One of the hardest steps for a new investor is to find funding! Here’s how to get the money you need to complete deals.
So you’re interested in real estate investing but don’t know where to start? Fix & flips may be an excellent option for you! House flipping is one of the easiest ways to break into the industry as they don’t require a lot of forethought: Buy a house, rehab it, sell it for a profit. But that “buy a house” part often trips new investors up, so I wanted to break down how to get money for your first fix & flip property through a loan.
I will lay out the whole process step by step in this article and include a few tips for getting your loans approved faster. If you follow what I write here, you will get fix & flip loans, guaranteed.
STEP 1: FIND A DEAL – THE TWO PILLARS OF FINDING A GOOD FIX & FLIP DEAL
The first step in finding a fix & flip property is to find one that meets the proper criteria for funding. This step trips up 95% of fix & flippers because it’s easier said than done. There are always the big boys out there, looking for dozens of flips with money to burn per year.
Then you’ve got tons of others, just like you, looking to break in. How do you find deals when there’s so much competition? Here are two ways to get your spot in the marketplace.
Search for Motivated Sellers
Sure, every person who puts their house on the MLS is motivated, but that’s not helpful. I mean to look for people going through a significant life event or change. Things that give someone a reason to want to sell their property fast.
Here are a few examples:
- The owner is about to lose their property to foreclosure.
- Three kids inherit an old, broken-down house and don’t have the time/energy/desire to fix it up and sell it for full price.
- A landlord finds out that his tenants trashed the property.
- An older person has an urgent need to move into a nursing home, but the house is in too much disrepair to immediately list on the MLS at full price.
And seriously, like a million more. Liens, bankruptcies, home improvement projects that have gone wrong, divorce; the list never ends. My point is to stop looking at the MLS for your deals and instead focus your search on situations where people need their house gone and gone fast.
Look for Properties with Equity
Next, you’ll want to find properties that have equity. This is the difference between the property’s value and how much is owed on the loan. In other words, if the owner sold the property right now, how much will they walk away with?
This is critical to your fix & flip project (and subsequently securing a loan) because an owner won’t sell you their house unless they’re going to be able to walk away with at least something—or, worst-case scenario, break even. So if someone owes $200,000 on their property and sold it to you for $180,000, they would be moving out of their house and still owe $20,000 on it! They’re not going to agree to that.
So, my rule of thumb is to look for properties with at least $100k in equity. You might be able to turn a profit in certain deals if the owner has $50k in equity, but it’s certainly less likely.
How to Determine the Amount of Equity an Owner Has
Look up an amortization schedule. This gives the schedule of payments that the owner pays on their property over 30 years. You’ll have to estimate their interest rate, but you can Google average interest rates. There’s also software you can use, such as Investor’s Edge. This is an extra step that will help your marketing.
STEP 2: CALCULATE YOUR ARV
Calculating your After Repair Value (ARV) will be the next step to tackle before getting your loan secured.
The ARV is the estimated market value of the property minus any debts and liens on the property. This is a significant number to know because it will give you an idea of how much money you would be putting at risk if you were to take out a loan to buy the property.
You can use a few different methods to calculate ARV, but the most common is comparative analyses. This involves looking at similar properties in the area and calculating their ARV. Here’s how to do it:
- Get three comps in 2 categories. My rule of thumb is to have three recently-sold properties and three properties currently for sale to use as my comps. That way, I have data from both recent and current markets.
- Pick the lowest price. Being conservative in your values is critical when dealing with such enormous costs. If you find comparable properties selling for $315k, $310k, and $302k, pick the $302k. You’ll be tempted to go with the biggest number, but what if you’re projecting a $25k profit and the property sells for $302k? Now you’re only a few unexpected costs away (which almost always come up) from being upside down on your deal.
A Few Considerations About Comps
Not all comps are equal, and when you’re estimating based on subjective data like this, you need to have a few guidelines in place. Prices fluctuate more the farther away you get from your property. Here are my standbys:
- 1/2 Mile Rule. Do your best to pick comparables located within a 1/2 mile of your property. If you must, expand that out to a mile.
- Same Neighborhood. Similar to the 1/2 mile rule, but if a comparable is two blocks away but very clearly in a different type of neighborhood, don’t use them. Perhaps that neighborhood has more parks, better roads, and streets, and the builder is more reputable.
- No Artificial or Natural Boundaries. Got train tracks or a river in between your property and the comparable? Throw it out. Often those types of things result in different values on different sides.
- Stay Away From Undesirables. If your property is next door to a Burger King, you can’t compare values to one located at the end of a quiet cul-de-sac.
What to Do If You Can’t Find Any Good Comps
If you can’t find 3-6 exact comps, it is possible to do some price adjusting. The price adjusting isn’t to get you a better price out of thin air but rather to hopefully verify other more accurate comps. You can do some research in the area and see how much an extra bed or bath usually adds to the price or see what the average price per square foot is in the area. If those slight adjustments corroborate your values from more exact comps, you’re in good shape.
STEP 3: ESTIMATE YOUR COSTS
When you walk through the property for the first time, you’ll want to do a quick assessment of the rehab. After you’ve done enough of these, you’ll be able to estimate the cost accurately. Until then, though, I’ve got a quick and dirty way to do the calculations:
- Rental: Basic rehabs, really just getting it to the point of “livable” so your tenants can make it a little more to their liking. $6 – $14 per square foot – $10 average
- Light Repairs: Paint, flooring, replacing some cabinets. $10 – $18 per square foot – $14 average
- Heavy Repairs: Gutting the house. $26-$48 – $37 average
As I said, it’s not an exact science, but it will get you close enough for now.
