Getting Started In Real Estate Investment – Financing A Flip

About 3 months ago I decided I wanted to get involved with Real Estate Investing (REI), so I got a book from the library and started reading.  It turns out the RE world is a highly complex world!  Always up for a challenge, I was hooked.

Next I joined BiggerPockets.com, and joined the forums.  Experts there are quick to answer your questions with fancy jargon and confusing acronyms.  After a few weeks I decided that I didn’t have the time to be a landlord or to do all the work of rehabbing and flipping a home.  Hmmm, I was stumped.  How could I make money, learn new skills, and not invest too much time in this fascinating world of REI?

Before giving up, I decided to send out a few emails to a few random but active RE investors in Colorado Springs (found via Bigger Pockets). I asked each person if they were willing to meet with me, teach me, and maybe eventually partner with me.  I told them I had money,but no time.  About 2 hours later, I got an email from a woman  - let’s call her Julie.

Julie agreed to meet me at Starbucks the following morning where she would walk me through some deals she was working, how she analyses a deal, and answer any of my questions.  When we met, I learned about RE financing.  It turns out there are these crazy people (like Julie) that have dozens or even hundreds of homes at a time – some rentals, some flips.  And since they don’t all have millions of dollars in cash sitting around, they are always looking for unique financing options.  Banks won’t give someone 50 loans on 50 houses, so other financing options are pursued.  One of these methods is finding a sugar-daddy – this is where I come in.

Julie had some active deals she was pursuing, with one being a foreclosure purchase that she wanted to renovate and flip.  She had done a complete analysis of the house, the local market, and already had contractors come in and quote the work.  All she needed now was cash to by the home.  Since I’m writing this post, obviously I eventually agreed to finance the purchase – here was the analysis:

Purchase price was $76K.  Various fees for purchasing the house were $500.  Next, we calculated $33K in repair costs and $11.5 in closing costs and realtor fees.  The comps (comparable houses sold in the area) predict about $145K after repair value (ARV).  All told, this venture should net about $24K in 4-6 months.  (Realistically $150K is a more likely selling price).  We agreed to split the profits 50/50 with me doing 100% of the financing and her doing 100% of the work, so I would then make $12K on a $110K investment.  If it takes 6 months to sell, that’s roughly a 24% CAGR. There’s a good chance I won’t make that much, but a very small chance of losing money.  I consider this a good investment and compliment to my Brave New Portfolio.

The thing I liked most about the deal is that it has a large margin for error.  Even if repairs end up costing $40K, and even if the house disappoints and only sells for $135K, we would still be making a $7K profit (much smaller, of course).  Considering this money is the “cash” portion of my portfolio, even a 7K return is killer.

Want to see the dump house?  Keep in mind, we have $33K budgeted for rehabbing – so it’s a little ugly.

I told you, it’s got a lot of work ahead.  Fortunately, I don’t have to do any of it.  It needs a new roof, new garage floor, new heater, kitchen renovation, new paint work, and a whole lot more.  Should be fun to watch it improve. I’ll be honest, when I went to the house the first time, I immediately thought Julie was insane to think this house was worth $76K.  But she (and others) really have an eye for improvement.  She walked around the house with a contractor explaining the work she wanted done – it was creative, innovative, and artistic.  I was blown away!  Before we left the house, I agreed in principle to fund the purchase.

We closed on the house last week, so I’m now the official owner.  Well, sort of…

In my specific case, since Julie had already worked out the purchase deal with the bank, it was required that she be the purchaser.  Of course I don’t want to lend $110K without official ownership, so I needed collateral.  For this, I received a lending note and the deed of trust on the house.  Now, if she bolts – I would get the house – identical to how a bank owns the note and deed on your house and can foreclose if necessary.

