There is money to be made in house flipping. There is also money to be lost. House flipping is a form of real estate investing that carries as much risk as reward. That’s why it’s hard to find lenders willing to get involved. For many would-be flippers, the answer is hard money. But even hard money lending is not necessarily a panacea.
Some hard money lenders, like Salt Lake City’s Actium Partners, will not go anywhere near house flipping projects. They prefer to keep their money in commercial real estate. As the thinking goes, commercial projects are far less risky. On the other hand, there are those hard money lenders who live for house flipping. They don’t mind funding such investments at all. Their biggest concern is going over budget.
When Rehab Gets Expensive
In a perfect world, a house flipper would buy a new property at a significantly discounted price. Renovations would be limited to cosmetics, transforming an average home into an outstanding property ready to sell at a premium price. But how often does that happen? Rehabbing houses can get expensive very quickly.
Imagine purchasing a home for $80,000. You originally figured your rehab costs would be about $50,000. But once you started demolition, you discovered hidden issues that had to be addressed. When all is said and done, you will have to double the rehab budget. How do you think your lender will react?
Although exceeding the rehab budget by 100% isn’t the norm, it does happen. Even going over by 20% cuts into a flipper’s margin. And if the flipper has to hit up their lender for more money to complete the project, going over budget can strain their relationship.
Covering Overruns Out of Pocket
Underestimating rehab costs is part of the risk of house flipping. If you do it only occasionally, and only by small amounts, it’s not a big deal. But when cost overruns seem persistent on every house, you have to seriously consider what you’re doing. You also must consider whether you have the capital resources to take on those overruns.
Hard money lenders are very particular about their LTVs. They have to be. They only loan a certain percentage of a property’s estimated value in order to protect their position. Hitting up your lender to cover cost overruns is an open invitation to exceed LTV. A house flipper may get away with it one or two times, but not continuously.
Where does that leave the house flipper? Covering cost overruns out of pocket. That is where things get dicey. One of the keys to successful house flipping is maintaining a steady cash flow to cover unforeseen expenses. If that cash is constantly being accessed to cover cost overruns during rehab, a flipper’s resources can be spread pretty thin.
Not Selling Quickly Enough
Cost overruns pale in comparison to not being able to sell a home quickly enough. The residential market is fairly fickle, and there is always a worry that rehab will take too long and prices will fall before the flipper can get a property back on the market. This is yet another reason some hard money lenders stay away from house flipping.
This is not to say that flipping is a bad financial strategy. It is a high-risk strategy, but not necessarily a bad one. Moreover, there are plenty of investors who do quite well with it. The key is learning how much to pay for properties and how to accurately estimate rehab costs. Figure that out and you will not have to hit up your lender for extra funding.
