Skip to main content

Control Your Money, Not Vice Versa

A few weeks ago, I wrote a post very similar to this - in fact, some aspects are identical - but I'm putting a slightly different twist on it to alter the perspective by a tad.  

Whenever I meet a real estate investor who likes to take the fix-n-flip approach, I always ask why they go that route rather than subscribe to a buy-n-hold approach.  There are different answers to that question, but they all seem to have a common thread running through all of them: "I need the money to go out and buy another house to flip."  Sure, most people have a limited supply of cash on hand, so that makes sense.  With that said, there are three options EVERY real estate investor should know about - but, usually, they only know about the first one.  Let me set this up:

Real-life example: the property in question costs $77,000 to acquire and $18,000 to rehab (total cash put out equals $95,000).  The property then can sell for $135,000.  Ready?

Traditional Fix-n-Flip
• $135,000 Sell price
• Get back total $95K put out (acquisition & rehab)
• $17,225 Profit (after costs of sale & short-term capital gains taxes)
• 18.1% ROI

Immediate Cash Out (0-6 months)*
• $135,000 Appraised Value
• Get back $77K
• Earn $435/mo in passive income
• 29% ROI in the first year
• No short-term capital gains taxes

Delayed Cash Out (Wait 6 months)**
• $135,000 Appraised Value
• Get back $101,250
• Earn $295/mo in passive income
• ROI is INFINITE – In 6 months, $6,250 in profit
• No short-term capital gains taxes

Any questions?  Sure, some of you are probably wondering how I came up with some of the numbers outlined in the scenarios listed above.  Buckle up, because here we go:

Traditional Fix-n-Flip Option
The costs of the sale tend to be approximately 10% of the sell price.  In this case that would be $13,500 – these costs consist of commissions, seller’s costs, and concessions.  After subtracting out the costs of the sale ($13,500), the cost of acquisition ($77,000), and the costs of the rehab ($18,000), there’s a profit of $26,500 of which 35% ($9,275) will go to short-term capital gains taxes for an overall net profit of $17,225.  Dividing $17,225 by $95,000 (the costs of acquisition and rehab) yields an ROI of 18.1%. 

PROS 
  • all costs were recouped
  • a net profit of $17,225 was made
  • there’s no further obligation  
CON
  • no property has been retained that may appreciate in value

*Immediate-Cash-Out Option
Once the work on the house has been completed, an appraisal is ordered, and it comes back at $135,000.  The property can be refinanced at that point up to 100% of the acquisition cost, which is $77,000 in this case.  The monthly mortgage payment of $465 is based on a conventional fixed 30-year mortgage at 3.875% (4.893% APR).  The difference between $900 (the projected rental rate) and $465 is $435.  Multiplying $435 by 12 yields $5,220 in annual profit.  Dividing $5,220 by $18,000 (which was the investment in this case – the rehab costs) yields an ROI of 29% for the first year.  

PROS
  • a property has been retained that may appreciate in value
  • the cost of acquisition was recouped
  • avoid short-term capital gains taxes
  • no sales costs
  • an income-generating property has been established

CON
  • a mortgage requires obligation

**Delayed-Cash-Out Option
Six months after work on the house has been completed, an appraisal is ordered, and it comes back at $135,000.  The property can be refinanced at that point up to 75% of the new appraised value, which is $101,250 in this case.  The monthly mortgage payment of $605 is based on a conventional fixed 30-year mortgage at 3.875% (4.893% APR).  The all-in costs for this property were $77,000 for acquisition and $18,000 for rehab, for a total of $95,000.  The difference between what can be pulled out in the refinance ($101,250) and the all-in costs ($95,000) is $6,250 in PROFIT.  Because the money available to pull out through refinance is greater than the all-in costs, the ROI is infinite. 

PROS
  • a property has been retained that may appreciate in value
  • the costs of acquisition and rehab have been fully recouped with a profit
  • avoid short-term capital gains taxes
  • no sales costs
  • an income-generating property has been established

CON
  • a mortgage requires obligation
Everyone has a different set of circumstances and needs, and they change as life events and other things take place, which means that no one option above is better than the other.  They each have their advantages and drawbacks - it's up to you to decide which strategy you want to pursue, and you may implement a different strategy for different properties and for different goals.  And that's the reason I wanted to line out the three options - it's kind of hard to exercise an option if you don't know it exists.  

Comments

Post a Comment

Popular posts from this blog

An Age-Old Concept Reaping Future Rewards

W hy are social media like Facebook and Instagram so darn popular among real estate and mortgage folks?   Hint: the top reason might be an endless supply of memes, cat videos, and the chance to be snarky, but the other reason runs a VERY CLOSE second.   Give up?   Answer:   They’re free – and they really help even the playing field by enabling a one-person shop look and market like an organization who employs an army of wordsmiths and graphic artists. This new century is glorious, right?   With that in mind, let me re-introduce you to a centuries-old concept that is equally glorious – and can help IMPROVE the playing field for you, regardless of the size of your team: karma.   On the subject of “free”, I’m not suggesting that you work for free, but when you freely give of yourself and your knowledge, you’ll see a greater payoff, I promise! Recently, an agent came to us with a question: she has a client who is looking to sell his condo.   It...
Post a Comment
Read more

The Power of Doubt

We find ourselves in that weird week between Christmas and New Year’s – that week that feels a bit like the Twilight Zone where no one’s sure what’s real and what isn’t.   Because of that, most people tend to focus on one of two things: eating as much as possible or setting goals for the upcoming year.   The former is squarely focused on the present – how much can I stuff into my gaping maw at this very moment before I pass out and/or puke – while the latter is focused on the future.    Last week, before the Twilight Zone kicked into full gear, I read a short article that resonated with me, and I think it’ll prick up your metaphorical ears, too.   The author of the article is a gentleman who professionally trains Olympic athletes, and he highlights the talents of a particular athlete from the Philippines who is training to be a marathon runner.   He points out that this runner is not a professional athlete, nor does she receive any type of financ...
Post a Comment
Read more

Get to the Point (Posted February 29, 2016)

As you may have already noticed, there’s some amateur art included in this week’s newsletter.   While it’s certainly better than a crayon drawing that might grace a refrigerator that’s supposed to be “mommy” but looks more like a B-movie creature, we all acknowledge there’s a reason the guy in our office who drew this . . . i s still working in our office rather than making a living elsewhere.   Be that as it may, there’s a point to the picture: is this how you’re allowing your client to choose their mortgage company?   In many cases, it’s probably not too far off.   Agreed, it’s wise to stay on the right side of the law and be sure you’re never accused of “steering”.   With that in mind, many agents tell their clients that it’s completely their decision as to what mortgage company they use (and it is, of course) and effectively step back from the entire conversation – using the illustration to the left, they’re putting the blindfold ...
Post a Comment
Read more