Commercial Loans and Fun Blog

fix and flip.jpg 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.

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

Debt buyers are desperate for yield. Treasuries, corporate bonds, and even junk bonds offer only very low yields.
Fix and flip loans are secured by real estate. In start contrast, corporate and junk bonds do not offer this kind of collateral.
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.
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.
New home construction is far below the levels of the early 2000's, so home buyers are attracted to newly-renovated properties.

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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.

Okay, we're halfway done discussing the loan-to-cost ratio in commercial mortgage finance. So far we've discussed how to compute the total cost of a commercial project. We have also discussed the loan-to-cost ratio in new, from-the-ground-up, commercial construction loan underwriting.

Today we're going to talk about the use of the loan-to-cost ratio while underwriting renovation commercial loans and fix-and-flip commercial loans.

By the way, if you happened to find this article because you were looking for a renovation loan or fix-and-flip commercial loan, you can submit your commercial renovation loan request to hundreds of hungry commercial construction lenders by clicking the button below:

The difference between a renovation deal and a fix-and-flip deal is that the fix-and-flip property will be offered for sale immediately upon completion. A property that is the subject of a renovation loan may, or may not, be sold upon completion. It might just be kept in the investor's portfolio and leased out for income. In either case, renovation deals and fix-and-flip deals are underwritten in exactly the same manner.

Renovation loans and fix-and-flip loans are underwritten just like commercial construction loans (or even residential construction loans). The only difference is that the Land Cost will include the cost of acquiring both the underlying land and the building in need of renovation.

An example will make this concept more clear. Suppose a property renovator ("the Flipper") spots an older rental house, zoned commercial, in need of repair on a busy commercial strip in an affluent area of town. He can buy the old rental house for $130,000, convert it into a cute little office building, and either lease it out or sell it for $325,000.

The house will need a new roof ($14,000), a handicap access ramp ($9,000), new exterior siding ($5,000), new paint ($8,000), new carpet ($6,000), and various repairs totaling another $7,000. Therefore the Hard Costs of the renovation will total $49,000.

There will also be Soft Costs of $22,000 for the appraisal, toxic report, loan points, title insurance, attorney's fees, closing costs, construction period interest, and leasing commission.

Every new construction loan or renovation loan needs a Contingency Reserve of around 5% of hard and soft costs. In this example, our Hard Costs are $49,000 plus our Soft Costs of $22,000 total $71,000. Five percent of $71,000 gives us a Contingency Reserve of $3,550.

Therefore our Total Cost is:

Land and Existing Building (old rental house) ... $130,000
Hard Costs ..................................................    49,000
Soft Costs ...................................................    22,000
Contingency Reserve ....................................      3,550

Total Project Cost ......................................... $204,550

So how much dough (equity) will the Flipper be required to contribute to this fix-and-flip deal? That's up to the lender. A reasonable loan-to-cost ratio in today's improving real estate market might be as high as 75%. Therefore a prudent commercial lender might be willing to make a new acquistion and renovation loan of 75% of $204,550 or $153,412.

Okay, so the Total Cost of the project is $204,550. The "construction lender" will make a loan of $153,412. Therefore the Flipper will have to cover the difference of $51,138.