Nothing Fancy – Just Another REO Purchase

This home was a standard REO home listed for $55,000.  We originally offered $35K and came to a final compromise of $38K with the bank.  Once again, our offer was accepted over other higher offers solely on the basis that ours was a non-contingent cash offer.

This is the 10th property added to our rental portfolio all of which are in the same neighborhood.  This property was purchased with all cash in order to keep things simple and provide leverage for our offer.  Based on the 50% LTV after repairs on this property and the large equity positions in our other properties, our commercial lender allowed us to cash-out 100% of the purchase price and and provided us 100% of the repair funds for our latest project.  So at the end of the day, we have no cash invested in this deal.

Project Numbers

Only 6.3 years to Payoff this Rental Property

The plan is always to use all the positive cashflow to help pay down the monthly mortgage in order to own these properties free and clear as soon as possible.  In this case here, after a proper cash reserve is established, we will take the $379 monthly cash flow and apply it to paying off the mortgage which will happen in a short 6.3 years!

Rehab Analysis and Walkthrough, Pt 1

Our construction manager and partner performs a detailed walk through of the property the day after we get it under contract.  We discuss numbers and first impressions since this is the first time some of us our seeing the inside of the property.

Rehab Analysis and Walkthrough, Continued…

Below our video continues with a look at the basement and the plan for its rehab.

Short-Term Loans

Hard Money Lender

A hard money lender makes short-term loans based on the value of an asset, in this case a property, with little regard to the borrower’s credit and/or finances.  Hard money lenders charge higher interest rates than standard banks due to the high risk nature of these loans.  Unlike traditional banks, hard money lenders can provide funds quickly, usually in 10-14 days, to purchase and rehab distressed properties.  These properties can be in need of significant repairs or be in various stages of foreclosure. This makes these loans popular with first time real estate investors that have little working capital or poor credit scores.  Look to use hard money loans to rehab foreclosures as your means to purchase and rehab your first couple properties.

Rehabber Loans

Hard money lenders will only provide loan terms of 4 – 6 months at which time the investor has to sell or refinance the property.  It is EXTREMELY important that the first time rehabber have a rock solid exit strategy, otherwise his rehab investments will soon belong to the lender.  Not having a SOLID exit strategy is the biggest and most common mistake that a newbie home flipper can make when utilizing hard money.  If this happens to you, work with your lender to get at least a 6 month extension and ask them for referrals to end-lenders that specialize in refinancing these situations.

In order to refi the hard money loan, you will need to find an investor friendly lender that has no seasoning requirements and will appraise the property in its newly remodeled condition and not at its most recent sale price.  Also, do not list the property on the MLS (multiple listing service) if you are planning to refinance.  Lenders will not refinance a property that is currently for sale.  The bottom line is that you either have to have the property pre-sold pending completion of repairs or have guaranteed refinancing in place.  Otherwise, you are setting yourself up for failure.

A typical hard money lender will lend up to 65-70% of the after repaired valve (ARV) of a distressed property.  The ARV is calculated by the lender’s appraiser and is based on an expedited sale scenario in case the lender has to foreclose on the property and resell quickly.  This gives the lender the safety margin needed to minimize their losses when things turn sour.

100% of Rehab Funds

The lender will typically provide 100% of the rehab funds needed to make the property saleable or rentable as detailed in your rehab estimate that you will provide to the lender.  This rehab estimate needs to correctly address the rehab plan in its entirety.  It is very difficult and time consuming to ask for more money in the middle of a project because you missed something in your initial estimate.  It often makes more sense to fund that portion out of your own pocket if possible.  Otherwise you most likely will be waiting for another appraisal and/or underwriting (or committee) approval for the additional funds.

The rehab funds will disburse in 3 – 4 draws as work is completed throughout the project.  Most hard money lenders will not issue your first draw until a portion of the home rehab has been completed.  Work with your contractor to have him put up the initial money to start the project.  If your contractor refuses or says he has no money then you shouldn’t be using him in the first place if he is that poor.  Be wary of giving unknown or untested contactors money upfront in order to start construction.  You will get burned eventually.

High Interest Rates

Depending on the lender, the down payment will vary from 0 – 10% of the purchase price and the origination points will also vary from 0-10% of the purchase price.  Interest rates will typically vary from 13 – 18% and will be charged on a monthly basis on your outstanding balance (only the money you have actually used).

Hard Money Loan

Hard money lenders vary greatly so the newbie rehab investor must shop around to find the best programs out there.  Local rehab clubs and real estate investment groups are a great source for finding hard money lenders you can trust.  Be wary of unscrupulous private money lenders and expert real estate investors that drive themselves around in their own limos.  This may sound funny, but you wouldn’t believe how many crazy people are out there.  Stay away!