If you decide to do something similar, I strongly recommend you set up a Joint Venture Agreement that states the details of the agreement.  In my case, the JVA states how much I’ve paid and how the profits and losses will be split.  It has a bunch of other legal jargon, but nothing noteworthy.  One thing I learned from Julie is that in the RE world you need to cover your bases.  Not that all RE investors are dirt bags, but some will take you for all they can.  Others are good people, but incompetent.  No different than other areas of life.

For renovations, I decided I didn’t want to set up an escrow (additional fees) so I’m paying as we go.  This allows me to check on the work before paying, which Julie agreed to.  According to Bigger Pockets, this is fairly customary.

My favorite part of the entire experiment so far was the closing.  Technically I didn’t need to be there, but since Julie knows I want to learn as much as possible she invited me along.  I walked in a bit late, and Julie introduced me to everyone.  The realtor immediately says “You’re the youngest hard money lender I’ve ever met. Usually they are grumpy old men.”  I thought it was great – I can add a little spunk to the RE circuit.

I’ll be honest, this has been the funnest side income experiment yet.  I’m learning a ton, meeting new people, and hopefully making a few bucks.  If this works out well, I’ll  be doing a lot more business with Julie. My long term goal will be to buy a house on my own and do 80-100% of the rehab myself (Scared of heights so there are a few things I can’t do).

Just like with Android apps, I’m not an expert.  But if you have questions or suggestions, let me know in the comments.

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46 Responses to Getting Started In Real Estate Investment – Financing A Flip

  1. [...] Read the original post: Getting Started In Real Estate Investment – Financing A Flip | Brave … [...]

    • 40Percent says:

      So where are you at with this now?

      • The deal is closed. I thought I had written about it before, but I can’t find it now…

        I ended up making about 7% annualized, once the deal was done. My partner ended up going over on the rehab, holding it on the market longer than we’d hoped, and selling for a tad less than we planned. Fortunately, all 3 variables were within our margin of safety, so we still made a profit.

        I wasn’t terribly satisfied with the deal, mainly because my partner, while honest and competent, simply had different motives. Since I had all the money in, she was motivated to get a higher price, even at the cost of holding it on the market longer. I, on the other hand, was only looking at my annualized return, so every day on the market meant we needed to charge MORE to make the same annualized return. It’s just not a good setup in hindsight, which is why I decided to go the more simplified “hard money” route for my next deal, which is in progress now. I’m making a guaranteed 12% annualized return plus financing fees with this new deal. I’ll be writing more about that here, once the deal closes completely and I get my check.

  2. Ooh, this is cool! So you’ll be able to tell us how it goes over the next 4 – 6 months?

    Most people I know who have renovated homes only did one at a time, usually the one they lived in. I wonder if that tends to be more expensive, because they pick a home that they love, not just because the repairs seem straightforward. Often these people find themselves throwing more and more money in on top of the repairs they originally budgeted for.

    Hopefully Julie’s expertise will overcome this kind of problem!
    Kellen @ Accountant by Day recently posted..October Give Away Week 2My Profile

    • I would be more worried about that if I didn’t see her in action with the contractor. She had a vision for the house that made sense, she was considering cost vs. value for each decision, and she had creative ideas that even impressed the contractor.

      As an example, the contractor pointed out that the railing would have to be replaced around the steps because it violated modern codes (the house is 50 years old). It would cost $5K. She suggested we instead replace it with a half wall instead, which would cost about $500. And it will likely look better to boot.

      Time will tell how good she is. If she’s not, I can look to invest with others,but I’m hopeful this will be a good relationship.
      Brave New Life recently posted..Getting Started In Real Estate Investment – Financing A FlipMy Profile

    • Chaz says:

      You note that houses in the area are selling for $75/sq ft and in another post state the house is only 1,000 sq ft above grade. Is the $75/sq ft based on total sq ft or just on heated living area (to which the basement doesn’t count)?

      Also, is your deed of trust in the amount of the purchase price or some higher amount that reflects your $33,000 loan for improvements?

      • The $75/sq ft includes the basement, which is heated and finished. The basement includes a living room with fireplace, a bedroom and a bathroom.

