This post is provided by Matt Rodak, CEO of Fund That Flip, a real estate financing platform designed specifically for residential fix-and-flip properties. Experienced flippers partner with Fund That Flip to reach a large network of investors who are interested in funding their projects. Investors review all the details of each project online and can start investing with a minimum of $5,000. Fund That Flip’s platform manages the entire process making it simple for both the flipper and investor. Using “other people’s money” (OPM) as a strategy to grow your real estate businesses provides a multitude of advantages:
- You can do more deals with more capital.
- You limit your downside risk to the amount of capital you put into each deal.
- You create win-win opportunities for investors which can open doors to other business ventures.
- You create an opportunity to scale your business allowing you to grow into other asset classes if you so choose. (i.e. Single family, multifamily, commercial, retail)
- You can turn your successes into positive referrals from your investors to help you further your business.
There are several different sources of OPM and they generally fall into one of two categories: Debt or Equity.
OPM real estate deals structured with equity
Equity deals can be structured 1000’s of different ways depending on your relationship with your equity partner. Negotiating each deal will be specific to the person with whom you are partnering. Putting together a deal that is mutually beneficial will largely be a function of what each of you are bringing to the table (i.e. capital, sweat equity, relationships, experience, etc.) and how each of you will get paid (i.e. preferred returns, liquidity preference, splits, etc.)
Therefore, there is not a one-size-fits-all formula for how to negotiate these types of deals. It is always good business-sense to involve a competent attorney to protect both partners’ interests as well as your relationship with one another.
I see many deals set up with the money partner getting 50 percent of the profits and the partner finding the deal, doing/hiring the work and selling the house getting 50 percent.
OPM flipping deals structured with Debt:
Debt, however is rather straight forward. A lender will agree to make you a loan for a fixed rate of return in exchange for some collateral, usually the asset the loan is being taken out for. You will pay back the agreed upon interest and principal when the note expires. You’ll find a comprehensive piece on this blog about Hard Money, Private Money and Portfolio Loans, which I’d encourage you to check out to learn more about the different sources of debt financing.
In most cases, the lender prefers not to “own” the underlying asset. In other words, they prefer to earn their agreed upon interest and have their principal returned when due, and not have to foreclose. I say “most cases” because there are a few Hard Money Lenders who expect and hope to foreclose on some percentage of their loans as part of their underwriting and operating strategy.
Understanding when you are working with this type of lender is important as it will impact how they price and underwrite your deal. It will also impact how likely they are to work with you if the deal doesn’t go as planned.
How will a lender decide to give a loan to a flipper?
For the purposes of this article, let’s assume the lender has no interest in owning your asset and is hoping for the same thing as you; a successful flip! So what is the lender going to look at when determining whether to give you a loan? While I can’t be sure how every lender underwrites their deals, there are some basic industry best-practices that every lender follows (or should follow) to some degree.
Here’s the most important thing to remember; lenders are looking for reasons to NOT give you money. Show too many negative indicators and you will likely not get funded, even if the deal is good. So how do you make sure you minimize negative indicators and maximize your chance of getting a loan?
How can you impress a lender enough for them to give you a loan?
At the end of the day, a project is only as good as the operator’s ability to execute. Here are positive indicators you can send to your lender:
- Demonstrate experience.
- If you’ve done similar deals before, find a way to highlight this through a PowerPoint Deck or other documentation. (At Fund That Flip, all of your past deals are maintained on your profile for easy review.)
- If you’re new to the real estate investing world, demonstrate that you have experience in other fields that will make you a successful real estate investor. Perhaps you’ve managed large projects at your day job?
Find a way to show that you are a qualified operator of your business. Feel free to get creative with this – but always be honest!
- Demonstrate Professionalism.
- Have an updated LinkedIn profile and ask for references from your network.
- Have an @mycompany.com email address (not Gmail or Yahoo).
- Create an email signature that is professional looking – a logo is a plus.
- Take time to spell/grammar check your emails.
- Submit information to the lender in an organized fashion.
