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Some markets also are still experiencing considerable downward pressure on prices. Arguably, it’s still a buyer’s market in many locations throughout the country. This results in many buyers being interested in a property only if they can get an exceptionally good deal — a circumstance that may be more difficult to achieve than many borrowers realize.
Finally, becuase of tighter underwriting guidelines from lenders, a sale’s average closing time has increased in many markets. These new underwriting guidelines also have decreased the eligible pool of borrowers — another condition that seriously undermines the profitability of the fix-and-flip model.
Consider the following example scenarios in order to illustrate the change in return on a fix-and-flip investment based on a change in the factors detailed above. A seemingly minor difference can result in a drastic difference in return. The following scenarios make no assumptions for financing costs and assume that the buyer purchases the properties with cash.
The first scenario assumes that all conditions align and that the buyer was accurate on all items. In this case, the rate of return would be approximately 23 percent.
The second scenario assumes that the property’s rehab costs are $15,000 higher than predicted. This is a common problem that can be caused by a variety of factors, including the need for a new roof, plumbing issues, electrical problems and so forth. In this scenario, the rate of return would be just 4 percent, a fairly low return given the risk, time and effort involved.
These two scenarios are relatively common in the fix-and-flip model. One major risk factor that’s difficult to calculate, however, is the span of time involved in a given situation.
Take scenario two, for instance, and assume that the additional repairs take several added months to complete. If the buyer needed funding for another fix-and-flip transaction, that buyer may be forced to drop the initial property’s price by as much as 5 percent. This action, however, would drop the return on the property down to -3 percent. Needless to say, the loss of 3 percent would not be worth the risk assumed for the investment.
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Although the fix-and-flip model can be lucrative, borrowers need to understand that current economic conditions are causing the risk of such an investment to increase while returns simultaneously are decreasing. In contrast, the fix-and-hold model is not as time sensitive — assuming that housing prices eventually will increase.
With that in mind, brokers and originators should educate their borrowers about the fix-and-hold model, which, in turn, can allow buyers to take advantage of future price appreciation while also minimizing their risk.
Glen Weinberg is the chief operating officer of Fairview Commercial Lending, a private wholesale direct hard-money lender.
He is recognized throughout the industry as a leader in hard-money lending. Weinberg specializes in funding residential and commercial hard-money deals in Atlanta (georgiahardmoney.com) and throughout Colorado (cohardmoney.com). More information on hard-money loans can be found at fairviewlending.com. Reach Weinberg at (303) 459-6061 or email@example.com.
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