        The deed of trust is a recorded document that there is an outstanding lien on the house, the amount is not what’s important. This prevents my partner from selling the house, because the loan must first be repaid or I would need to agree to transfer the loan note. The note (separate document) is where the amount is documented, and that includes both the house principal ($76K) plus the money I lent for repairs.

        There is a third document, which is the Joint Venture Agreement. This is where we document the payout terms of any profit, specifically that I will be repaid the entire amount of the loan on the day of closing, then the percentage we will split all profits/losses.
        Brave New Life recently posted..On Becoming a MillionaireMy Profile

  3. Weston says:

    Not quite following why you aren’t co-owner of the house.

    I understand why Julie would have to be the purchaser, but it takes all of ten minutes after the closing for her to execute and record a quit claim deed from her as sole owner to you and her as joint owners.

    Is there some reason why you (or your lawyer) didn’t suggest this? There may be a good reason, just asking for my own edification.

    • Weston – Perhaps I just stated it wrong? (I’m still learning) I actually am the official owner despite what I stated above.

      My understanding is that we did do this by way of the Deed of Trust I mentioned above. In the Deed of Trust document, I am listed as the grantee and Julie is the grantor for this property. The DOT is registered with the county clerk, meaning if she tried to sell this house they would put a hold on it because they would see that I am the rightful owner.

      Please correct me if I’ve gotten this wrong.
      Brave New Life recently posted..Getting Started In Real Estate Investment – Financing A FlipMy Profile

      • Weston says:

        I thought a Deed of Trust is the equivalent of a Mortgage. Wouldn’t that make you the secured lender not a co-owner?

        Just asking questions, please don’t read anything into them.

        I assume that you had independent counsel representing you in this transaction. If you have any questions please consult with a licensed Colorado attorney if you haven’t already done so.

        I have no expertise in Colorado real estate law.

      • There are several documents in our deal:

        1. The loan note. My partner is the borrower, and I am the lender. This document highlights the terms of the loan like the amount, interest rate (0%), and payback schedule (when the house sells. It is signed by both of us and legally binding – no notarization is required.

        2. The deed. This shows ownership of the house. It has the grantee as the bank that we purchased from, and the grantor as my partner. This makes her the legal owner.

        3. The deed of trust. This document legally transfers the title to a trust beneficiary (me). It must be registered with the county clerk and notarized, and now I hold it as my physical security on the loan. If she fails to pay me back, I would keep the home.

        4. Joint Venture Agreement. This is an agreement of terms on the limited partnership. Think of it as an LLC for one deal. We could have formed an LLC, but this is easy, cheap (free), and is less binding. If she breaks the law on a deal and our LLC is found responsible, we would both suffer. With a JVA, only she would suffer. I would simply break our bind, take the house, and move on. The JVA lists how much I invested, that she is responsible for all labor, and that profits are to be split 50/50 within 1 week of selling the house.

        I should also admit that I did not use a lawyer for any of this. Although many people recommend one, I saw no reason to spend the money when one is not required and all information is available at resources like Bigger Pockets.

        As a CYA, however, I’ll recommend to any readers that they consider a RE attorney that specializes in their state because each state is different.
        Brave New Life recently posted..Retire By 35: September 2011 ResultsMy Profile

      • Weston says:

        BNL

        Does #3 also protect you from refinancing?

        Again, an act of curiosity and nothing implied about the deal or your partner. I myself don’t know the answer since I am a long way from Colorado.

        Just wondering if Party A loans 20k to Party B. Party B uses the 20k to improve the property to the point where there is now 50k in equity over and above Party A’s security interest. Can Party B strip the 50k in equity by doing a cash out refinance of the property without the knowledge and consent of Party A who holds a deed of trust but is not a title owner to the property?

