Why Gap Funding Is Difficult

[Ryland Taniguchi]

If I were to start real estate all over again with no credit and no money, I would start by getting awesome at finding deals. 

I systematically find deals by systematically driving for dollars. I have detailed my approach to marketing in other sections. We have direct mailers, door-knockers, secret niche strategies that few know about, etc. 

If you can find a great deal for a flip or BRRRR, you can borrow Gap funding from a private lender. If I were starting all over, I would do a HML first and get a 2nd gap fund at 20% and 5 pts.

But here is the challenge. On a 12% HML first, you maybe paying let's say 3 pts. Then if the project sells in 10-months which is not uncommon in my market where permits can take way too long, you pay an addition 4 pts in extension fees. You pay 1% per month in interest on the first mortgage. It costs 8% of ARV for every six months that you sit on hard money. Very little room for error. If you take out Gap funding at 20% and 5 pts, you room for error shrinks even further.

This is why I prefer BRRRR over flips. On a flip, the room for error is tiny. Speed and velocity are paramount. Very hard in my market where construction is in such high demand. On a BRRRR, I have 10-15 years for my returns and a couple of delays won't kill me.

Anyway, with a HML first and a 20% 2nd Gap funding the holding costs may eat up your profit if you don't turn that property fast. Your looking at a blended cost of capital around 24%.

When I run my hedge fund, we get a blended cost of capital of less than 5% using a credit facility/warehouse line based on Libor at 3.25% currently blended with the targe returns of the fund at 8% (10% to 11% if interest is compounded). From experience, it is hard to make money if your blended cost of capital is 24%.