Every successful house flipping entrepreneur began their journey with one fix-and-flip project, and then another—building on each success, learning from each mistake, and creating a reliable and repeatable process for minimizing risk and maximizing reward.
As simple as it may sound, the most important thing for you to be aware of as you set out to grow your house flipping business is that your success will ultimately be determined by the interaction of these two factors:
- Maximizing ROI on each of your fix-and-flip projects
- Increasing the number of successful fix-and-flip projects you complete
If your goal is to grow your house flipping business and maximize overall fix-and-flip ROI, you will find that as you increase the number of fix-and-flip projects you are completing, your minimum acceptable profit on each project can be lower if you are leveraging your cash-on-hand with hard money financing. This will be discussed later, but for now, let’s focus on arriving at a strategy for maximizing overall ROI for your house flipping business by asking these critical questions:
- Have you set a minimum ROI each flip must meet?
- Does your fix-and-flip business plan include the goal of scaling up volume beyond a few house flips a year?
- Does the funding strategy for your house flipping business include leveraging cash on hand with a bank loan or with hard money financing?
Setting Your Fix-and-Flip Projects’ Minimum ROI
If you are operating in a highly competitive market, you may be tempted to get a leg up on competitors by paying more for a fix-and-flip property than you should. But in any scenario, “should” is relative, and your offer will ultimately be determined by how much profit you are willing to accept for each fix-and-flip project you undertake.
One strategy successful house flipping entrepreneurs use is setting a minimum project ROI and sticking to it. Before you make an offer to purchase a fix-and-flip property, know what your minimum acceptable ROI is, then do the math.
A fix-and-flip property is available for $100k and the after-repair value (ARV) is $225k. You might think $125k is a great margin and there should be plenty of profit built in to that deal. However, if the minimum profit percentage you will accept is a 25% return on investment (and the seller will not accept a lower purchase price), you should pass up a deal like this one:
|Fix-and-Flip Property Sale Price||$100,000|
|Additional Acquisitions Costs||$4,200|
|Estimated Improvement Costs||$60,000|
|Holding Costs (4 month estimate)||$4,300|
|Hidden Costs (buffer)||$5,000|
|–||(net return on $189,500 investment)|
Of course, if your business plan includes a minimum acceptable per-project ROI of 18%, this deal could work for you. In this same sample scenario, if you are able to get the purchase price down to $88,000, your net return jumps to $27.3%, which is why negotiating a lower purchase price is a great way to increase a fix-and-flip project’s ROI.
|Fix-and-Flip Property Sale Price||$88,000|
|Additional Acquisitions Costs||$3,700|
|Estimated Improvement Costs||$60,000|
|Holding Costs (4 month estimate)||$4,000|
|Hidden Costs (buffer)||$5,000|
|–||(net return on $176,700 investment)|
Maximizing Overall ROI by Increasing Fix-and-Flip Project Volume
One strategy you might be using to maximize the overall ROI of your house flipping business, is to accrue the profits from each successful flip and use that accrued cash to purchase and rehab more fix-and-flip projects. For example, let’s say with capital reserves of $500k you purchase two fix-and-flip properties this year. After costs, you realize a 20% net return of $100k, so now you have $600k in capital reserves. Let’s say next year, you invest your $600k in three fix-and-flip projects and you receive a 25% net return on that investment ($150k), so the following year you will have $750k to invest. And so on.
This growth strategy can work if you are earning sufficient profit on each fix-and-flip project, if you are cycling your profits back into your business, and if you have the patience to grow your house flipping business at a slow pace. For house flipping investors who want to scale up more quickly, there is another growth strategy that involves partnering with a lender.
Maximizing Cash-on-Cash ROI by Partnering with a Lender
House flipping entrepreneurs whose goal is to scale up volume more quickly understand that there is a critical difference between setting a minimum per-project return on investment and setting an overall cash-on-cash ROI.
