Ever wonder why you pay interest on money you borrow, or collect it on money you lend? For many, it’s one of those questions that seems obvious yet hard to nail down exactly. At the heart of the matter is the time value of money. Put simply, it’s better to have a dollar in your pocket today than to be promised a dollar in a week from today. Why? For one reason, if the dollar is in your pocket, there is no risk that you won’t get it, because you already have it. A lot of things can happen between now and next week that could put that future dollar payment at risk. It’s worth something to be sure that you have the dollar today compared to next week, and that’s one facet of money’s time value.

Another reason you’d rather have your money today is that you can spend it today if necessary. If you need that dollar to buy a loaf of bread, you don’t want to go hungry for a week waiting to receive your dollar.

But you’re a reasonable person. You tell your friend that you’ll accept the one-week delay if you’re paid something extra to compensate for the wait. That extra something is interest, and it compensates you for waiting to receive your money. After some haggling, you agree to take $1.02 in a week or $1.00 today. While that doesn’t seem like much, remember that there are 52 weeks in the year, so if you waited a year to accept the dollar, you could demand $0.02 x 52, or $1.04 in interest. In one year, you’d receive the original dollar plus $1.04 in interest, giving you a final payment of $2.04. That’s a simple annual interest rate of 104 percent.

If you are mathematically inclined, you can use the following formula:

A = P(1 + rt)

 

Where A is the total amount, P is the principal ($1), r is the interest rate (104%) and t is time (one year). So,

 

A = $1.00 (1+ 104* 1)= $2.04.

 

However, you insist on a little tweak to the deal. You want the interest to compound monthly. Compounding means you add the interest you’ve earned so far to the original principal, so that you begin earning interest on interest. For monthly compounding, you add in your interest every month. It turns out that you will receive $2.71, which works out to and extra $1.67. You like compounding so much, you demand it be performed daily, and voila, the amount mushrooms to $2.83, an extra windfall of $1.79 compared to simple interest.

OK, we know that this is pretty rudimentary for most of our readers. But it’s necessary background when you start considering net present value and internal rate of return, two very important numbers when contemplating the financing of a fix-and-flip project. And that’s exactly what we’ll do in our next blog article.

 

 

If you are serious about getting into the house-flipping game, it’s important to make a number of preliminary preparations in order to reduce your risk. Two important activities you should undertake are market research and lender selection.

Research the Market

You will need to narrow your focus to neighborhoods that offer profit potential based on your budget. Some of the items to research include:

• What are the hottest neighborhoods?
• How long is it taking to sell properties in the neighborhood?
• Which types, layouts and sizes of properties are moving the quickest?
• What is the average home sale price?
• How are bank REOs priced? (REO stands for foreclosed real estate owned by a bank and which didn’t sell when the bank tried to auction it)

You need to invest some shoe leather walking through as many open houses as you can find in the neighborhoods of interest. Also, spend some quality time with local experts who know the economic state of the community, including qualified real estate agents. Input your findings into your math calculations to see if flipping is feasible in a particular neighborhood.

Select Financing Method

If you’ve got a wad of cash in the bank and can afford to buy the property outright, more power to you. The only interest cost you’ll encounter is the amount you’d earn if you left the money in the savings account, which nowadays is nil. Here are the other popular options:

• Hard money loan: Available from commercial real-estate lenders, this is usually the fastest way to obtain financing, a very important feature during times when newly available properties are being snapped up quickly. Typically, you put up about 30 percent of the property value, and the lender provides the rest. Hard money loans are based on property value, not borrower creditworthiness, so it’s a great alternative if your credit rating isn’t the best. Contact Specialty Lending Group for all the details.
• Bank mortgage: This is usually the cheapest route, but normally takes way too long to arrange, especially in a hot market. Bank financing is available only for customers with the highest credit ratings. Many feel it doesn’t make sense to take out a 15- or 30-year mortgage for a short-term investment. We agree.
• Home equity line: You might be able to tap excess equity in your own home. This presupposes you have a great deal of equity and that you are willing to risk it.
• Private money: Some well-heeled friends or acquaintances might be willing to partner with you on a fix-and-flip deal. Beware of personality difficulties and cumbersome legalities.

Whichever one you chose, finalize your source of funds beforeshopping for property. Remember, speed is key in today’s hot fix-and-flip market. If you ask around, you’ll quickly learn that the services of a good hard-money lender are indispensable for success. If you are planning a fix-and-flip project in the Greater

Flipping a house is a lot harder than just slapping on a new coat of paint. But it is certainly within reach of enterprising individuals who are properly prepared with the skills and support they need. Check out these five requirements before contemplating your first fix-and-flip project.