      • Yes, it does. For any title transactions to occur (and the bank would want the title as collateral for a loan) they would need to register with the county clerk – which is where I’m protected with my deed of trust (also registered with the county clerk).
        Brave New Life recently posted..Getting Started In Real Estate Investment – Financing A FlipMy Profile

  4. Nice one! Getting into real estate investing is not an easy thing so I’m glad you did your homework (no pun intended lol).
    I’d like to hear how it goes. I hear stories all the time about how rehabbing often goes over budget. That’s my primary fear of getting into the flipping market.
    Financial Success for Young Adults recently posted..Why Your Degree Means NothingMy Profile

  5. Squirrelers says:

    This is pretty interesting. Looks like you’ve got a pretty good margin for error, assuming this price point is solid and that prices don’t decline further.

    The rate of return, in terms of potential here, seems pretty good compared to other alternatives. I’ll be curious to see how this project develops for you, and how things go throughout the process. Certainly worth follow up posts on your part!
    Squirrelers recently posted..Emotions, a Mortgage, and a New Baby: What Would You Do?My Profile

    • I think the price point is pretty solid. Most houses in that area are selling for $75 per sq ft. and this house is 2000 sq ft. And most of those houses aren’t fully and recently renovated, including a new roof, new kitchen appliances, and new furnace.

      Then again, I could be totally wrong. I’ll be honest, this has been more about learning a new skill, so any profit at all will be satisfying.
      Brave New Life recently posted..Getting Started In Real Estate Investment – Financing A FlipMy Profile

  6. Weston says:

    BNL

    Just wanted to compliment you on this posting. Many personal finance bloggers seem to spend a lot of energy trying to look like experts on a topic.

    Your willingness to post from the point of view of “I’m a beginner at this but I’m plunging in” made the posting informative and human.

    It was a refreshing change of pace and I learned a lot. Particularly from your responses to my comments.

    Well done.

  7. Mrs. MM says:

    This is fascinating! I’m very interested to see how it all turns out.

    I must admit that the whole thing makes me nervous, but it sounds like “Julie” knows her stuff and that she’s done this many times before.

    As far as the documents go, it sounds like you’re the lender and could foreclose on Julie if needed, just like any other bank that lends out money for a mortgage.

    I am curious as to why you’re not charging any interest on the loan though…? I guess the potential profit is the reward. Also, did you request an appraisal or CMA (usually free from a realtor) for the house? Or maybe you know your market well enough to know it was a good deal?

    Good luck! I’ll be watching for updates. :)
    Mrs. MM recently posted..Avoiding Ivy League Preschool SyndromeMy Profile

    • Thanks for stopping by, Mr’s MM.

      This whole thing made me a little nervous too, which I think is what made it interesting to me. We could all sit around all day not taking risks, but what fun is that? If you were into that, you’d probably be in a cubicle right now instead of retired and hanging out with your kids… :)

      Actually, the risk is also what leads to higher returns. I realize this is an investment many people are scared to make – which means supply is down and demand is up – and you know what that means…

      The reason I’m not charging interest on the loan is because we chose to do this as partners, where my input is capital and her input is “sweat equity.” An alternative option that we did discuss was that I could have been a pure “hard money lender.” In this case I would have charged a very high rate, say 18% or so, and she would have paid me monthly until she sold the house. Then she would have paid off the loan with no penalty, and I would recieve none of the house profit.

      If this deal goes well, I may try a hard money loan sometime in the future. But since a big reason I’m doing this is to learn the trade, I wanted it to be a partnership. Because of our setup, I’ve been able to join in on meeting with the contracter, went to the closing, and now have a key to the house to watch progress. I send her emails regularly with questions guilt free since we’re partners and all.

      Also, hard money lenders just seem like old misers to me for some reason…
      Brave New Life recently posted..Getting Started In Real Estate Investment – Financing A FlipMy Profile

      • Mrs. MM says:

        Haha! Yup, you caught me… I’m not much of a risk taker (plus we recently got burned). It’s probably a good balance to MMM.

        It makes sense that you’re not charging interest and going for the gold instead with profits.

