Most professional real estate investors tend to have a preference in their exit strategy between flipping houses or holding properties long term. In some cases, an investor’s strategy has less to do with habit and more to do with current market conditions – sometimes it just makes sense to hold a property long-term when rates are favorable, while at other times it may make more sense to sell an asset immediately after improving it if housing prices are on the rise. Even if you used a hard money loan to acquire a property with the intent to flip it after making improvements, you can always refinance into a long-term investment property mortgage to lease the property out and collect monthly rental income.
There are several factors to consider when determining which exit strategy you want to pursue with any given property. Let’s dig a little bit deeper into the advantages and disadvantages of selling vs. refinancing as exit strategies for real estate projects.
Flipping Houses Means Quicker Profits
As experienced real estate investors know, a typical fix & flip project starts when an investor finds a good deal on an old or otherwise distressed property that could use some upgrades prior to being placed back on the market. When working with a hard money lender, an investor will typically be responsible for bringing 30-40% of the property’s purchase price to the table at closing. As work is completed and draws are requested/funded, an investor is only on the hook for interest payments until the time that the property is sold.
On the back end of the deal, when the property is sold, the investor will be able to pay off the hard money loan and reap an immediate profit, typically in a 5-figure range. It’s not unheard of for investors to achieve a six-figure income by completing just a handful of flips per year. Larger organizations can pull off a few dozen projects per year and can establish a successful business around fixing and flipping distressed properties, which can help to revitalize communities. Experienced flippers with a solid process can pretty easily turn these projects around in 6-12 months, providing a relatively quick payoff compared to holding long-term rentals.
Fix & Flip Projects Can Have Their Hangups
While it’s true that quick profits are achievable, it’s wise to be aware of the fact that a slow real estate market can make flipping houses more difficult. Even if you’ve made excellent improvements to really make a property desirable, potential homebuyers won’t be buying houses when prices are inflated and mortgage rates are through the roof. The past year saw a rash of foreclosures, in part due to economic strains on families, but also due to a slow-moving market in which investors found themselves taking losses on properties that were taking too long to sell.
When this scenario arises, it’s important for investors to maintain a creative edge by leaving room for a strategic change of plans. After all, selling a property is not the only way to reap a profit from a property, nor is it the only exit strategy to satisfy the requirements of any hard money loan that may have been used to finance the project. When selling doesn’t seem like it’s bound to be very successful, it may be a good idea to consider refinancing out of a hard money loan and holding a property as a rental until market conditions improve.
Sometimes It’s Best to Refinance Out of a Hard Money Loan
As described above, when the housing market slows to a crawl, it may make sense to refinance a property after making improvements rather than attempting to sell the property. While refinancing doesn’t bring the immediate profit of selling a property, investors are often able to recoup the money that they put into a property while also satisfying the terms of a hard money loan. Assuming that an investor is able to rent the property quickly, it’s fairly easy to achieve positive cash flow and collect passive income from a rental property.
When mortgage rates are high, refinancing into an adjustable rate mortgage for an investment property can be a great way to keep monthly costs low (ARMs are typically interest-only for the initial 5, 7, or 10-year term of the loan). The idea, of course, is that over time mortgage rates will fall, at which point it may be easier to sell the property for profit or refinance again into a fixed-rate loan at significantly better rates.
Long-Term Investment Mortgages Are Not for Everyone
Refinancing is not a one-size-fits-all solution for investors, and this is because long-term investment mortgages typically have stricter approval requirements than hard money loans. Most lenders will look for a minimum FICO score for the guarantor, usually above 600 (though some may require a minimum score as high as 700), and will also take into consideration whether or not the property is leased, what the DSCR of a leased property is or would be, and whether the minimum seasoning requirement (typically six months) has been met.
Ultimately, not everyone will be able to meet the requirements for refinancing a property out of a hard money loan, so if you know that your credit score is an issue, or you do not want to hold the property for six months prior to refinancing, this may not be the exit strategy for you.
Work With a Private Lender Who Offers Long-Term Investment Loans
Ultimately, if you want to have the flexibility of financing with hard money while keeping your exit strategy options open, it’s best to work with a private lender who can offer both hard money and rental loans. Pimlico Capital is proud to work with local real estate investors on both hard money loans for fix & flips, as well as long-term rental mortgages for those wishing to buy & hold. No matter what investing style you prefer, we’re happy to partner on projects, and offer lower rates, higher leverage, and better service in the process.