A Team of Experts

You can’t be expected to have all the requisite real estate, legal, financial and insurance expertise to handle on your own all aspects of a fix-and-flip, especially as you are under the gun to get the project done as quickly as possible. Your real estate agent will help you identify a suitable property, while your lender will qualify your credit and arrange the funding. Proper contracts and insurance coverage are also handled by experts. Work with proven, experienced specialists like Specialty Lending Group to avoid mistakes and wasted time.

 

Neighborhood Knowledge

Before buying a property to flip, get to know the surrounding community, as this alone can have a substantial influence on the project’s profit potential. You need to know the predominant features that characterize houses in the neighborhood, including average acreage, type of home, number of rooms, etc. You also need to know your comps, the prices achieved by recent local sales of comparable properties. Don’t overlook any changes contemplated for the area, such as the building of a new school or shopping center, as these changes can reset the local balance between supply and demand.

 

Proper Estimates

Your task is to buy a house at a low enough price and fixing it within a tight budget to be able to sell it at a reasonable profit. If you miscalculate the amount of time and money you’ll have to devote to rehab before you can sell your flipper, you might suffer a substantial loss. Not only do you need a comprehensive professional house inspection, you also must understand the costs of materials and labor, as well as local construction and inspection codes, the availability of labor and a reasonable timetable. Your lender must be onboard with your estimates – if there is a disagreement, your lender probably has good reasons for its opinion, so pay attention and learn.

 

DIY Skills

Whether you supply the skills yourself or you hire labor, it pays to do things right the first time rather than paying to do them over after a problem is discovered. Many house-flippers have good DIY skills, and that makes a lot of sense. Doing it yourself is sure cheaper than hiring out, and you can ensure the work is done just the way you want it. If you can install a sink or attic fan yourself, you not only save labor charges, you also don’t have to rework your schedule to meet someone else’s availability.

 

A Dose of Zen

Things go wrong, take more time than expected, and often exceed cost estimates. A successful flipper must be like a duck, in that emotional upset and impatience roll off your back without causing damage. Avoid overindulging your frustration, anger and greed – emotions can be very costly. Stick to your plan, anticipate contingencies, and keep a positive attitude. That’s how we do things here at Specialty Lending Group, so give us a call today.

It’s no surprise that the Washington DC real estate market is an excellent choice for investors. Conditions that favor investment in new and redeveloped property include:

• Constrained supply: Demand for housing continues to exhibit strong demand coupled with depleted available inventory.
• Faster sales: Sales have accelerated over the last two years, with dropping average days on market. The suburbs saw the steepest drop in days on market, spurred by low interest rates, and relatively more inventory compared to closer-in neighborhoods.
• Seller reluctance: The demand for new and redeveloped units is extremely high, in part due to the reluctance of homeowners to sell. Apparently, price appreciation over the last several years has not been sufficient to stimulate sales of existing properties.

These factors point to a golden, if perhaps short-lived, opportunity to invest in housing throughout the D.C. region. Demand far outstrips supply, yet inventory remains low and homeowners are staying put. Renovation of apartment buildings and single-family-homes would help increase the demand for housing. 

The window of opportunity is also defined by the relatively low costs for labor and materials that currently apply. The fiscal stimulus, which is targeting 4 percent annual growth in GNP, will inevitably stoke inflationary pressures, meaning a year from now it might be more expensive to flip residential property than it is today. In other words, the cost of capital will be going up.

To sum up the reason to use a hard money load instead of a bank loan:

• Banks are slow: The pressure to quickly begin renovation projects provides investors with a unique opportunity for returns, because the need for speed creates demand for hard-money loans. Time-sensitive projects need fast and flexible funding, not the strong suit of bank financing.
• Banks are fussy: Banks present hurdles, such as required debt-to-income ratios, credit scores, existing investments, and verification of income, assets and down payments. All this red tape wastes a lot of time and creates uncertainty.
• Hard money loans are flexible: Hard-money loans are funded by private investors who have the flexibility to loosen certain constraints in order to facilitate good-looking deals. Investors thus have the opportunity to enter into deals that banks can’t because of their concerns about risk, short timelines and flexibility.
• Hard money loans offer investors higher returns: Naturally, the benefits of hard-money financing also require higher costs of capital, meaning that investors can expect higher returns by funding hard-money loans. Risk can be reduced by spreading investments over a portfolio of properties and by careful selection of each project.

