When the financial crisis started in 2008, there were fewer people flipping houses. However, it seems that house flipping is now back with a vengeance. In 2016, it reached a 10 year high, in fact.
193,009 single family homes and condos were flipped – sold in an arms-length transfer for the second time within a 12-month period – in 2016, up 3.1 percent from 2015 to the highest level since 2006, when 276,067 single family homes and condos were flipped.
Rising Popularity of House Flipping
What flipping properties means is that investors need quick and smooth access to a lot of cash, even if that means paying a higher rate of interest as well. Because there is usually at least an 8% return on the loans provided to investors engaged in house flipping, hard money lenders find those loans attractive. Providing loans for house flipping has been an interesting industry for a very long time, but it is becoming more and more popular again, despite the fact that there are some significant risks attached to the loans.
Risks of Providing Loans to House Flipping Investors
Some of those risks include an inability of a developer to pay the loan back. Additionally, there is always a chance that there will be a decline in real estate prices. When that happens, it becomes impossible to sell the property for a profit, and charging rent will usually not be enough to cover the cost of the hard money loan.
Today, there are numerous lenders that focus specifically on the hard money industry. They have increased their transparency and their underwriting process is becoming more conservative as well. At the same time, this can be risky for investors, because these type of constructions have not yet been tested by the market.
That said, the loans remain very attractive, specifically because of their speed and ease of access. Yet, some experts say that it was house flippers who were behind the financial crash, rather than people who borrowed beyond their means.
The latest comes in a new NBER working paper arguing that it was wealthy or middle-class house-flipping speculators who blew up the bubble to cataclysmic proportions, and then wrecked local housing markets when they defaulted en masse.
Lessons Have Been Learned from the Previous Financial Crash
Yet, it seems that lessons have been learned. Bank mortgages are much less stable, because they have such a low loan-to-value (LTV) ratio, which is what is used as a risk assessment. On average, the LTV is around 55% for hard money loans, where it stands at between 75% and 80% for a bank mortgage. This means that, if a property does indeed lose its value, the lenders are still protected. It also means that flippers won’t walk away from the property, since nearly half of its value is their own money.
Why Hard Money Lending Works
Many also feel that hard money lending works because it is a form of partnership. The lender wants the borrowers to be successful and what they do. With a bank mortgage, the goal is simply to earn as much money as possible. Hence, if a problem does occur, a hard money lender is more likely to help find solutions. This is particularly true because the loan itself is usually only in place for 12 months.
Lenders do not believe that there is a possibility that another bubble burst will happen because of the short duration of each of these loans. At the same time, however, they do diversify their own portfolios as well. Mainly, they do this by investing in different geographical areas, and by focusing on a wide range of real estate properties, such as land, commercial properties, and residential properties.
Of course, this does mean that capital has to be raised from individuals as well. Hard money lenders are, more often than not, individuals or small groups of individuals. They need to be attracted to these systems by making it clear that their portfolio will instantly be diversified. Furthermore, there is a chance of an 11% return within 12 months, which is very significant. Meanwhile, for lenders, one of the greatest benefits is the speed at which the loan can be made available.
It is possible to score a hard money loan very quickly! This is one of the great benefits of choosing a hard money lender versus a traditional bank. The first step is to gather together all of your deal points and fill out an application. Within a 10-minute conversation with the lender, assuming you present the circumstances of your plan in a clear and organized fashion, they should be able to tell you whether or not it seems like a deal they are interested in funding.
Price to Pay for the Speed and Convenience of Hard Money Loans
Of course, there is a price to pay for this speed and convenience, one of which is the high interest rate. In fact, interest rates are often around 12%. Added to that are fees, charged as percentage points, which usually stand at a further 4%.
Yet, what makes these loans so attractive is the fact that there is a lot of money to be made in this industry. Choose the market right, and a return of 35% to 40% is possible. That said, returns tend to be quite lower, but certainly more than enough to repay the loan and the interest rates, and still have a significant profit at the end of it.
The big worry at the present time, however, is whether a collapse is looming or not. When we consider, however, the fact that many high net worth individuals are moving towards providing hard money loans rather than moving away from it, it seems that they feel quite confident about the market still continuing to be strong. Just like with every type of investment, you must consider each option on an individual level. Calculate the cost of fixing the property before flipping it, what the market in your geographical area is like, your ability to invest not just your money but also your time, and so on. It seems unlikely that the crash of 2008 is only just around the corner, or even that it will happen at all. However, that does not mean you can become complacent when investing in real estate either.