I have personally purchased HUD foreclosures with only $500 out of my pocket using a hard money lender to finance the whole project including all closing costs.  Once you have some cash in your pocket, look for cheaper ways to finance your deals.  Community reinvestment banks are who you need to develop relationships with next.

Example of Hard Money Financing:

After Repaired Value (ARV) is $90K

70% of the ARV is $63,000.

As long as the total loan amount is less than $63,000 the deal will work.

Bank foreclosure (REO) purchased for $25K

Rehab Estimate is $30K

10% down payment on purchase price is $2,500

4% origination is $1,000

Closing, attorney, insurance, titles fees – $2,000

Total loan amount in this case would be $55,500 (assuming the lender rolls in closing costs and points).  This deal will work every time.

Note: Remember to subtract your down payment from the calculation of the loan amount.  Depending on the tax pro-rations (in most states the seller has to give you the prorated amount for the current year’s taxes) you may not have to bring the full down payment to the closing table.

Related articles

• What you must do PRIOR to Obtaining a Hard Money Loan

A cheap and effective roofing rehab choice can be the use of roll roofing.  This choice is better suited for homes with steeply pitched roofs.  Instead of shingles, this roofing choice is rolled onto the roof and stapled in place.  This choice is cost effective and reliable if installed correctly.  Now it does not look as nice as a shingled roof, but we have not had any difficulty renting out homes because of this.  The appraisal was not effected either.

Another option is to add another layer of shingles to the roof depending on what the local building code allows.  If the roof is very old there is a good chance that the plywood will have to be replaced also.  Analyze the roof carefully because there is ~ $4,500 difference between a full tear off and replacement versus just a re-shingle or roll roofing.

Soffit, fascia, and gutters

Many older homes have wooden soffits and fascia that can be scraped and repainted without having to replace every piece of wood.  Gutters can sometimes be salvaged but in cases where they are bent beyond repair replacing them will cost around $1,200.  Make sure the water adequately drains away from the house to avoid unnecessary basement leaks.

Siding

Some homes many have perfectly good siding its appearance is just plain ugly.  In these cases consider adding new siding to just the front of the house.  This works especially well in neighborhoods where the homes are close together and the side views are not easily visible.  Some investors paint the siding on the front of the house for a fresh appearance.  Again this depends on positioning of the home in relation to its neighbors.

When dealing with wooden siding, one can sometimes replace the broken sections of siding and move on.  Generally the older foreclosed homes will be in such poor condition that new vinyl siding will be required.  Brick homes on the other hand can usually be tuckpointed for much less then residing an entire house.  Keep that in mind when evaluating properties.

Privacy fences

Privacy fences greatly increase the appeal and safety of rental properties.  This is especially true of the rentals located in rougher neighborhoods.  The privacy fence will run about $20 per foot installed but is worth every penny due to the extra protection offered to the tenants plus its appeal from the street.  This is always a good selling point to prospective tenants.

Exterior doors

The exterior doors to the house should be solid wood or steel doors with the added protection of metal security screen doors on the front and back of the house.  The need for the metal security screen doors will vary depending on the neighborhood the rental property is located in.  Install the security doors at the beginning of the rehab project for extra protection from break-ins.  The additional cost of the security screen doors is worth every penny given the peace of mind they will provide you and the tenant.

Windows

In order to pass a section 8 inspection all windows must open, close, and lock freely.  Very rarely will this ever be the case.  If the windows are in good working order, this can save you $3,000 – $5,000.  Otherwise, be prepared to spend around $250 per window installed.  Many old homes have windows that were painted with lead paint which will need to be professionally scraped off and repainted.  These old windows are also horribly energy inefficient.  With that said, replacing the windows on an old home is many times the best decision.

Avoid placing regular windows in the basement.  On single family homes, basement windows should generally be glass block windows because of the extra security they provide.  Weak basement windows are a popular entry point for thieves.  Sometimes this is not possible if the basement is actually a garden unit in a two flat.  In this case, installing bars across the windows may be necessary.

Porches

Replace individual wood planks that are broken or rotted.  Once complete scrape off any old paint and apply an exterior paint to seal the job.  The freshly painted porch will enhance the curb appeal which in turn will help rent the property faster.  If the porch is slanted or falling, this can usually be fixed by jacking up the porch and repairing the foundation below.  Most rental homes will not have tall porches that require professional inspections, but when dealing with two-flats or homes with stairs that lead to the second floor make sure your contractor is familiar with the local building codes regarding porches in your area.

Related articles

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• 4 Great Reasons Why REIs Must Do A Green Rehab
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• Estimating Construction Cost – Actual Repair Budget Attached
• Landlord’s Rehab Flooring Guide
• How to Find a Contractor to Flip That House