It starts with our system giving us a “Green” light or a “Red” light based on 4 values of the property:
- After Repair Value (ARV)
- Rehab Cost (Rehab)
- Length of Rehab (months)
- Market Rent (rent)
We first calculate the maximum purchase price for the property based on the following equation:
- Maximum Purchase Price = (ARV – Rehab) x 70%
Example: for a property with an ARV of $100,000 and rehab costs of $15,000, the maximum purchase price would be ($100,000 – $15,000) x 70% = $59,5000. The property also has to have a rent to ARV ratio of at least 1.3% ($100,000 ARV must rent for at least $1,300 per month). We are finding properties in the Midwest and South all day long that meet these criteria. They are in C-class areas, which are our preferences due to the ability to hold their rent amounts during a bad economy. Once we have the two “Green” lights for both the flip and the buy and hold, we do our due diligence to verify the assumptions and use very specific processes that manage our risk for flipping a property (over estimating ARV and underestimating the Rehab costs and timeframe).
3 Interconnected Companies
The Finance Company: Our finance company issues the 1st mortgage loan (30-year fixed amortized assumable loan at a 10% annual rate with 4 points upfront at 70% LTV of the purchase price) and the 2nd mortgage loan (30-year fixed interest-only assumable loan at a 12% annual rate with 4 points upfront that covers the remaining down payment, the closing costs on the purchase, and the rehab costs) to the flip company (the borrower).
The Flip Company: We use 100% financing for the purchase, rehab and closing costs, so we cover upfront out of pocket costs, points on the 2nd mortgage and 6 months’ worth of holding costs. We come in highly leveraged with less than 10% of the total project costs. We buy at a discount, rehab and flip within 6 months. We generate at least a 25% cash-on-cash ROI on our cash within 6 months. If we can’t sell the property retail (at ARV with full sales commissions) or wholesale (below ARV but above our costs using For Sale By Owner), we sell the property to our buy and hold company by assigning the loans to the buy and hold company and transferring title (no escrow, limited paperwork and takes one day).
The Buy and Hold Company: Our buy and hold company pays the flip company its out of pocket cash costs plus at least 25% profit. The buy and hold company has already calculated that it can rent the property at 90% of market rent and still generate at least a 10% cash-on-cash annual ROI after taxes. The buy and hold company has 3 months’ worth of holding costs to find a tenant and expects to pay a month’s worth of rent to acquire a tenant. It considers the financing costs of the assumed loans, a 10% property management fee, and deducts 5% of the monthly rent for a vacancy rate and 2% for maintenance costs and capex, which all go into a reserve account.
We rolled this system out in April 2017 and have our first property in Tulsa, OK under contract using our Worst-Case Scenario assumptions: