Commercial Loans and Fun Blog

You will recall that a fix and flip loan is a loan used to acquire a run-down home and to renovate it in anticipation of a quick sale.  When a fix and flip lender orders the appraisal, he will ask the appraiser for two values - the current "as is" value of the property and the after repair value ("ARV").

The after repair value is the value of the home after the renovation has been completed.  This number is also the single most important number in the whole underwriting process.  If a fix and flip deal passes the after repair loan-to-value ratio test, a lot of flaws in the deal can be overlooked.

Okay, so what must the loan-to-value be based on the after repair value?  For most fix and flip lenders, this ratio must be 70.0% or lower.  Many fix and flip lenders will not exceed 65% of the after repair value.

Ultimately the after repair loan-to-value test is a measure of the profit in the deal and of the wisdom of even doing the deal at all.  At a recent conference, several fix and flip lenders reported that they had had investor-flippers actually thank them for turning down their deals because the projects lacked profitability.  The appraiser and the lender had caught a big mistake that the investor-flipper was about to make.  In several cases, the investor-flipper was able to go back to the seller, show him the numbers, and convince the seller to lower his asking price!

I hinted earlier that some flaws might be overlooked if there was a enough potential profit in the deal.  For example, normally a fix and flip lender will require that the investor-flipper contribute (put down) 20% of the purchase price of the run-down home.  If the after repair loan-to-value ratio was less than, say, 65% then the investor-flipper might be able to convince his fix and flip lender to allow him to put down just 15% of the purchase price of the run-down home.

If the project has lots of potential profit, in other words, the after repair loan-to-value ratio is less than 65%, the investor-flipper might get approved with a credit score of less than 600 or with better credit but with no experience.  No matter the size of the potential profit, it is unlikely that the investor-flipper would be approved if he both lacked experience and had poor credit.  Potential profit can only do so much to help.

I just finished an extended article on fix and flip loans, and I encourage you to read it.  The guys making the big money in finance these days are the ones either using fix and flip loans or originating them.  Fix and flip financing is a target of hot money on Wall Street.

One of the most important questions asked by fix and flip borrowers is, "How much cash do I have to bring to the closing table?"  The good news is that fix and flip loan borrowers ("renovators") need far less cash than home builders or commercial real estate developers.  In fact, I promise you that you will be thrilled and pleased with how little cash a renovator has to bring to the table. Hooray!  Just be patient.

Before we get into exactly how much cash a renovator needs to qualify for a fix and flip loan, let's use this opportunity to review commercial construction loans and the Loan-to-Cost Ratio.

The Total Cost of a commercial construction project is calculated as follows:

Land Cost plus
Hard Costs (brick and mortar) plus
Soft Costs (governmental fees, interest reserve, etc.) plus
Contingency Reserve (5% of hard and soft costs) equals
_______________________________________________

Total Cost

When underwriting commercial construction loans, banks usually require that the Loan-to-Cost Ratio not exceed 75%.  In other words, if the total cost of the project is $1 million, the developer must contribute at least $250,000 in cash to the project.  Ouch.

Prior to the Great Recesssion, when banks got killed on their commercial construction loan portfolios, most banks would happily lend up to 80% loan-to-cost.  In other words, the developer only had to come up with 20% of the Total Cost of the project.  Some banks were even going 90% loan-to-cost.  After commercial real estate collapsed by 45%, Dr. Phil might have asked the banks, "How did that work out for you?"  Ha-ha!  

Having learned their lesson painfully, banks now require that commercial real estate developers contribute at least 25% to 35% of the Total Cost of the project.  But you and I don't care!  Our fix and flip loans are residential loans, not commercial loans, and the secondary market is absolutely ravenous for fix and flip loans.  You or your renovator will NOT need to contribute 25% to 35% of the Total Cost of the project.  No-no-no.

So how much cash will a renovator need to contribute to qualify for a fix and flip loan?  Well, the first wonderful thing to appreciate is that fix and flip lenders do not even use the Loan-To-Cost Ratio.

To qualify for a fix and flip loan, the renovator only has to come up with
 20% of the price of the dilapidated house being purchased!

Please note that we are NOT talking about 20% of the Total Cost of the project.  We are only talking about 20% of the property purchase price.

Example:

John Renny is buying a rundown house in a nice area for $100,000.  He will need another $60,000 to renovate the property.  John only has to come to the closing with $20,000 - 20% of the purchase price of the rundown house!  His fix and flip lender will loan him 100% of the dough to effect the repairs and upgrades.  Wow.  Is this a great country or what?

Just for fun, let's compute the Loan-to-Cost Ratio of John Renny deal above - a fairly typical residential fix and flip deal.

House Purchase Price (in a dilapidated condition) plus
Hard Costs (of renovation) plus
Soft Costs (closing costs, report fees, 4 mo's interest reserve) plus
Contingency Reserve (5% of hard and soft costs) equals
______________________________________________________

Total Cost

Now let's plug in the numbers.  C'mon, guys, don't zone out on me here.  This is fourth grade math.  Maybe third grade math.

House Purchase Price = $100,000
Hard Costs = $60,000
Soft Costs = $16,000
Contingency Reserve = $3,800
__________________________

Total Cost = $179,800

In our example, John Renny is bringing only $20,000 in cash to the closing table, which is the magical 20% of the cost of the dilapidated house.  Therefore his fix and flip lender will make him a loan for the difference - $179,800 minus the $20,000 downpayment equals $159,800.

Okay, so what is the Loan-to-Cost Ratio of John Renny's imaginary fix and flip loan?

$159,800 / $179,800 x 100% = 88.9% Loan-to-Cost!!!

Wow.  Nowhere else in the civilized world can a real estate developer get this kind of leverage.  This is why successful fix and flippers are making incredible retuns on their money.

I met a nice lady from Alaska a few years ago who lives in Anchorage.  Every year several people in Alaska are stomped to death by a moose, so finding one in your swimming pool is not really a laughing matter.  A college classmate (interestingly she is white) of my daughter is from Swaziland, and she is crashing with us over the Thanksgiving holiday because its too far to travel back to Africa.  When I asked her about wild lions and tigers and bears, she said that the hippo's are the big killers in Africa.  Huh.  Who would have thunk it.  Such friendly looking animals.  And don't even get me started on the dangers of Porky Pig...  :-)

My son, Tom, and I just returned for the 5th Annual American Association of Private Lenders Conference in Las Vegas.  At the conference, fix and flip loans were all the rage.  Everyone was talking about them.  Several of the break-out sessions were about fix and flip financing.  There were even hedge fund managers and Wall Street investment bankers prowling the conference floor in search of hard money shops (private money mortgage brokers) to sell them more fix and flip loans.

There is a lesson to be learned here:  Give the investment community what it is seeking.  If you are not already active in fix and flip financing, you need to start focusing your efforts there.

There are a number of reasons why the investment community is so hot-to-trot to make fix and flip loans:

1. Debt buyers are desperate for yield.  Treasuries, corporate bonds, and even junk bonds offer only very low yields.
   
   
2.  Fix and flip loans are secured by real estate.  In start contrast, corporate and junk bonds do not offer this kind of collateral.
   
   
3. Wall Street has learned that a portfolio of rental homes provides an excellent source of cash flow and potential appreciation.  Its is far from the end of the world if an investor has to foreclose on  a home.
   
   
4. Homeownership rates have plummeted to levels not seen since the 1960's, thereby creating a huge demand for rental homes.  Once again, if a fix and flip lender forecloses on a newly-renovated rental home, it is far from the end of the world.
   
   
5. New home construction is far below the levels of the early 2000's, so home buyers are attracted to newly-renovated properties.

The typical fix and flip loan is a first mortgage loan to a renovator to buy and renovate a one-to-four residence and then to quickly sell it for a profit.  The typical fix and flip loan is a 12-month, interest-only loan, and it has no prepayment penalty.

Virtually all hard money lenders making fix and flip loans will require that the renovator cover at least 15% of the acquisition price of the unrenovated house.  Then most hard money lenders will lend to the renovator 100% of the funds needed to renovate the property.

