What not to do on your next rehab project!
You buy a house for cash or with a small loan on it, your all excited to begin the rehab, you gut the house, start doing the work and then realize that you’re in over your head and don’t have enough money to complete the project. Sound familiar?
Too many rehabbers get into this position and find themselves in a panic. While the numbers going forward might make perfect sense, a lot of lenders (or at least experienced lenders) know the pitfalls of making a loan on a property where the work has already been started.
Here is what happened to one of my borrowers:
They purchased a property in Virginia for 210k and it needed just over 100k in repairs with an end value around 435k. They borrowed 50k from a private lender they knew and put 160k down in cash. From 1st look there were good numbers on this deal. So about 11 months ago they purchased the property and the day after closing, all excited, they began the demo and got to work.
They had all their estimates lined up and contractors ready to pull permits and put the house back together. They used their own cash to fund the bulk of the project and they got just about half way through. They were using their salaries to pay the rehab along the way, and they figured at that pace 5 months would get this property completed.
Mistake #1 – NEVER BUY A REHAB FOR CASH IF YOU DON’T HAVE ALL THE PURCHASE AND REHAB MONEY IN THE BANK BEFORE YOU CLOSE
About 2.5 months into the rehab, the husband ended up getting laid off and his salary which was going towards the rehab wasn’t there anymore. They didn’t panic at first, the work continued on the property as they tapped the rest of their retirement account to keep the project moving forward. Their thoughts were “if we could just finish and sell we will be O.K.”.
Now we get to month 4. The borrowers get a call from their contractor that they need to meet. He proceeds to tell them he is running way over budget. This sent them into a panic. They were just about out of money. So they told him to push forward figuring they would just figure it out. Unknown to them, the sub-contractors weren’t getting paid by the contractor in full, because the contractor wasn’t getting paid in full.
So now we have unhappy sub-contractors, a contractor not getting paid in full and borrowers out of cash. The borrowers decided it was time to get a hard money loan to finish this project. So they decided to call their “mortgage broker” that got them their FHA loan on their home several years ago.
Mistake #2 – THEY CALLED THEIR HOME LOAN MORTGAGE BROKER TO GET A HARD MONEY LOAN. THIS IS LIKE HAVING YOUR PEDIATRICIAN DO SURGERY ON YOU.
So their “mortgage broker” shops around, thinks he has a few options for them but in the end he wasn’t able to get this closed for them. He did a title search and when title came back there were 14 liens on there from sub-contractors and vendors. This scared the “home loan broker” off the deal right away.
I’m sure a lot of you at this point are asking what the issue is with just doing a refinance and paying the debts. A lot of private and some hard money lenders would be scared at this point that there could be other liens out there.
In a position like this obtaining lender title insurance could be next to impossible. What else is hanging over this property that has been filed but not yet recorded? Filed but not showing up yet liens could endanger the lenders 1st lien position on the property. Many title companies would not want to insure this.
Eventually they called me directly and we were able to dig into this.
First thing we did was try and get a handle on these liens, do they really owe them? We contacted the sub’s and the GC and found out how much was needed to pay off past due + how much was needed to complete. We then asked for all checks/receipts from the GC showing what he paid his subs. After about a week we were able to get numbers from the subs and the GC as to what needed to get paid at closing and what we needed to escrow for construction to complete the repairs. We were able to get the title co attorney to draw up affidavits for the GC and his subs to sign saying that there were no other liens pending.
Here is where the borrowers made their BIG mistake….
The original scenario:
Purchase 210k
Repairs 100k
Completed value 435k
Borrowed 50k
They were in the deal for just under 200k cash (150k to the purchase and 48k to the rehab)
BUT they still needed another 72k to complete the rehab as the contractor was 20k over budget.
If they would have just gotten a loan from day 1
Purchase 210k
Repairs 100k
Completed value 435k
Putting 20% of the purchase and 20% of the repairs out of pocket they would have needed just over 60k in the deal, the construction would have been in escrow and given in draws and this project could have wrapped in about 100 days.
So, by trying to “save money” and not paying interest or points, they cost themselves a huge headache, took a 5 or 6 month project to 11 months and in the end they put just over 140k more out of their pocket than they should have. Doesn’t a hard money loan from the get go sound better now? They wanted to save 4 points – or just over 8k in points. Looking back, penny wise and dollar foolish comes to mind.
With that being said, they closed last night (5/14) and in about 5 weeks the rehab should be 100% completed.
The lesson here: If you don’t have every dollar of the rehab + contingency in the bank before you close, get a loan before you do any work on the property.
If your reading this and your thinking “hmm I’m doing a rehab now and this could be me running out of money before completion” or you have a new purchase +rehab coming up that you were going to pay cash for, but you’re not sure you have enough to complete it, get in touch with us, let us fund your next rehab and don’t be the topic of our next “what not to do” on your next rehab blog posting.
Contact HardMoneyman.com LLC on your next rehab project before you close! call us at 516-526-8445