How to finance the rehabbing of a Buy and Hold Investment?

Question

Hey BPers!

So I recently checked out a duplex (2 3bd/1ba units) that’s listed at $220k, but requires a great deal of work given its age. For instance, the seller has already agreed to credit the cost of rewiring the house back to the buyer, as it’s 70% knob-tube. After running several pro forma scenarios, I’m highly confident that this property will cash flow after rehab.

I’m going back with both my contractor and electrician (both of whom are family members offering some of their precious time) this weekend to inspect the home and prepare a fair market estimate/scope of work. From what I’ve seen so far, both kitchens and bathrooms will need rehabbing, new electrical, outside paint, etc – I’m estimating around $30K in rehab, but of course this is subject to change.

My Question:

Let’s assume that the house does in fact require $30K in rehab and the seller is willing to come down on the price significantly (because he knows there’s a ton of work required, he just doesn’t want to do it) – let’s say we agree on $190K. I’d be happy with this figure, but, I would be left with very little cash for the rehab after paying down payment/closing costs.

What are my options for being able to creatively structure the deal in order to come up with the needed rehab cash? As this is a motivated seller* (more on this below), I’m thinking I can perhaps take a conventional loan for $160K, and have the seller loan me $30K (a la partial seller financing) on a 4-5 year balloon note amortized over 30 years (in 2nd position). Is this even realistic? How can I make this attractive to the seller? I’m assuming he has a significant amount of equity in the home, but, what is the best way to verify this as I am working with his agent (dual agent)?

*This is a motivated seller who has not been able to move this property for nearly a year – he inherited the property from his mother, is currently having it managed by a 3rd party management company (which is doing a TERRIBLE job) and he just wants to get out of it. He’s currently renting the units for $1150 each, while market rents for such units is easily $1600-$1700 rehabbed.

Thanks to everyone in advance!

Desi Arnaz · Answer

My suggestion is to consider using the FHA 203K program. this is a program that funds the acquisition & renovations in one loan.

Find a good Loan Officer.  Make sure that he/she has done the program at least a few times in the past.  Their experience will save you a ton of grief.

Good Luck.

Desi Arnaz

Greg N. · Answer

Hey @Dillon Loomis - Yes I plan to live in one of the units throughout the rehab. Goal is to move out with 18-24 mos.

The @ feature is a bit finicky on this site. Usually you have to type @[part of person's name] and wait 3-4 seconds for some options to display below.

Greg N. · Answer

I finally have an update my friends!

After checking out the house with my contractor again (and another follow up meeting after that), I decided not to move forward with the house. I did this for a couple reasons, but mainly because it would have been way too much of a project for me to take on, especially having no experience in RE investing. While the numbers did work out (on paper at least), it just came down to my personal style. My idea of investing was to have fun, and not make this a miserable experience by taking on too much and potentially running into major pit falls.

I kept searching around the area and ended up finding a beautiful duplex that required much less work. After negotiating with the seller for 2 weeks, I finally got the house under contract with a closing date targeted for mid November!

Here's what the numbers look like more or less;

Purchase Price: 205K

Rehab Cost: ~4K (Mostly cosmetic)

Unit 1 Rent (2b/1ba): $1250 (occupied by me for the next year)

Unit 2 Rent (3bd/2ba): $1350

Cashflow (once fully rented): ~$300/mo (using very conservative expense figures)

Next steps - Now I have to focus on setting up a solid lease agreement and researching how to become an effective landlord. Cheers!

Will Stewart · Answer

I'd go with @Anthony Joseph Kendall II and say use the credit cards. anything you can't put on one, i'd use either personal money (if you can) or look at Lending Club for a personal loan of like $20k. Get one unit ready and get the stream of income flowing. I've done a 203k, it works, its just a LOT of headaches and i'd avoid it if you can.

Good luck, keep us posted.

Greg N. · Answer

@Anthony Joseph Kendall II Haha that sounds pretty wild, and I'll definitely keep that in my toolkit. By the way, that could turn out to be a pretty sweet deal if you use an airline/cash back rewards card!

Adam Anderson · Answer

There's is a new version of the 203k loan that allows you more flexibility to do the work yourself.  I have a good friend who does both residential and comercial lending and is always talking about it. He's doing quite a few of them here in NJ.  Anything 4 units and under is considered residential. He's done 1/2 a dozen Loans for me and works with lots of investors, I'd be happy to introduce you if you want....pm me

Adam

Greg N. · Answer

Hey @Tom S. - I was trying to be conservative with my $30k, but I won't know for sure until this weekend when I get it checked. I have a feeling it could be more like you said - which will get factored into my offer.

I'm definitely going to check out some local banks as I'm doubtful an equity line is even in question in my case. I see a lot of googling/calling local banks in my near future - hopefully I can work something out.

Thanks for the input!

Greg N. · Answer

Hey @Darren Sager - thanks so much for chiming in! Could you elaborate more on your statement the 'other options of financing improvements within the same loan'? Do you mean that other lenders (e.g. smaller community banks) can put together a quasi-203k loan that allows you to use your choice of vendors?

Also, your point of necessary improvements, is something I completely overlooked. Thank you for that. I could have see myself going way overboard with the initial rehab, but you specifically calling that out will make me think twice.

Tom S. · Answer

@Greg N.

Greg - I've done a number of gut rehabs and think if you're doing a true gut rehab, the numbers will be higher..my average is about $40/SF - so $60k on a 1500 SF house.  If you're not completely opening up walls then it could be less.

Regarding financing, I don't think the option of closing on it and immediately getting an equity line will work, because they're going to use the lower of purchase price or appraisal.  So if you paid $190k for it, it's now worth...$190k.  Maybe in 6-12 months you can get it re-appraised.

If it's a rental, I've had good success working with small local banks that can provide purchase + rehab funding.  Shop around a lot.

Good luck!

- Tom

How to finance the rehabbing of a Buy and Hold Investment?

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