Example:

John Renny plans to buy a $100,000 house and then to spend another $60,000 in renovations.  The hard money lender will require that he put down at least $15,000 on the home purchase.  The hard money lender will then lend him $85,000 of the acquisition price plus the $60,000 cost of renovation plus the loan points and sometimes even plus a four-month interest reserve.

"I applied for an SBA loan but they turned me down."  Okaaaay, but what did the second SBA lender say?  How about the third?  Today's article is pretty long, so if you don't get to the end, please remember this important lesson:

Every SBA lender is different, and just because one SBA lender turns you down, this doesn't mean that another might not still approve your deal.  By using C-Loans.com to  apply for your SBA loan (the orange button below), you can quickly shift your SBA loan application to six more of our 218 different SBA lenders. 

A lot of commercial mortgage borrowers think that the SBA is the lender, and therefore if the SBA turns them down that they are toast.  The SBA does not make commercial loans.  It only insures a part of the loan.  The actual lender is the bank making the loan.

Example:

Bank of Wyoming makes a $900,000 new SBA loan to renovate a successful but aging truck stop on I-25.  Because the business was an existing one, rather than a start-up, the borrower was able to qualify for an SBA loan of 90% loan-to-value.  Had the business been a start-up, the maximum loan-to-value ratio would have been limited to just 70%.

Now the Small Business Administration is not going to guarantee the entire $900,000 loan.  The SBA wisely demands that the bank have some skin in the game.  The general rule is that the SBA will only guarantee between 50% and 85% of the loan made by Bank of Wyoming, depending on the SBA program (7a versus 504) used and other factors. 

For the sake of this example, let's assume that the SBA agrees to guarantee 70% of the $900,000 truck stop loan made by Bank of Wyoming.  This means that Bank of Wyoming has 30% of $900,000 at risk in this loan or $270,000.  Requiring the bank to have some skin in the game helps to makes sure that banks don't make SBA loans willy-nilly.

In real life, Bank of Wyoming has less than $270,000 at risk.  The bank can sell off the insured portion for a substantial premium.  The insured portion is 70% of $900,000 or $630,000.  Now a premium is the amount that a loan buyer or a bond buyer will pay in excess of the face value of the note.

In this case, lets suppose that Bank of Wyoming can sell off in the secondary market the insured portion of this truck stop loan at a premium of 10%.  Why would bond buyer pay a 10% premium?  An SBA loan yields 2.75% over Prime.  Since Prime is 4.25% today, that's a whopping government-guaranteed yield of 7%.  Thirty-year Treasuries today are only yielding about 2.8%.

Now a 10% premium on $630,000 (the insured portion of our $900,000 loan) is a whopping $63,000!  Therefore Bank of Wyoming doesn't really have $270,000 at risk in the deal but it quickly sells off the insured portion for a $63,000 premium.  Now the bank has only $207,000 at risk in our $900,000 truck stop loan.

In doing my research for this article, I discovered that SBA lenders earn a handsome loan servicing fee of 1% per year.  Therefore the bond buyers are actually only netting 6% after loan servicing fees, but they are still quite happy to pay a 10% premium.  Heavens, I sure love-love-love loan servicing fees.  Every month my own hard money shop enjoys $90,000 in loan servicing fees, whether we close a new loan that month or not.

Okay, we are closing in on the point of today's article.  It is quite possible that the Bank of Wyoming was the third Wyoming SBA lender to look at this deal.  The first two lenders might have turned down the deal because of the fuel tanks or because the deal depended on fuel sales increasing after the renoavtion.  The deal was too speculative in the eyes of the first two banks to look at the deal.

In stark contrast, the President of Bank of Wyoming loved the deal because his dad had owned a trucking company, and his dad had complained for years that this section of I-25 desperately needed a truck stop.  

Remember, despite the large premium paid for SBA loans in the secondary market, Bank of Wyoming still had some serious skin in the game - $207,000.  Therefore the approval of any SBA loan is NOT guaranteed.  It depends on whether or not the bank reviewing the deal is willing to put a ton of their own dough at risk.

If you are trying to get your SBA loan approved, be sure to submit it through C-Loans.com to our 218 SBA lenders.  If one our SBA lenders turns you down, you'll be invited to submit the same application to six more SBA lenders, with no additional paperwork on your part!  One, short SBA loan app works for all 218 of our SBA lenders.  Start by using the orange button below.

