Hard Money Case Study: The Importance of Thorough Due Diligence

We met Natalie at a local REIA meeting in the Fall. She’s an experienced flipper who also holds a few rental properties. So, it was no surprise when she had another project in the works and wanted to discuss it with Green Block. She had a plan, but needed funding to make it happen.

Since the deal looked good, we encouraged her to apply and provide the required due diligence.

The property, while not stunning, was a solid three bed, one bath ranch-style home located in Pinckney, MI. It was typical for the area where it was located. The purchase price was well below the market average and the projected after repair value (ARV) provided a nice cushion, even after accounting for the required rehab. The house needed a fair amount of work, but the rehab budget (which included her actual contractor’s estimate) seemed sound and included a decent margin for any unexpected minor issues.

The following table outlines the estimates and assumptions used for our analysis. Natalie was applying for our maximum loan-to-value (LTV) of 75% of purchase price plus rehab costs with a six-month loan term.

With an ARV of $130,000, this was shaping up to be a great opportunity with a decent profit margin after accounting for holding costs, loan costs, and selling costs:

With an expected sale price of $130,000 and total costs of $112,371, Natalie could expect to make just under $18,000 in profit. Even better, Natalie’s Cash-on-Cash Return (COC) was projected to be:

From an underwriting perspective, assuming title was clear and the rest of the requirements were fulfilled, the loan was shaping up to be an easy approval.

One challenge remained, however. Since Natalie’s contractor had walked the property with her and provided a detailed rehab estimate, Natalie thought our requirement for a property inspection was unnecessary. Simply put, she didn’t want to spend another $350 dollars for someone else to walk the property. As with all of our acquisition loans, we insisted. Natalie quickly lined up the inspection.

A few days later we received a call. Natalie sounded dismayed. The inspection had revealed that there was a serious foundation issue. After contacting her contractor and a few others, it was determined that the foundation repairs would add $14,000 to her rehab costs. Even worse, the repairs would push the rehab timeline back by three weeks. With the added cost of the work and holding costs, Natalie’s potential profit was essentially wiped out.

In the end, Natalie was glad to have spent $350 on an inspection rather than earning no profit, or worse, losing money on the deal. It is exactly for this kind of scenario that our underwriting process requires inspections. Green Block’s goal is for all of our loans to be win-win. We certainly want to make money lending, but we will not fund a loan if the borrower isn’t projected to make money as well.

Note: Borrower’s name and property image have been changed to preserve the privacy of our client.