- Be timely with your responses and give direct answers to questions.
Just as you prefer to deal with professional contractors, real estate agents, title agents, etc., lenders prefer to deal with professional borrowers.
- Have Your Finances in Order
- Most lenders required some down payment. You’ll need to demonstrate you have these funds.
- Your credit will likely be checked. If less than a perfect score, disclose this early. Many times it’s not a deal-killer and the lender will appreciate the forwardness.
- You’ll need capital to pay interest payments, prepay for rehab work (if on a draw schedule), pay taxes, utilities, etc. Be honest with yourself on how much you’ll need and be sure to demonstrate to the lender you’ve thoroughly thought this out and have the funds to successfully complete the project. Here is a great article on how much it costs to flip a house.
Choose a lender that specializes in your loan type
It’s important to find a lender that makes loans for your type of deals. Certain lenders have identified markets that they prefer to lend in. Despite this preference, they may advertise to be a “one-stop-shop” for all real estate loans. Most aren’t, and trying to work with them will be a waste of your time. Get to the truth about whether they support your type of deals. Here are things to ask you lender:
- Get a copy of their underwriting or lending standards.
- What Geography do they lend in? – Some are national, state, or as small as one zip code. Be sure their geography aligns with your strategy.
- What type of loans do they typically make?
- Some are only fix-and-flip while others have the capability to do commercial. What’s their focus and which type of loans account for most of their business?
- This is important because if your loan type is a small percent of their book, they are less likely to get comfortable with it as they have less experience with these type of loans.
- Find a lender that is making a lot of loans that are similar to yours.
- How much capital do they have access to and what percent is currently loaned out?
- There’s perhaps nothing more frustrating than going through the entire underwriting process to find out that the lender has just reached their max capacity and will be unable to make you a loan.
- If the lender is running at a high utilization rate, ask if they are able to earmark the capital you need so that it won’t be used in other deals while you go through the underwriting process.
How the deal is will impact your ability to get OPM
In asset backed loans, the deal is one of the most critical components of the underwriting decision. I put it last because if you don’t put a good foot forward personally and you pick a lender with the wrong appetite – it won’t matter how good the deal is. Once you get to this point here’s what lenders are looking for.
- Skin in the game – How much capital are you bringing to the deal? There is a balance here of achieving enough leverage to make the process worth it for you and enough capital that the lender knows you’re committed to completing the project successfully. Most lenders want you to contribute 10-20% of the purchase price to the deal.
- Downside Protection – A lender, usually does not participate in the upside of a project. Therefore, they don’t care if you make $20,000 or $200,000. That said, the less margin in the deal the higher the likelihood that something could go wrong to turn the deal upside down. The more you can show how you are mitigating risks to protect the downside, the better likelihood you’ll get your loan.
- Exit Strategy – In order to pay back the principal, you’ll need to have a plan to either sell the property or refinance it. Be clear what your strategy is. Lenders don’t like to hear “I’m going to try and sell it for 3 months and if it doesn’t sell I’ll just refinance it and rent it out.” There are too many assumptions here and additional underwriting that will have to be factored in.
- How are you going to refinance it? Do you have a lender lined up with a pre-approval letter to refinance you?
- What if you can’t rent it? How much can you sell the home for?
- Will rent cover your carrying costs? If not, do you have enough reserves to cover the difference?
If your strategy is to refinance and rent the home, have a clear plan on what that looks like going into the deal. Using it as a risk mitigation strategy doesn’t always fly with the lender, especially if the lender does not make or hold loans on properties that are occupied. (This complicates foreclosure proceedings, especially for lenders who have no interest in owning the asset).
What backup options do you have if the home does not appraise for enough to pay back the lender? Will you have enough equity to sell or enough reserves to absorb the costs?
Debt is a great way to scale your business. It is rather straight forward once you have a relationship with a lender that likes your type of deals. The process will continue to get easier over time as you do more and more deals. Understanding how your lender thinks will increase your likelihood of getting funding. Get to know your underwriters and most will be happy to tell you what their ideal loan looks like!