Working on my first deal, Need your suggestion,Cash buy Finance?

Question

Hi Guys,

I am new to the forums and am currently working on my first deal.  Here is the scoop, we found a home that we thought was currently owned.  Come to find out it is sitting empty and has been for awhile after a foreclosure.  I have pulled the comps with my realtor as well as done my own research and found this home will meet the 70% rule.  Here is the breakdown.

-1500 sq ft Home with 500 of finished attic space we plan to have included.  Over 50% is higher than 7' and will be finished out the same as rest of home with full bathroom.

- Neighborhood averages $136 per sqft for run of the mil homes, comp homes, modernized run on average of $165-$185.   We have 3 immediate, recently sold homes that were 1800-2000 sqft that sold between 250k and 290K with similar finishes done.

-I think i can get the home for $75k.  I have walked the home several times plus with my contractor.  I have put together a rehab budget of $128,500K.  I honestly think I can do this project for $100K Max once we get started.  I am know to drive a good bargain, while keeping contractors happy.  ( I own a non related business that utilizes sub contractors from time to time.)

-All said in done, at 128,500 I am meeting the 70% rule, anything below that will be on top.

Here is my dilemma where i need your experience.  I am short on cash on this deal.  I have 80K on hand my self, should i use my 80K to make a cash offer or should my offer be contingent on financing which i know without a doubt i am eligible for.  The home is being sold thru an auction an I know cash appears much better in this situation.  If i use up my cash then i will need to take a mortgage on the house or a heloc.  I have reached out to a few potential PML but since there experience with me is still new I am not holding my breathe here yet.  HML is too expensive, i will find other creative ways to get the deal done.    Thoughts on cash offer or financing?

Brad Fausett · Answer

Greg,

What I was wondering was should I use cash then refi against the home value.  I am buying the home under value, refi against the value should boost my cash on hand to renovate.

Thomas S. · Answer

Defiantly finance. The less of your own money in the purchase the better.

Sam LLoyd · Answer

Ok, I wasn't sure from your post if the 128 rehab price included the purchase price or not.  If the 128 is in addition to the 75, that puts you at 203.  Based on working in real estate in general, and the one flip I did, the margin is not there.  If you get the 290, this is exactly 70% rule.  It's only safe to count on the lower number of 250, especially since your house might not be 'as normal' as others.  So, that would put your max purchase/rehab at 175... less the cost of purchase, that puts your rehab budget at 100k.  However, there is no margin for error in this.  I would take the contractor's bid of 128 and add 10%.... say 140, which would mean you have to purchase the house for 35k to keep under the 70% rule.  Looking only at the numbers, this does not jump out at me as a good deal.

As far as the home's value, you might run into problems getting it to appraise for 110 right after you buy it.  The bank is going to want to see a justification for the value going from 75k up to 110.  The biggest determiner of value is what people are willing to pay, and it will be obvious that you paid 75.  If you wait 6months or a year, you'll be able to tell the bank believably that the value rose over time, or you affected changes that raised the value.  Also, in my experience, getting an appraisal after you start working on it will probably throw up red flags for the lender.  The appraiser will value things as unfinished or unsafe.  For example, at least in my area, if there is no flooring, the appraiser is going to say the building is in a state of construction... which is not financeable.  In my experience, the only chance of getting conventional financing is if you get it financed before you start tearing into things.

I'm not trying to put a damper on things, just pointing out some of the obstacles to be overcome.  Remember to have more than one exit strategy.  I hope these thoughts help.

Brad Fausett · Answer

Thanks Sam!

Can you clarify "Finance it for 75% of purchase price..... so you put in 80, borrow 60 back out.... use that to finish the house... with a budget back up to 140 for fixing and any overages"?    If I borrow 60K out I will come up short on the cash needed to get the project done.  You then mention with a budget back up to 140 for fixing and overages?  Where does this come from?

Another thought, the house should appraise for $110k or more, the refi would be based on the appraisal value and not what i payed for the house correct?  This method would actually boost my cash on hand by going this route then.

Sam LLoyd · Answer

This option jumps out at me.  Make that cash offer.. tie up the deal... this will go fast and with less problems.  Once you have it, since you're sure you qualify for financing, immediately get a refinance rolling.... Finance it for 75% of purchase price..... so you put in 80, borrow 60 back out.... use that to finish the house... with a budget back up to 140 for fixing and any overages.

The way I would do it (which might not be available to you), would be to purchase it with cash, then use interest deferred credit cards to finish it quickly and get it on the market... but this is not the best option for everyone.

One caution:  Be very careful using sqft for the value.  Unless you're comparing it to houses with finished attics, using a sqft value for an abnormal house could get you in trouble.  Even if it appraises at 250 because of the sqft... anybody with a 250 budget is probably going to lean towards a house with a normal floor plan, and you'll have to lower your price.