Have you guys ever heard of a smartphone app called TuneIn.com?  I stumbled across the app recently, and I am enjoying it so much that I thought I'd share it with you.  I am not getting paid for this article, ha-ha.  I am simply sharing my wonderful experience with TuneIn.com because you guys are my buddies.  I teach my loan officers to write to their contacts, not as some stuffy, boring "professional", but rather as if they were buddies sharing a beer at the end of the day - so pop open a brew and prepare to be wowed.

I am a huge Notre Dame football fan, but my daughter plays soccer for Earlham College, and the Saturday games always start about the same time.  Therefore I obviously can't watch the Notre Dame game on T.V.  But what about radio?  Couldn't I listen to the game?  Well, if my daughter was playing her soccer games in Northern Indiana, and if I could find an old fashioned transistor radio, I might be able to pick the game broadcasting out of a local radio station in South Bend.  Unfortunately Jordi plays her games in Ohio and Eastern Indiana.  Hmmm.  Stay with me, folks.  This gets good.

So I googled "Notre Dame football radio and discovered that I could stream an audio version of the games using a smartphone app called TuneIn.com.  The premium service is only $99 per year, so I bit the bullet, paid the $99 annual fee, and thoroughly enjoyed my Notre Dame games.  You can listen to 50 or 60 different college football games using TuneIn.com, including the Alabama Crimson Tide games, the Georgia Bulldogs games, the Ohio State Buckeyes games, the Clemson Tigers games, etc.

But wait, there's more!  You can also listen to every NFL football game, every NBA basketball game, and every Major League Baseball game.  Wow.  All for just $99 per year.

Now I am a huge audiobook fan, and rather than listen to my music tunes or to music on a local radio station, I am constantly listening to historical fiction audiobooks.  I am a big fan of Napoleonic War naval yarns, like the Horatio Hornblower series.  The problem is that my monthly bill at Audible.com is on the order of $60.  Ouch!

So I was playing around with TuneIn.com and discovered that they also offer free audiobooks!  Right now I am listening to Bill O'Reilly's (the former anchorman on Fox News) smash hit, Killing England, about the Revolutionary War.  It's a fascinating yarn, with exciting, vivid battle scenes, including Indians scalping British redcoats while they were still alive.  Yikes.  After that I am going to listen to Origin by Dan Brown (DaVinci Codes) and then The Cuban Affair by Nelson DeMille (The General's Daughter).

But wait, if you order now... haha, remember I'm not getting paid for this.  I am just a thrilled user of TuneIn.  The app also offers all of the major news shows on radio, like CNN, CBS News, NBC News, Fox News, etc.

Lastly TuneIn offers free podcasts.  Podcasts are pre-recorded audio shows of 30 minutes to 10 hours in length.  I was personally thrilled to note that TuneIn.com offers scores of history podcasts; but if you are a politics junkie or an economics junkie, you will swim in a warm pool of scores and scores of such podcasts.

When you write to your buddies and contacts, you do NOT always have to talk about business.  The idea is to get in front of them and reward them with fun or interesting stuff if they read your marketing piece.

I have been marketing for commercial loans for 37 years, and the most successful marketing piece that I ever wrote was entitled, The Ebola Virus Is Going to Kill Us All.  That piece tells the true story of The Hot Zone, where the Ebola virus mutated in a lab in Restin, Virginia in 1989 to become transmissible by air!  Hellooo?  You no longer have to touch the blood.  You just had to breath the same air as the sick person to become infected with Ebola.  The infected person didn't even need to cough on you.  Apes in totally separate rooms became sick and died.

That marketing piece generated more commercial loan leads for Blackburne & Sons than any other piece in 37 years, and nowhere in the marketing piece did I even mention commercial loans.  As for that mutated strain of Ebola, it turned out that the same genetic mutation that had made it transmissble by air also made it harmless to humans - even though it had spread all throughout the lab, and it had killed 30 different apes and monkeys.

That's it for today.  Did any of you note that Notre Dame, despite losing the first game of the season, has climbed to #3 in the college football playoff rankings?  Go Irish!