        Thanks for the response! I look forward to learning the risk-free way: through you. :)
        Mrs. MM recently posted..Avoiding Ivy League Preschool SyndromeMy Profile

  8. That’s amazing! I can’t wait to hear how it all turns out.
    retirebyforty recently posted..Gold As Emergency FundMy Profile

  9. I am definitely really interested in seeing how this goes. Maybe the silver lining of the bad housing market for a real estate person is that contractors are cutting their profit margins. Up here in Canada there is no way you could find people to repair a roof etc for that price. I know it really is all about location, but anytime you can get a 2000 sq ft house for that price, you’re right, it’s tough to lose much money. At the very least it’s a fairly low risk way to get your foot in the door with some real experience.
    My University Money recently posted..Would You Rather Be “Book Smart” or “Handy”?My Profile

  10. Jesse @ BP says:

    I’ve been interested in REIs since I first heard of them. I currently own a rental property and hope you have better luck with yours than I am with mine…
    Jesse @ BP recently posted..Do You Fit the Portrait of a Millionaire?My Profile

  11. Wow! how cool–you’re doing what they do on HGTV and TLC–I love those shows!

    I can’t wait to see how it all turns out. Either way, it will be great learning.
    Amanda L Grossman recently posted..Retail and Manufacturer Competition: When Consumers LoseMy Profile

  12. [...] This explains why I’m splitting my time reading about economics and investing, writing, investing in real estate, writing Android apps, running an online business, and being a dad/husband. And I want to get [...]

  13. Jack says:

    And Julie will pocket all the discounts on all HW bought, at least 10% of the 33k, most likely much more. She will always come out with a profit, and you might not. Shouldn’t the Suger daddy concept work the other way around?

    • Yes, we are receiving discounts on some HW. But Julie provides receipts for all parts and labor before I release the funds, so I also benefit from those discounts.

      Of course, she could be receiving kickbacks and/or rebates after the fact- unbeknownst to me. But, as I see it, I need to analyze the deal as it pertains to me. As an investor, I’m investing in her business. She needs to make me money, just like a corporation needs to make money for its stockholders, otherwise I’ll walk away. If I’m satisfied with my risk/reward ratio, I don’t see how anything else matters.

      It seems like your comment is comparable to choosing not to invest in a stock that has consistently high returns because you think they might be paying their executives too much money.

      BTW – what do you mean by “Shouldn’t the Suger daddy concept work the other way around?” If there’s a situation I can improve, I’m ready to learn.
      Brave New Life recently posted..Yes. I’m Doing A Giveaway.My Profile

  14. Before I read this post, I never imagined that anyone would connect with and trust another person they met on the internet with their money. Obviously, I need to get back on biggerpockets and start posting more…

    I’m glad to see a blogger talking about alternative RE investing. You don’t always have to be a landlord: there’s a million ways to invest in real estate.

  15. [...] partnership with a local real estate investor who was seeking money to purchase a distressed house.  I invest the money, she does the work, we split the profits.  An distressed house is now a livable one, and a family [...]

  16. jlcollinsnh says:

    great post and I love the attitude of it being a learning adventure. my bet is you’ll do fine and have more cool stories to boot.

    Awhile back I had a pal who was planning to buy a farm in Zimbabwe. 150k. because of the political risk there were screaming bargains to be had.

    This is a guy who’d traveled there several times and who ran a business in Liberia, so he was a bit of an African hand. After our discussions, he decided to walk away. months later the government confiscated all the privately held farms to redistribute the land. so he dodged a 150k bullet.

    meanwhile, I was busy losing 150k in tech stocks. no story and not much learning there…

    We should have bought the farm. ;)
    jlcollinsnh recently posted..How to Give like a BillionaireMy Profile

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  19. [...] of the readers here weren’t around back in November 2011, so you may want to go back and read this post where I discuss my first ventures into real estate investing via financing home rehab projects. [...]

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  28. Amber says:

    What type of legal agreement was drawn up between you and Julie before you funded?

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