OPM (Other People’s Money) is a method widely used by real estate investors as leverage to carry on large investment projects without their own money.
If you’re low on investment capital but still want to flip houses, this article discusses several OPM methods on how to get money to flip a house. You’ll also learn about the implications of using these methods to help you decide if they’re worth using.
Using OPM Methods to Flip Houses
The concept of “other people’s money” is one most house-flipping investors can easily relate to, but we can trace it to one of the founders of modern-day investment, Warren Buffett. Although he was a stock market guy, we can still apply the lessons from his method to generating funds for flipping houses.
To expand on this, we’ll explain five methods to get money to flip a house:
1. Crowdfunding
Picture this:
You want to go into house flipping; you have the knowledge but no cash. So, you open a fund and announce it on your social media platforms with a nice pitch, calling for investors willing to invest at least a thousand dollars.
After 24 hours, you get over 50 contacts willing to invest, with the total pooled fund equal to $120,000. This is a perfect explanation of crowdfunding.
Crowdfunding follows the idea that you can get large investment equity by collecting smaller funds from the crowd. It’s a method several startup firms adopt, which seems much better than giving away parts of the company to venture capitalists.
Whereas there are several types of crowdfunding (most of which determine if the contributors are called investors), real estate crowdfunding seeks to offer contributors (investors in this case) an opportunity to be a shareholder.
In other words, investors contribute their money to the fund but don’t manage the flipping operations. This gives you more flexibility over the business and better leverage to make more profit.
Sounds good! But the question remains: Is this even legal? And what are the implications of using crowdfunding?
The Implications of Crowdfunding
Crowdfunding is legal in the US as far as the Jumpstart Our Business Startups (JOBS) Act still stands. This allows accredited investors and ordinary people to invest in a project like house flipping.
However, crowdfunding activities must take place on a regulated broker platform. Here are some of the best crowdfunding platforms for real estate projects:
- Crowdstreet
- EquityMultiple
- PeerStreet
- RealtyMogul
The fact that crowdfunding is legal in the US is a relief, yet there are still things to consider.
- Crowdfunding requires a regulated platform, which limits the amount of funds you can pool. These platforms also impose up to 2.5% in fees that can reduce your earnings.
- Your reputation can be at stake because you can’t vet your investors. A few spoiled eggs within your fund might just be a ticking bomb for when you decide to go public.
2. Wholesaling (Flip Arbitrage)
Wholesaling is one of the best ways to generate capital to flip a house. This method involves getting cheap houses and finding a buyer willing to close on them. However, it’s not this straightforward. Here’s a breakdown of the entire process.
It starts with you finding a homeowner who’s likely in distress and wants to sell off their property without involving a real estate agent. After contacting them, you’ll have to deposit an agreed sum— the earnest money deposit.
This amount helps you secure the property while you find a cash buyer for the property.
In your agreement with the homeowner, there’s a fixed purchase price and a time frame for when the earnest money deposit expires. Assuming you find a buyer before the time elapses, you can reassign the contract to them at a higher price, usually about 10% extra.
For instance, the property sells for $200,000 in the original contract. When reasoning the contract to a cash buyer, you can close the deal at $220,000. The difference of $20,000 becomes your profit.
The Implications of Wholesaling
Wholesaling is legal and most states do not require you to have a real estate license to work as a wholesaler.
Considering that the only money you have to invest is a small fraction of the investment capital, we can say wholesaling is a low-risk investment opportunity. Hence, also making it the best choice for beginner house-flippers.
Yet, you might also want to consider these points:
- You’re prone to losing your earnest money deposit on your first flip if you don’t have cash buyers. If your contract duration expires, you might not get your deposit back.
- There’s a lot of sweat equity required, which is reasonable considering that you’re making money without much financial commitment. However, it can become draining, especially when starting.
- You’re stuck until the deal pulls through. Because your profit comes from the sales spread, you can’t make money if you don’t sell.
3. Seller Financing
Seller financing is almost, but not quite, like taking a loan from the home seller.
Instead of taking up a traditional house loan from a bank, you negotiate with the seller to get a flexible payment plan. While this is not particularly a way to get money to flip a house, it’s a practical method you can use to flip houses if you have no cash options.
This is how seller financing works:
First, you find a house to flip. In some situations, the homeowners already spell out in the advert that they allow this option. But in cases where they didn’t, you can approach them with the idea.
Usually, you have to be convincing enough to make this work, especially if the seller hasn’t heard of this option before. So, take time to draft a good pitch, but don’t sound too pushy.
Like in wholesaling, you sign a promissory note with details about the initial down payment, the payment structure, interest rate, and default consequences. Since this isn’t a traditional loan, there’s a leveled playing field regarding how the terms are set— if the deal doesn’t sound good you can negotiate or walk away.
The sellers might need extra conviction that they’re safe, so you might need proof of employment or credit history to show you can pay in due time.
One good thing about seller financing is that you can be as transparent as possible. You can talk about your goals for the property and how you plan to achieve them within the specified time. Having conversations like this with the homeowner helps build trust.
The Implications of Seller Financing
The key advantage investors enjoy from seller financing is not facing the traditional loan process.
For one, you don’t need to wait long before getting approved. And the terms can’t be as suffocating as a traditional or hard money loan.
