"Fixer Upper Homes: Rehab, Refi & Rent for Solid Long Term Returns"

A short-term strategy focused on rehabbing fixer upper homes is more viable than a simple buy-and-flip strategy. But if you, like most, plan to utilize a traditional mortgage to buy a fixer upper, then you may have trouble getting financing.

MAIN BARRIER: GETTING FINANCING

I have found that traditional lenders do not want to take on the perceived risk associated with fixer upper homes or rehabs. The main problem is that at the time of purchase these properties are generally not livable, which makes their valuation and appraisal difficult & subjective – two characteristics that traditional lenders don't like.

And, there's not much you can do to avoid this "livability" issue with fixer upper homes. It doesn't make any sense to do repairs prior to closing in order to please the lender, because you never know when a deal will fall through. And of course, if that happens you will lose everything you put into the property up to that point.

MAIN BENEFIT: EXCELLENT CASH-ON-CASH ROI

That said, once you find a non-bank lender, rehabbing fixer uppers that require mainly cosmetic updates can be an excellent long-term strategy, because you gain an equity cushion for your willingness to coordinate the repairs. Many people call this "sweat equity." Post-rehab, you can do a cash-out refinance into a traditional 30-year fixed mortgage by essentially using your built up equity cushion as the down payment.

For example, I recently bought and rehabbed 2 multifamily fixer upper homes where this strategy was successfully deployed. Both were foreclosures that were sold by the REO departments of the banks through the regular MLS listings.

In both cases, I minimized out-of-pocket expenditures by using a private lender to fund both the acquisition costs and the rehab work. In both cases, thanks to my "sweat equity," I was able to refinance into 30-year fixed loans with no down payment or PMI (private mortgage insurance). This allowed me to keep the largest expense – the mortgage – to a minimum on both properties.

One fixer upper was a triplex. My total financed costs were $160K ($125K to buy the property itself, and $35K in rehab & carrying costs). The rehab took 6 months to complete, after which it appraised at $230K. Thanks to my $70K equity increase, my loan-to-value ratio was only 72% ($165K/$230K), enabling me to easily refinance into a traditional $165K 30-year fixed rate mortgage to pay off the private lender plus an extra $5K in cash to fund my closing costs.

Thanks to the power of leverage and credit, my total out of pocket cost on this investment property was only $2,500. In 12 years when I sell, thanks to the additional monthly payments I make toward the principle, my mortgage payoff should be about $96,000. I expect to sell the property for $300K, which will generate a profit of $161K after subtracting out sales expenses and capital gains tax. This equates to a greater than 6,400% cash-on-cash ROI!

The other recent example involved a duplex that I bought for $150K, put $20K in, and it appraised for $217K 3 months later. The resulting $47K equity gain again allowed me to easily refinance. In 12 years I expect this investment property to sell for $250K, which I calculate will provide a profit of $109,382. My initial out-of-pocket cost was $3,200, which equates to a greater than 3,400% cash-on-cash ROI.

TIPS & TIDBITS

So clearly, rehabbing fixer upper homes is an excellent strategy, especially from a long-term perspective. YOU can do this! Just tread carefully, and please heed the following:

• Realize that this is more of an "advanced" strategy because you'll first need to build your network and find a private lender you can trust (because again, traditional bank financing is difficult in this scenario).
• Like any other investment property, you must ensure that the numbers work. Your main concern here will be the price, which should reflect an approximate 20-30% discount relative to a "non-fixer upper" property.
• If the price is concern #1, then your rehab costs are a close #2. You must do a thorough walkthrough and take inventory of as many repair items as possible. Click here to download your free Property Inspection Checklist (note: you'll need Adobe Reader...to download a copy, click here). Estimate the repair costs and add the total amount to the purchase price to get your true cost basis.
• Be leery of structural deficiencies. Be appreciative of cosmetic deficiencies.
• It's in your best interest to do as much of the rehab work yourself as possible, so do not target fixer upper homes unless you can at least do some very basic repair work (painting, minor woodwork, change locks, replace a doorknob, etc.)
• Rehabs require a greater short term time commitment than other investment strategies, so make sure you have the time to commit.
• Remember that your private lender will likely want to have a 1st lien-holder position on the property until paid off. Not a problem, just something to be aware of.
• Probably not a good idea if you have a weak stomach.
• Make sure you study the rest of this site before diving in. This page describes a strategy (rehabbing fixer upper homes), but the details required to execute this strategy are found throughout other areas of the site.

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