumbling blocks for new members is knowing when a deal makes sense, and how to figure out the numbers. In fact, questions about calculating After Repaired Value (ARV) amounts and making offers that fit within our guidelines are addressed every day. So, for my first entry, I would like to go over the basic calculations that you should use when structuring your deal.

As you know, our guidelines state that we will lend “up to 65% of the ARV on a property”. The keys there being ‘up to’ and ARV. Remember that all deals are evaluated on their own merits. If you are in an area where home values are continuing to slip, or homes are sitting on the market more than six months before selling, we will want to be more cautious and may not hit that 65% mark – and you should be cautious too.

But let’s assume that not the case with your property, and we are in an area where 65%ARV makes sense. What does that mean to you? How do you properly structure your offer and your deal?

Step 1 is to determine the ARV of the property. This is typically done by looking at sold comparable properties (comps) from the last 60 days. Of those comps, they cannot have been on market more than 180 days. Why? Because your goal is to get in, fix, and get out as quickly as possible. If homes are generally sitting on market more than six months, you may want to reconsider that property. You don’t want to end up holding a home that you can’t get out of quickly. So pull your MLS sold comps and get a good, honest average of what this property would be worth when you have finished your rehab. I always look at the lowest comp as my ‘worst case scenario’ so that I structure conservative deals.

Step 2 is to get a contractor to go with you and look at the home. Make sure you are working with someone who has subcontractors at the ready to get in and do these repairs on time, and in a budget that you have agreed on. Some members elect to act as their own general contractor, and hire the subs themselves. If you have the time and experience to do this, great! You can save a few dollars. If not, hire a GC to give you estimates of the cost of repairs on your property. If you can build a business relationship with a good GC, and let him know that you will not just do one house, but one every other month, you will find yourself ahead in the game.

Step 3 is math. I know math may not be your favorite subject. But I am going to show you the very simple calculations you need in order to make your deal a sensible one.

1. Average the sold comps. I’m sure most of you know how to do averages, but here’s a refresher. Add up the total of the comps, then divide by the number of comps. If you have four comps at $100k, $110k, $120k, and $140k, the total is $470k. Divide by 4 (the number of comps) to get an average of $117,500.

2. Multiply your average by 0.65. Remember, we go *up to* 65% ARV on a property. So this number would be the absolute maximum we could lend on your deal. In this case $117,500 x 0.65 = $76,375. That amount would be the maximum we could loan on this property.

3. Subtract your repair costs. Remember, we will roll rehab costs in with the deal, as long as we are within our lending guidelines. Let’s say that this project needed $16,000 in repairs. $76,375 – $16,000 = $60,375

4. Subtract another 10% to account for points and closing costs to be rolled into the deal. I suggest 10% as a guideline when making your offers. There is no guarantee that we will be above, or below that number when your file gets to underwriting. But allocating this amount will usually keep you within tolerances when structuring your deal. Multiply $60,375 x 0.90 = $54,337.

5. This number should be your guidepost when making your offer. Or, when deciding if the deal makes sense. Offering this amount, or less, would keep you within the maximum allowed percentage of ARV for our loan.

6. Double-check your math by working backwards: Add your offer price ($54,000) and your rehab costs ($16,000), total $70,000. Divide that number by the ARV ($117,500). You should come up with 60% (rounded). This leaves you $6,375 room in the deal to cover points and closing costs. Assuming we are able to lend 65% ARV on this deal, you have a deal that makes sense!

Again, every deal is evaluated, and decisions are made based on the merit of the deal. These numbers should be used as a guide to ensure that you are not over the maximum we will lend on a property.

Now, can a deal make sense at 68% ARV? 70%? More? That’s for you to decide. You would be taking a thinner profit margin when you sell these properties, and would be left with less ‘wiggle room’ when negotiations start up. Also, if you are over our allowed limit, you would need to cover the overage in cash at the closing table in order to put your deal together. Keep these things in mind when structuring your offers. While 3% on a $50,000 home may not be a big deal, it can make or break you on a $250,000 home, when you need to come up with the extra $7,500 to get your deal done. Frankly, I prefer to error on the side of caution and stay below that 65% mark.

I have often been asked why we look at 65% ARV as our maximum. Simply put, it allows you enough room to make a sound investment, and a respectable profit on your project. We are here to protect YOUR interests. We want you to be successful and make a profit on every deal.

Plus, if you need to slash the price in order to move the home, you can do so and still take a profit. Should you wind up in month five, and not had any offers; you can comfortably reduce your selling price by 10% and still turn a nice profit.

Let’s say the home you are in has an ARV of $200,000. But you were smart and set your deal up right, so you are in the home for $130,000 (65% of $200k). If you need to lower your sale price to $180,000 to make a deal you are thinning your profit, but it’s still a very respectable gain on your investment. Your buyer got a great deal, you made a profit and everyone is happy.

So keep these facts in mind when you sit down to pore over the latest REO’s and MLS lists in your area. There are some great deals to be had out there. And if you work these basic calculations when determining your offer, we all win.

Good luck, and happy hunting!