There can be no two more important phrases in the investors’ lexicon than diversification and asset allocation. Many folks pay lip service to diversification without really grasping its essential tenet: To achieve maximum risk reduction, you must diversify your wealth over assets with returns that are poorly or negatively correlated with each other. In other words, while having a wide range of stocks and bonds in your portfolio is a good start, these conventional assets don’t provide the diversification you need to withstand bear markets. This is an important reason why the last decade has seen increased interest in alternative investments such as real estate, precious metals, private equity, hedge funds and commodities. To a large extent, these investments offer returns that are not closely correlated with those of stocks, bonds and cash.

Once you accept the importance of real diversification, asset allocation embodies your judgements about how much of your wealth to plow into each asset class. One of the most useful notions concerning asset allocation is the “20 percent rule,” which states that investors should allocate no less than 20 percent of their portfolios to alternative investments like real estate. The rule gained notoriety from the performance of the Yale University Endowment, which has outperformed traditional endowments consisting of conventional assets for more than 25 years. In fact, Bloombergreports that a 1995 investment of $1,000 in the Yale Endowment would be worth about $13,000 in 2015, twice the return investors would have made with the average $1 billion+ endowment.

Other university endowments run by protégés of Yale Endowment investment chief David Swensen have also benefited from the 20 percent rule, including Princeton, MIT, and Bowdoin College.

Investments in real estate have their own risk/reward profiles and payback periods that markedly differ from those of conventional assets.RealtyTracreports that for the second quarter of 2016, the average return on investment for fix-and-flip home rehabbers was 49 percent, compared to a 2006 ROI figure of only 27 percent. Q2 average gross profits per flip were $62,000, and the average time required to flip a home was 185 days.

These numbers are very exciting from an investor point of view. Investors in bridge loans can expect at least a 2 percentage point premiumover the average fixed-rate mortgage, without the long time horizon required by 15- and 30-year loans. In other words, investors in short-term bridge loans receive higher returns than do investors in 15- and 30-year mortgage notes.

Once again, diversification plays an important role. The risk of bridge loans defaults can be minimized by spreading the allotted funds over many properties. To varying extents, the loans are collateralized by cash and property, which affords a cushion in cases of default. Risk is also constrained by adjusting the loan-to-value ratio on each deal, based on the value of the property and the creditworthiness of the borrower.

As the Yale Endowment example clearly shows, prudent investors should look to allocate at least 20 percent of their portfolios to investments like bridge loans in order to increase their risk-adjusted returns.

The term “property development” encompasses a fairly wide range of activities, most of which require financing. A good framework to think about property development loans involves the starting stage. In some cases, you’ll want to start by acquiring raw land and will need a loan for land purchase. Land loan financing is often accomplished with a hard money loan. Property development loans can also be used to develop tracts of prepared land, as well as the renovation and sale/re-lease of existing properties. These real estate development loans, often called bridge loans, frequently employ short-term hard money loans that help finance a project for six months to a year, until long-term financing can be arranged.

A land development hard-money loan is a secured advance of funds for the purpose of converting raw land into building sites ready for construction. The loan allows a developer to buy a large parcel of raw land and divide it into smaller, improved parcels ready for sale to builders or owners. Following the title search and purchase of the land, the activities (called horizontal improvements) financed by this kind of loan include:

• subdivision of land
• leveling and grading
• building roads
• installing sewers and drainage systems
• bringing water and power to the site

A property development loan that includes the purchase of the land (known as an acquisition & development loan) goes a step further, in that part of the loan is used to develop the properties on the improved land. Frequently, the developer is separate and distinct from the construction company responsible for putting up the residential or commercial properties. However, an individual might want to buy a piece of land (raw or improved) and personally manage and/or perform the construction of a home.

As mentioned, hard money loans for land and development are secured, meaning the borrower must provide collateral, often in the form of cash. Specialty Lending Group will provide hard money land development loans of up to 70 percent of the parcel’s value, with 30 percent cash from the borrower. This percentage might be different if the borrower uses non-cash collateral, such as a seller-carried second mortgage.

Hard money loans are popular with developers who participate in land development, redevelopment, renovation, or fix-and-flip projects. This popularity stems from:

• The speed and flexibility of a hard money loan
• Access to financing based upon the value of the property rather than the credit history of the borrower
• Competitive interest rates commensurate with the riskiness of the project
• No prepayment penalty

Specialty Lending Group has long experience providing development and land loans. We would be happy to discuss the financing options we provide, so contact us today and we can get started.