Tips for Flippers in a Changing Market

[Nghi Le]

I just wanted to give some thoughts from both an investor and lender perspective, especially for those in WA state where the market has been changing. I've been seeing a lot of refinance requests to get out of hard money (and paying ridiculous extension fees and default rates). So here are some tips to not get into that situation:

1. Get at least a 9-12 month loan, and know your HML's extension policy upfront. This doesn't solve the real problem, but it makes it so much less painful when you're in a rough spot at the end of your loan. Most of the lenders in the Seattle area will charge a pt for every 45 days (or 2pts for 3 months) to extend. Some are worse than that. Some also put you in a higher interest rate while paying extension fees. I know someone paying $800/day right now (for one property). I find that the typical break-even point of "Should I refinance out of my hard money loan into another one?" is typically 3 months. You can normally get a 1-yr loan these days (at a lower interest rate) for 2pts, whereas it often costs 2pts to just extend for 3 months.
A 5-6 month loan no longer works because things are taking longer to sell. Also realize that so many things are out of your control during a flip. My favorite story to tell is a flip that we did where a homeless encampment moved in right when we listed. Who would have thought that the church nearby that owned an empty lot across from our flip would turn that into a home for tent city?

2. Have multiple exit strategies (and be prepared to execute on them). If you had to keep a flip, could you afford to? Does your credit/income allow you to? We've been through some rough times with our flips, but our day jobs helped us refinance them if needed. Our favorite strategy if a flip couldn't sell (or couldn't sell at the price point we needed it to) was to lease option it. Or sometimes you have to turn it into your new primary.

3. Buy right. My old simplified rule for flips used to be purchase + rehab have to be no more than 75% of ARV. On my out-of-state projects, it was 70% of ARV. In this market, I'm dropping both 5% to 70% / 65% (but at the same time shifting more towards cash-flow deals). Adjust accordingly for your own experience level and risk tolerance.
I still see people buying at 80%. Please realize that closing costs (buyer/seller, realtor commissions, excise taxes, etc) are already 10%. Loan fees (points, interest, junk fees) and holding costs (utilities, insurance, taxes, etc) are usually another 10%, especially in a slower market where you're holding onto things longer.

4. Don't over-leverage. The fad over the past several years has been to flip with 100% financing using gap funding. We bought into that fad in the beginning as well, but it's a strategy that doesn't work in a flat or recessive market. Engaging in partnerships is probably a better option, especially if the partner has the income/credit to bail you out if you need to keep the property, or the experience to minimize your mistakes.

5. Realize that flipping is a cash-intensive business. If you have just enough money to do a flip, you don't have enough money. Most flippers, whether you've done 0 flips or 50 flips, often go over budget and over time. The last crash happened because people who had no right buying a house bought one, and maybe now it will be caused by people who have no right buying a flip... (being a little dramatic here)

[Jeff S.]

I'll add another. Be realistic on your expected sale price and don't get greedy. For a number of years, in our overheated market, many flips sold for well above the ARV initially estimated when the property was purchased. This became a windfall for some and I think a lot of rehabbers thought the trend would continue forever.

Now that prices are flat to dropping, those who had stars in their eyes are now realizing they will only earn a fair profit at best and in some cases will be lucky to get out whole.  Others, who don't believe it could happen them or that somehow they are different, think the market will support unrealistic expectations and they continue to overprice their properties.  Here, greed causes them to chase the market down as prices fall, while their properties sit unsold.

It's important to understand that you don't set the sales price of a property -- the market does.

Jeff S. -- Private Lender in Los Angeles