Here is an example of a fix-and-flip project with a $750k purchase price and an ARV of $995k. Let’s compare profit and ROI using all cash vs. hard money financing:
|ALL CASH||HARD MONEY LOAN|
|Property purchase price||-$750,000||-$750,000|
|Purchase closing costs||-$7,500||-$7,500|
|Loan down payment||N/A||-$166,000|
|Total cash investment||-$837,500||-$213,893|
|Property sale price||+$995,000||+$995,000|
|Sale closing costs||-$69,650||-$69,650|
|ROI (cash on cash)||–||10.49%||22.19%|
In this scenario, the hard money lender puts up most of the capital, and shares in the profit. Although the house flipper realizes a significantly lower profit on the deal, their cash-on-cash ROI more than doubles.
For this reason, many of the most successful house flipping entrepreneurs are high volume flippers who use hard money financing to leverage their cash on hand and substantially increase overall ROI.
Hard Money Financing vs Conventional Bank Loans: How Are They Different?
Hard money financing, also known as “fix-and-flip loans” or “rehab loans,” are short-term bridge loans specifically intended for the financing of real estate investments. Unlike traditional home mortgages that are issued by banking institutions, fix-and-flip loans are funded by private, direct lenders.
Below are 5 Key Differences Between Fix-and-Flip Loans and Traditional Home Loans:
- Funding Speed
Fix-and-flip loans are fast and flexible a. These loans can be approved and funded in as little as 5 to 10 days, whereas a traditional bank loan generally takes 45 to 60 days to close.
The bank’s longer timeline includes an extensive borrower application, strict rules about property condition and a microscopic look at your finances. If anything at all sets off a red flag, a traditional mortgage lender will ask for more documentation, further prolonging the approval process. Securing a traditional home loan rarely takes less than a month, which is like an eternity to a fix-and-flip investor. If auctions, short sales or foreclosure properties are part of your fix-and-flip game plan, be aware that you will compete with buyers who are executing their purchase agreements while you’re waiting weeks to hear back from the bank.
- Loan Length
While a standard home mortgage is typically amortized over 15 or 30 years, with a fix-and-flip loan you will make monthly interest-only payments for a term of 6 months to two years. Because most fix-and-flip lenders do not charge penalty fees for early payment of the loan, you can pay off the balance as soon as your property sells, and, conversely, if you need more time to complete the flip, many private lenders will offer 3 to 6-month loan extensions for qualified fix-and-flip borrowers.
- Condition of Your Investment Property
Another important difference between fix-and-flip loans and traditional bank loans is related to the condition of the property being purchased. A conventional mortgage lender will likely have strict requirements regarding the condition of the property, and the loan amount you can qualify for will be limited by your credit-worthiness and the property’s as-is value. For fix-and-flip loans, the as-is condition of the property is irrelevant if there is sufficient after-repair value (ARV) to justify the loan amount. Since the property is being purchased with the intent to fix it up, its condition is often poor—and that is expected by the fix-and-flip lender.
- Your Credit Score
While a traditional home loan is based heavily on the state of your credit, that is less important to a fix-and-flip lender. A fix-and-flip lender will base its approval decision more on the value of the property than your creditworthiness. Although there will likely be a minimum score a fix-and-flip lender will prefer, with this type of asset-based lending, if you hold a significant equity position in a property, or you have a few successful flips under your belt, many lenders will take that into account and grant a fix-and-flip loan regardless of your credit score.
- Loan Costs
When you borrow from a traditional mortgage lender, your interest rate will be significantly lower than with a hard money lender, and the origination fee will usually be no more than one or two points (1% to 2% of the loan amount). A fix-and-flip loan will carry a higher percentage rate, and you could be charged two to four (or more) points for the origination fee. You’ll also need to bring a down payment to the deal, which will likely be around 15-25% of the amount you are borrowing.
Anchor Loans is the Nation’s Leading Fix-and-Flip Lender
If you’re interested in taking the next step to grow your house flipping business, Anchor Loans is happy to help you get started. We know that this process can feel overwhelming, but it doesn’t have to be. Feel free to contact us with any questions you may have, and we’ll do all that we can to help you every step of the way.