Hard Money Loans for Retail Flip Properties?

Question

I know hard money lenders often loan on rental properties, and the difference between the loan/other expenses and the rent is the cash flow.

But do hard money lenders ever loan for a retail flip? That is they loan on the house, you rehab, and sell it back? Not sure how that would work out with the loan and having to refinance out etc.

Thanks for clarification?

Bobby Gerry · Answer

Hi Samantha,

Before calculating the profit on a flip using a hard money loan, the best thing, I think, is to calculate the profit on the flip as if you were buying the property with 100% of your own capital and then paying for all the rehab and carrying costs yourself as well. There are probably some posts here on BP that show all of the costs involved with that. The profit is calculated as the sales price minus sales commission minus rehab costs minus carrying costs (property taxes, utilities, etc) minus purchase price minus any title company charges (recording, title policy etc).

Once you have all of that down, and the profit margin looks good, then I’d go ahead and calculate the profit margin net of the hard money loan. Each lender is going to have their own particular costs, but I think generally speaking just take the points and interest on the loan and subtract that from the equation above.  Then you have your net profit on a property using a hard money loan.

Regarding being unable to sell a property:

Yes, this is one of the risks to your profit margin. If you cannot sell a property before the loan comes due (usually around six months), it will probably be necessary to roll the hard money loan into another hard money loan which will mean another set of points. That gets expensive.

If I can, let me add a couple of items here from my own experience.

I’ve been lucky enough to have been flipping properties for a few years now and coincidentally I also now run a hard money lending business. I’ve seen both the debt and the equity side of this business.

From my own experience originally as a borrower, here are 3 key items to remember.

1) The deal must be good enough upfront that you can bring the property to market for a little bit less than what other properties are currently selling for in the subdivision. This means I wouldn’t use hard money to try to upscale a property. By upscaling I mean adding lots of expensive improvements and then trying to sell the house at the high end of what properties go for in the subdivision.

2) I would plan at the start to get the property out the door in less than 6 months. This means the rehab must get done fast, fast, fast because I’d want the property on the market quickly, usually no more than three weeks after I took out the hard money loan. I always have to remember that the buyer is going to need about a month to close, so even if the property is under contract in 4 months there’s another month before it can close.

3) I always want to make sure to call the banks that provide pre-approval letters to make sure that a potential buyer is really going to be able to close if I let them put the property under contract. There’s nothing worse than having a property fall out of contract because the buyer couldn’t actually get the financing. In this sense I became like a banker myself. I got actually got into the kung-fu of what the banks do to underwrite both a property and a borrower so I could make sure that the borrower and the property were going to actually qualify for the loan before I let the borrower put it under contract.

Lastly, I would say to anyone working on their first flip: Do not use hard money for your first flip. The learning curve in dealing with new contractors etc is most likely going to be too steep to get the property done and out the door in 6 months.

Therefore, for a first flip, I would suggest finding an equity partner. An equity partner will fund the whole deal for 50% of the profit at the end, and if you go over six months there’s no penalty. Getting all the learning done with an equity partner first is safer and easier in my opinion. Then once you have the system down you’ll be ready to try it with hard money.

The great advantage of hard money is that once you have an efficient flipping system in place, the cost of capital for a hard money loan is less than the cost of capital for a full equity partner.

That’s pretty much it! I hope this helps!
Best, Bobby

Bobby Gerry · Answer

Hi Samantha,

Most hard money lenders would actually prefer to lend on a flip rather than on a rental, but before explaining why, let me go over a bit of background here just so we can be on the same page.

There is always an exit plan in place for a hard money loan. The exit is defined up front and is a key basis for making the loan to begin with. If there is no exit (such as in financing for a long-term rental) it’s probably not a hard money loan.

There is usually only one of two reasons to take out a hard money loan to start with.

1) For purchase and rehab capital for a property that cannot be financed by a bank because it is an investment property, needs work, is vacant, and won’t be occupied by the owner. Hard money lenders step in to finance these deals for an investor.

2) Speed of funding.. Even if a bank would finance the above deal, the underwriting process will take a number of weeks. A good deal isn’t going to sit around waiting for 3 to 4 weeks for an investor to get a non-conventional bank loan. However, hard money lenders step in to finance these deals quickly for investors.

With the above said, a hard money lender will usually prefer to lend on pure flips. With a pure flip, the exit is clearly defined upfront, and, for a single-family property, the flip from purchase to sale takes place in usually no more than 6 months.

A hard money lender will also lend on a rental property when the exit for the borrower is to refinance out of the hard money loan into a conventional loan when the property is rehabbed and stabilized (usually already rented out). In those cases hard money lenders will want the conventional lender to make a commitment to make the conventional loan before the purchase transaction takes place. In these cases, the conventional lender agrees in principal to make a loan on the property once it is stabilized, and the hard money lender originates its loan to then purchase the property. The hard money lender makes sure that the bank starts its underwriting process right away as the goal of the hard money lender is to be cashed out within about 6 months.

So, in a nutshell, those are the two main hard money scenarios for investors. One is a pure flip, the other is purchase and rehab money for a property that will be turned into a rental.

In some cases an investor may want to hold a rental property in an LLC and not in fact apply for a conventional bank loan to finance out of a hard money loan. In these cases, the investor finds a different financing source to finance a portfolio of rental properties. Strictly speaking, these are not hard money loans. They are longer term business loans secured by the rental properties. They are usually a bit higher yielding than conventional banks loans on rental properties, but the loans themselves aren’t really hard money loans. The capital may start out as a hard money loan for purchase and rehab, but then the capital refinances into one of these LLC business loans.

I hope some of this might help!
Best, Bobby

Nathan Emmert · Answer

Don't forget your closing costs.

Most do it something like this:

Sales price - 10% - purchase price - rehab costs - carrying costs.

Samantha M. · Answer

Bobby Gerry Thank you for the insightful response Bobby, that must have took a great deal of effort and I really appreciate your response.

Just one additional question. If the exit strategy for a property with the hard money loan is for a retail flip, how is profit for the investor calculated? Is it simply the difference between the hard money loan and its interest and whatever the house sells for?

For instance hard money loan + interest is $85k, house sells for $120k, investor nets $35k profit, in simple terms.

The other important point here is if the investor is doing a retail flip, and they are unable to find a buyer. They will be stuck in the hard money loan.

Bill Gulley · Answer

2 minutes apart Nathan, LOL

Transactional lenders may be more appropriate for you as they look to points and fees earned in the short term for yield rather than holding at an interest rate. It will cost you too!

You might consider a money partner instead to front the flips until you get your feet wet and build up some reserves to obtain financing yourself from a conventional lender/broker.

Nathan Emmert · Answer

Samantha, you seem to have things backwards.

Most HM loans are going to be anywhere from 6 months to 2 years in duration, at least from what I have seen.  They will almost all require you to have an exit strategy of either selling or refinancing quickly to get them out of the game.  They generate a good bit of their returns in the loan origination fees upfront, the points.  They want to recycle money quickly to increase their returns, they aren't looking to collect installment payments long term.

Rental properties generally get either conventional financing (15 - 30 years fixed) or after that's exhausted or otherwise unavailable, will go with private funding (generally a bit more expensive, shorter amortizations, and variable rates).  The cost of capital is generally significantly cheaper than Hard Money thereby increasing the cash flow on the rentals.

Hard Money Loans for Retail Flip Properties?

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