However, there are still some downsides to consider, like:
- You face the risk of foreclosure if the former homeowner has an existing mortgage on the house with a due-on-sale clause. This clause requires that the homeowner pays the full loan before selling the property. Most times, the homeowner might not inform you of this arrangement, which can lead to foreclosure if not settled.
- You can lose your initial deposit if you can’t pay the full amount within the agreed period.
4. Partnerships
Like crowdfunding, a partnership gets money directly from a contributor. However, in contrast to the former, you can vet those you partner with.
The concept of partnership is that your partner(s) provides the money while you focus on the other aspects, like providing the sweat equity.
You can partner with anyone, from family members to fellow house flippers. But before the partnership, ensure the terms and conditions are well-spelled-out and documented.
Each partner’s role should be outlined, including the percentage each gets after the flip.
The Implications of Partnership
One benefit of a partnership is that you get to flip a house without going into debt. You and your partner have a mutual understanding and share in the business’s risks. So, if there’s a loss, you share it with your partner instead of bearing the burden alone.
But on the other hand, you should still consider that:
- Reporting taxes for house flipping in the case of partnership can be tricky. You might need the services of a CFA to ensure you get the reduced taxes.
- Again, you might want to register the house-flipping business as an LLC to become a legal entity.
5. Hard Money Lenders
Many types of loans, including hard money loans, are secured loans. For home-flipping hard loans, the property becomes the security or collateral against which the loan is secured.
This loan type is used by house flippers looking to round up their fix and flip in months. The loans are short-term, usually lasting for less than a year, so it’s advisable to stay off if you can’t meet the deadlines, especially if the hard money lender uses balloon payments.
For context, balloon payment is a payment structure where you get a mortgage and make little to no monthly deposits towards an agreed duration, usually within six months. Once the time elapses, you’ll make a one-time (balloon) payment to cover the balance.
Payments like this can either be interest-only or non-payment. However, it can be risky if you can’t complete your payments.
The Implications of Hard Money Loans
Private lenders provide hard money loans, not banks. Thus, you can expect to get the loans approved faster and without much of the official verification process. This makes it a backup option if you can’t secure a mortgage.
Also, hard money lenders don’t operate by a fixed regulation, like conventional loans. So, you can negotiate your loan terms for something more comfortable.
While hard money lenders provide all of these benefits plus a chance to flip a house without money, you should consider that:
- The costs can be relatively higher than traditional loans. Judging from rates across several platforms, you’ll pay a higher rate in terms of closing costs and upfront fees. Some lenders include a prepayment penalty whenever you pay up before the due date.
- While hard money loans operate like quick loans, Federal and state laws still bind them to conduct verification before offering a loan. You’ll have to prove you can repay the money in the agreed time.
What to Consider When Seeking Funding for House Flipping
Doing business with other people’s money is not a route to follow without proper preparation. Making mistakes can put you in some undesirable situations. It’s best you first consider:
1. Type of Funding
This is basically about checking your options to see what works for you. Some house flippers are better off applying for a traditional loan than a hard money loan.
For instance, if you’re flipping a house without experience, you’ll likely not have a market initially. Taking a hard money loan in this situation can put you at risk since there’s a high chance you might not meet the short-term deadline for payment.
2. Cost Assessment
One mistake common amongst most newbie house flippers is making a wrong cost assessment. They either underestimate or overestimate– any of which can put them into a tricky situation.
To avoid any of these, ensure you double-check your entire calculations. If it helps, seek an opinion from a second person. You can also adopt the 70% rule or use a house-flipping calculator to reduce errors.
3. Creditworthiness
Regardless of the type of funding you decide to seek, it’s only right that you have the means to pay it back, besides, of course, the proceeds from the house flip.
That’s why you should at least have a full-time job or other investments to prove that you’re a safe bet when lending money. Having a healthy credit score can also help show that you have good financial habits.
4. Exit Strategy
Your exit strategy refers to your plan for the property after fixing it. This could be a plan for sales or rentals. It also includes a backup route if none of those options worked.
While some house flippers don’t see a need for this, having it in your business plan can improve your chances of getting funding. Investors or contributors will feel more comfortable when you’re honest and tell them how you intend to work things out if your initial plan fails.
5. Legal Considerations
Whatever you do investing-wise, you should understand the legal implications. We’re talking about property taxes, registrations, licenses, agreements, clauses, etc.
The last thing you want is to have your property seized– or worse– serve time in jail because you’re trying to avoid costs and cut corners. Make sure you’re doing your business within the confines of the law. And if you ever get confused about interpretations, it’s best you seek professional help from an experienced lawyer.
6. Contingency Plan
Like having an exit strategy, a contingency plan covers unforeseen situations like market changes or budget overruns. You can save up some funds in a separate account to cover situations like this so you don’t get stuck if it ever happens.
Final Thoughts
Not having money to flip a house is often an issue in real estate investing. But if you’re in this category, it’s nothing to feel bad about, since there are other options.
Some of the best methods to consider are hard money loans, crowdfunding, and wholesaling.
If you’re using any other methods we’ve not mentioned in this article, please do well to share them in the comment section. And if you found this article resourceful, maybe your friends will appreciate it if you shared it with them.
