You’re almost finished with your rehab on one of your fix & flip deals. You got a great purchase price, and the rehab went well, on time and almost within budget. You’re in a good mood, call up the rental investor you had all excited about buying the home, and the sky falls. The investor has had a setback and can’t buy the home. You’ve worked with them several times, and this has never happened, which is why you didn’t have anything in writing to protect you.
OK, there’s no reason to panic. You are a week away from completing the rehab, and you have others on your buyer list who should want a home like this one. You jump on the phone and a couple of days later you’re officially getting worried. You haven’t found anyone who wants to take this home off your hands.
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When the Fixer Doesn’t Flip
1. When the Fixer Doesn’t Flip
You’re almost finished with your rehab on one of your fix & flip deals. You got a great
purchase price, and the rehab went well, on time and almost within budget. You’re in a
good mood, call up the rental investor you had all excited about buying the home, and
the sky falls. The investor has had a setback and can’t buy the home. You’ve worked
with them several times, and this has never happened, which is why you didn’t have
anything in writing to protect you.
OK, there’s no reason to panic. You are a week away from completing the rehab, and
you have others on your buyer list who should want a home like this one. You jump on
the phone and a couple of days later you’re officially getting worried. You haven’t
found anyone who wants to take this home off your hands.
It’s Due Diligence Accuracy Time
Before you jumped into this deal you knew that you were going to (oops, planning to)
sell to a rental property investor. There were several due diligence items you
completed to verify that this was a workable deal:
2. ARV, After Repair Value Calculation: You used a normal CMA, Comparative
Market Analysis, to come up with the current market value of the home if all
repairs are completed. We’ll use $150,000.
o Rental Market: Your survey of the rental market shows that your buyer
can rent this home out for $1350/month.
Rehab Project Budget Calculation: The materials and labor to rehab the
home were estimated and you got a second opinion from your favorite
contractor. $25,000.
Preliminary Purchase Price: You did some preliminary negotiating with the
seller to come to the probable price you’d have to pay.
Backing into the Purchase Price: Once you had all of the pieces, you put
them together. Backing up from the ARV:
o Selling Price: Knowing your investor, you started with a selling price
10% below current market value, a number this investor likes. $135,000.
o Rehab & Profit Deduction: Subtracting your desired profit, rehab costs
and funding/closing costs (transaction lender), you came up with the price
you’d be willing to pay for the home. Funding costs are $3,000, so rehab
and funding is $28,000. You want a $25,000 profit. So, you’re willing to
pay $135,000 - $28,000 costs - $25,000 profit = $80,000.
The seller wanted $84,000, but you negotiated them down to your $82,000 number.
The question is: did the numbers work? If you did a good job, you should be holding a
property with a current market value of $150,000 and a transaction loan of
approximately $110,000 to be paid off ($82,000 + $28,000). But, now you have no
buyer.
Why not become a rental investor?
You can keep searching for a flip buyer, as you have a couple of months left on your
transaction loan, but you’ll be accruing some stiff interest costs. And, you still may not
find a buyer, or be forced to sell for less because you’ve become a little desperate.
Why go through this when you’ve created a really nice deal for a rental buyer? You can
become that buyer.
Refinancing the transaction loan with a 30-year mortgage will put you into the rental
business. Sure, it wasn’t the original goal, but it’s not a bad investment at all. A 5.5%
mortgage rate with insurance and taxes escrowed will have a monthly mortgage
payment of approximately $880. Renting it out at $1,350/month will yield a gross cash
flow of $470/month. Even allowing for repairs and other expenses, clearing
$350/month isn’t a shabby investment cash flow.
3. If you use your $25,000 profit you didn’t receive for the calculation, the Cash-on-Cash
return is 16.8%. Not a terrible outcome for a plan that didn’t go the way you wanted.
The lesson here is that doing your due diligence carefully can make lemonade out of
lemons.