By Greg Herlean
Let’s face it, if you aren’t already independently wealthy, you’re going to need to borrow money to get into the house flipping business. Of course, as you likely already know, you won’t be borrowing money in the same way that you would to get a mortgage on your primary residence. You’ll be partnering with investors, getting capital from private lenders, and/or borrowing from hard money lenders. The idea of the risk involved with borrowing someone else’s capital to get started flipping houses (or to grow your existing flipping business) scares a lot of new investors off. But it really shouldn’t.
How Leverage Works
There’s a term in the investment world for what you’re doing when you use someone else’s capital to increase your returns – it’s called leverage, and it’s an amazing tool if you know how to use it. To really understand how to use leverage to your advantage for your house flipping business, though, you need to first understand the difference between positive and negative leverage.
With positive leverage, you significantly increase your ROI by borrowing money for an investment. With negative leverage, you either don’t increase your investment potential at all or actually decrease your income. For example, let’s say that you find a flip house for $70,000. You know that it needs $30,000 of rehab, but you also know that with current market values for comps in the area, you can easily sell it for $150,000. Looks like a good investment, right?
To get cash quickly for this opportunity, you take out a hard money loan with a 15% interest rate. If it only takes you two months to complete the rehab and sell the house, then you’re looking at a case of positive leverage, in which you were able to make a purchase you wouldn’t have otherwise been able to afford and get a significant return.
On the other hand, if the property doesn’t sell quickly, you’re going to have to start paying that loan off, and with each payment you’ll be losing money to that high interest rate. If this goes on long enough, you will be in a negative leverage situation, and you’ll be looking at losing money instead of making it.
Situations like this come with some significant risks when you’re using leverage to pay for your investments, and it doesn’t pay to ignore those risks. If you have a loan on a property that outstrips the property’s value, then you’re looking at losing more money the longer you have to pay on that loan.
Why It’s Worth It
Now you’re really scared of borrowing money for your flips, right? Honestly, you really shouldn’t be. Knowing the worst-case scenario is incredibly important for any real estate investor. House flipping comes with inherent financial risks, but if you do your due diligence on each property you invest in (including market analysis, researching comps in the area, etc.), then you’ll know your risk factors for every investment you consider.
If, for every property you think about buying, you find out about property taxes, amenities, average time houses spend on the market in the area, and local market trends over the last 18 months, you’ll have a good idea of what price you can get for your house and how long it will take to flip it. With that knowledge, you can determine how risky the investment is, what kind of leverage you can use to purchase it, and whether or not it’s a good deal for you right now.
As you get started flipping houses, you’ll see that you can greatly increase your wealth by reaching out to private investors and lenders to leverage their capital for your house flipping projects. Like I said, leverage is a powerful tool, and you should definitely use it to grow your wealth and continue making more and more profitable investments.