STEP 4: GET THE PROPERTY UNDER CONTRACT
Since you’re working directly with the owner, you’ll likely negotiate and place verbal offers while you’re with them. Here are a few pointers to help with this step:
- Have them walk you through the house. You can point out some things that will need to be fixed during the rehab to understand why a discount is necessary.
- Explain what you do. Tell them that you need to make 10% of the house’s purchase price to make sense for you to take on the project. Show them the numbers and the price you need to make that happen. People understand that it’s a business and won’t begrudge you for wanting to make a profit on their house.
- After they tell you a price, ask them this question: “Is that the best you can do?” And then wait for an answer. Get uncomfortable. This often works for me.
STEP 5: GET TWO CONTRACTOR BIDS
After you’ve negotiated a price and the seller has accepted your offer, it’s time to nail down the rehab costs as close as possible!
Since you’ve done your estimates before this, you should have a rough idea of what your bids will run. However, your calculations will never be so good that you can skip this step, especially if you plan to get a loan. That’s not to insult your incredible powers of deduction; far from it. It’s actually because of one reason: The Itemized List.
The Itemized List is a document contractors will use to submit bids for your project. It’ll list down all of the materials and services they’ll need to complete the project, including the cost of each one. It’s essential to have this document so you can be sure you’re getting a good deal on everything and so that you’ll have a backup plan should something go wrong.
Your itemized list ends up being more like a to-do list that gets crossed off as you go. If one contractor ghosts you or screws something up, it’ll be much easier to get back on track with an itemized proposal than a general bid.
Why Two Contractor Bids are Better Than One
This brings me to my next point: You must get two different contractors to bid on your property. This is because you want to make sure you’re getting the best possible price for your rehab. If you only have one bid, there’s a good chance the contractor who submitted the lower bid will do the work, regardless of their quality. This is especially true if the contractor who submitted the higher bid isn’t the best option for the job.
Once you have two contractors bidding on your project, you can compare the bids to see who offers you the best deal. And if one contractor ends up doing a lousy job, you can get them replaced without any trouble since you’ll have your Plan B on standby.
STEP 6: GET FUNDING
Now for the funding! You’re likely going to start with a hard money lender. Sometimes it can be hard to get a fix & flip loan if you’re a beginner, but some lenders (like us) have removed many of the barriers for new investors to get started.
However, most deals will require some money—it just doesn’t have to come from your bank account:
- Partner. Whether you need someone to help cover the cash-to-close, or they have better credit than you and can apply for a line of credit, a partner can help get the deal done. This could be a formal business partnership where you form an LLC and plan to do multiple deals, or it could be a one-off arrangement. Often the partner providing the money/credit doesn’t do the actual rehab work, and you split the profits. If they only provide money, you could structure it so that you’re just repaying the money with interest.
- HELOC. This is perhaps the easiest way to get money for a deal that doesn’t come from your bank account. If you have equity in your home, you can tap into it with a home equity line of credit. With low-interest rates and the ability to make payments by withdrawing more from your HELOC, you can often use $0 of your cash and pay off the debt out of the profits of your deal.
- Credit Card Advance. This is a little-known strategy. Some companies will help you get money from your credit card with a small origination fee, and there is 0% on that money for 6-24 months, often meaning you can finish the deal and pay it off before interest occurs. It’s a little like when you get those 0% balance transfers credit card offers, except a little more formal.
- Self-Directed 401k or IRA. You decide where the funds are invested with self-directed retirement accounts, including real estate! Bonus points if you’ve got a Roth account because then any profit you make will never be taxed! Any profit you make goes right back into the retirement account.
There are plenty more ways to get the funds for your fix & flip. You can read my Complete Guide to Getting Loans for Investment Properties here for a deeper dive.
STEP 7: REHAB YOUR INVESTMENT PROPERTY
Now that you’ve got the loan secured and the property transferred to you, it’s time to begin the rehab work.
This is where the hard work really starts! You’ll need to assess the damage, make repairs, and upgrade any critical systems. Make sure you work with an experienced contractor to fix & flip properties, as this is a very skillful process.
Follow the instructions in your homeowner’s insurance policy to make sure you’re repairing what’s required by law. You may also want to consult with a home inspector to ensure you’re fixing things properly and keeping your property in top condition before listing it for sale.
STEP 8: LIST YOUR PROPERTY FOR SALE
You’re so close to the end! Now that your property is ready to be shown, there are a few pieces of advice I have that can make this as smooth a transition as possible:
- Hire a real estate agent, even if you are one. In most cases, I recommend letting someone else handle this step. I know you can save good money by not hiring one, but you can make even more money by spending your time finding more deals! Let the agent do what they do best, and you stick to doing the most profitable tasks yourself. If profit margins are razor-thin on your deal, perhaps it’s worth selling it yourself (if you’re an agent), but otherwise, don’t. I was a successful real estate agent in a former life, and I generally hire agents.
- The first profit is the best profit. The first offer placed on the house that represents anything close to the profit you were looking for should be accepted! What happens too often if the investor holds out for a better price, but it never comes. Then they get stuck with holding costs (utilities, insurance, interest payments) that often cost $50 per day. Also, as I mentioned before, you want to get your money and move on to the next deal because that’s where the most profit comes from. If you wait an extra three weeks and somehow pocket an extra $3k, you still probably would’ve been better off in the long run if you’d already been working on your next deal.
STEP 9: RINSE AND REPEAT
Onto the next one! Use the lessons you’ve learned from the last sale to make the next one even better. Don’t get complacent with staying up to date on your market. Some investors think they’ll just move from one property to the next without looking at market trends and quickly get stuck in a bad situation.
This beginners guide is an excellent primer for anyone looking to get into the fix & flip business, but nothing beats experience. Take your time and do the work, learn the market, and build your network so that every flip gets a little bit easier and more profitable.