Investors dream of the day they can simply write a check for their next flip property. That has always been my goal too. But before meeting that goal, I connected with a local bank in Knoxville, TN that had a special loan program for fix/flip properties. They simply wanted 15% down of the purchase plus repair cost at a rate of only 4.25%. For a new investor, I thought this was amazing! Interest only payments at 4.25%! After reading all the books that told me to stay away from hard money lending, this seemed like the perfect tool to start my investing journey.
Fast forward a month; I had finally found my first flip property! I immediately texted the loan officer that I had pre-qualified with. Two hours went by and…..crickets. The next morning, I tried to call him and…..nothing. I had no other choice but to begin exploring a different option. I thought to myself, “wow, my first deal is going to be private money with a high interest rate.” I had investigated private money while getting my LLC set up. The double-digit interest rates always scared me away. I thought it would be insane to use high interest money during a time when rates were at a historical low and they always came across as “loan sharky.” Ironically, I went to college for finance and accounting. I have lived and breathed financial ratios since starting college in 2011, all the way to my current career position. For some reason, I never thought to calculate any ratio other than return on investment (ROI) for my real estate investments.
That morning while trying to figure out what avenue I was going to take for funding, it occurred to me. I remembered reading a book written by J Scott. J Scott is widely popular on BiggerPockets, and I find him highly relatable since his goal was to get out of the 9-5 corporate world grind. It was one of the first books I read when I knew I wanted to begin flipping houses. It was hands down the best book I ever read on real estate. Anyways, I remembered a ratio he discussed called cash on cash (COC) return, and how that should have just as much emphasis in a real estate transaction as ROI. You can find an excellent video about COC here. So, me being me, I opened excel. I had this quick and easy spreadsheet built out to analyze a potential flip property. Nothing fancy, just something that laid out my costs, as well as an investment summary section that showed my profit and projected ROI. You can see just how fancy this thing is.
I reached out to a private lender to hear what the terms were exactly. I gave him all the numbers, purchase price, estimated rehab, ARV, etc. I waited by the phone to hear some outrageous loan projection number. He returned to the phone and said the following, “Jeff, we can fund 100% of the purchase and rehab costs since this is such a great deal.” Wait, what? “I don’t have to put any money down?” He explained that I would have closing costs and title fees of course. But they were extremely reasonable. In addition, I had worked in a seller credit for closing for $3,500 when I scored this deal, thus eliminating 50% of the closing costs. My interest rate would be 10.99% interest only payments for 6 months. That sounds extremely high, but then I plugged the numbers into my excel sheet to calculate my formulas! I will analyze the first scenario (scenario 1) where I had hoped to fund my first flip as well as the private money lender below.
Purchase Price $95,000
Rehab Costs $38,500
Selling Costs: $14,300
Scenario 1 (Bank in Knoxville)
Down Payment + Closing = $24,525
Monthly Payment = $402 x 4 months = $1,608
ROI = 16%
COC = 72%
Scenario 2 (Private Money)
Down Payment = $4,000 (only remaining closing costs)
Monthly Payment = $1,250 x 4 = $5,000
ROI = 13%
COC = 197%
Wow! Using private money increased my cash-on-cash return from 72% to 197% while only reducing my ROI 2%. It’s safe to say, my first lender not answering his phone was a blessing in disguise. It gave me the opportunity to analyze my deal a second time and utilize a different funding type. This allowed me to tie up less capital, which allowed me to continue investing in other properties. If any investors are not utilizing this ratio during your analysis, I highly advise you to do so. In my opinion, it is the best ratio to analyze when evaluating a flip property. ROI will always be king in my opinion, but I will sacrifice 3 bps to gain 125 bps on my cash return. Thank you, Jay, for not answering your phone and allowing me to reintroduce myself to COC!