By glen Weinberg
Chief operating officer
Fairview Commercial Lending
Nip the Flip
Should mortgage brokers and originators discourage fix-and-flips?
For years, myriad homebuyers have tried to make fortunes by fixing and flipping homes. In
reality, however, very few people are
successful with the fix-and-flip model,
as there are numerous conditions that
must be ideal for a fix-and-flip investment to be worthwhile.
For instance, the home’s purchase
price must leave ample room for rehab
costs, and the rehab estimates must be
accurate. Further, the home’s final sales
price must be close to the buyer’s original estimate, and the property must be
sold quickly enough to allow the flipper to move homes and proceed to the
next deal. Bearing in mind these factors, mortgage brokers and originators
should advise their clients that there’s
significant risk in flipping a house.
In lieu of the fix-and-flip model, brokers and originators increasingly are
suggesting that their clients take a different approach: what one might call
the fix-and-hold approach. Under this
model, investors buy a property, rehab
it and then rent the property, ultimately
either selling it or simply holding it in
their portfolios.
Clients should know that this model
is considerably less risky than the fix-and-flip model. For instance, with the
fix-and-hold model, investors aren’t
pressed to flip their properties as
quickly as possible; instead, they have
the ability to wait for market downturns
to pass and still make financial returns
from their rental income.
risks versus returns in the fix-and-flip model
The first scenario assumes that all conditions align and that the buyer was accurate on all items.
The second scenario assumes that the property’s rehab costs are $15,000 higher than predicted.
scenario one: 90 days
scenario two: four months
Purchase price:
$80,000
Purchase price:
$80,000
Rehab costs:
Prorated tax/insurance:
Basis in property:
$20,000
$438, assuming taxes of $900/year
and insurance of $850/year
$100,438
Rehab costs:
Prorated tax/insurance:
Basis in property:
$35,000
$438, assuming taxes of $900/year
and insurance of $850/year
$115,438
Sales price:
$125,000
Sales price:
$125,000
Less Realtor commission:
$6,250 (5%)
Less Realtor commission:
$6,250 (5%)
Net income:
$18,313
Net income:
$3,313
Rate of return:
23%
Rate of return:
4%
exceptionally good deal — a circumstance that may be more difficult to
achieve than many borrowers realize.
Finally, becuase of tighter underwriting guidelines from lenders, a sale’s
average closing time has increased in
many markets. These new underwriting
guidelines also have decreased the eligible pool of borrowers — another condition that seriously undermines the
profitability of the fix-and-flip model.
“in many markets,
foreclosed homes are
turning up at auctions in
rougher shape, making it
more difficult for investors
to accurately estimate
their rehab costs.”
That said, the fix-and-hold model
works on the assumption that investors can obtain longer-term financing
on their properties. Brokers and originators, therefore, should seek out lenders that write loans between one year
and five years, as opposed to a traditional hard-money lender that writes a
loan between 90 days and one year.
This increased financing time gives investors breathing room to stabilize the
property and then either sell it or take
out a more conventional loan.
A risky investment
In considering the fix-and-hold model,
it’s useful to take a closer look at the
fix-and-flip model — examining the in-tricacies of why this kind of investment
can be so risky. Many borrowers still
believe that the fix-and-flip model is a
good one, so brokers and originators
may want to delineate the reasons why
it’s becoming increasingly difficult to
succeed in this endeavor.
as stated earlier, there are a number of conditions that must be ideal in
order for the fix-and-flip model to succeed. To complicate matters, each of
these conditions continues to evolve
due to economic factors.
For instance, housing prices are rising as more novices enter the market
under the assumption that they can
make a fast return on their investments. along with increased bidding
at auctions, many markets are seeing a
decreased supply of foreclosed homes,
another factor that can lead to higher
prices at the initial auction.
Further, in many markets, foreclosed
homes are turning up at auctions in
rougher shape, making it more difficult for investors to accurately estimate
their rehab costs. an auction typically
allows prospective buyers to do exterior inspections of the property, but it’s
still rare for buyers to be able to perform interior inspections prior to the
sale itself.
Some markets also are still experiencing considerable downward pressure on prices. arguably, it’s still a
buyer’s market in many locations
throughout the country. This results
in many buyers being interested in
a property only if they can get an
Two examples
Consider the following example scenarios in order to illustrate the change
in return on a fix-and-flip investment
based on a change in the factors detailed above. a seemingly minor difference can result in a drastic difference
in return. The following scenarios make
no assumptions for financing costs and
assume that the buyer purchases the
properties with cash.
The first scenario assumes that all
conditions align and that the buyer was
accurate on all items. In this case, the
rate of return would be approximately
23 percent.
The second scenario assumes that
the property’s rehab costs are $15,000
higher than predicted. This is a common problem that can be caused by a
variety of factors, including the need for
a new roof, plumbing issues, electrical
problems and so forth. In this scenario,
the rate of return would be just 4 percent, a fairly low return given the risk,
time and effort involved.
These two scenarios are relatively
common in the fix-and-flip model. One
major risk factor that’s difficult to calculate, however, is the span of time involved in a given situation.
Take scenario two, for instance, and
assume that the additional repairs take
several added months to complete. If
the buyer needed funding for another
fix-and-flip transaction, that buyer may
be forced to drop the initial property’s
price by as much as 5 percent. This action, however, would drop the return
on the property down to - 3 percent.
Needless to say, the loss of 3 percent
would not be worth the risk assumed
for the investment.
• • •
With that in mind, brokers and origi-
nators should educate their borrowers
about the fix-and-hold model, which,
in turn, can allow buyers to take advan-
tage of future price appreciation while
also minimizing their risk. •
glen Weinberg is the chief operating officer
of Fairview Commercial Lending, a private
wholesale direct hard-money lender.
He is recognized throughout the industry as
a leader in hard-money lending. Weinberg
specializes in funding residential and
commercial hard-money deals in atlanta
( georgiahardmoney.com) and throughout
Colorado ( cohardmoney.com). More information on hard-money loans can be found
at fairviewlending.com. reach Weinberg at
(303) 459-6061 or glen@fairviewlending.com.
