Stretching your capital is the fastest and smartest way you can scale your flipping business to multiply your returns.
The rewards are massive.
But if done without some careful planning, so too are the risks.
Stretching your capital allows you to undertake bigger rehab projects or purchase multiple properties simultaneously, ensuring you never miss a golden opportunity when it presents.
It can propel you from the clutches of a part-time flipper into a fully-fledged entrepreneurial real estate developer.
The trick is to do it without over-leveraging and potentially putting your entire operation in jeopardy.
The importance of capital leverage
Most flippers rely on capital leverage to finance their projects.
They borrow money and use it to buy and improve a property before selling it for a profit.
But many are shackled by the amount they can afford to borrow.
This may either limit the scale of their development or prevent them from beginning new projects before cashing out their initial one.
Essentially, they run out of ‘dry powder’ or cash reserves.
It may expose them to crossing the line from good leverage to dangerous leverage.
Good leverage uses debt strategically and responsibly to deliver a positive return.
Dangerous leverage results when risk outweighs return.
This may be due to low cash flow or economic changes such as a fall in the value of your asset or rising interest rates.
But there is a way to secure additional capital leverage to give you greater flexibility.
How a capital stack works
To grow your business beyond a basic single flip buy/renovate/sell mentality, you need ways of stretching your capital.
The solution is to do it is with a capital stack.
A capital stack is merely the hierarchical structure of different kinds of debt and equity used to finance a building project – in this case, a flip.
It comprises four layers.
Senior debt – This is the foundation of the stack and normally represents the largest amount borrowed. It is the first mortgage and typically the least expensive form of capital. Senior debt is repaid first when the property is sold.
Mezzanine debt – This is the second tier of funding and may come from a private lender or company. In the case of default, mezzanine creditors are only paid after senior creditors. Hence interest rates are somewhat higher because of the greater risk.
Preferred equity – Third in line is preferred equity. It is not secured by a mortgage but remains contractually bound to the property. Interest rates are higher again and investors are paid a fixed return before profits are taken.
Common equity – Common or ordinary equity lies at the top of the stack and is the last to be repaid. There is no guarantee of a return but common equity holders stand to make the greatest profit. The flipper is the common equity holder.
Creating financing options
Savvy flippers use hard money lenders to finance their projects.
They do it because they provide greater flexibility than traditional lenders.
Funds will often be approved in as little as 48 hours.
But when it comes to stretching your capital and building your stack, there are a number of options that can be explored.
Hard money bridge financing – a short-term loan allowing someone to borrow money to purchase a new property before selling an existing one. It’s designed as a quick fix when cash is coming but not yet available.
Joint venture capital partnerships – this involves bringing in equity partners from outside the project in exchange for a portion of the profits.
Private money loans – sourced from private individuals rather than traditional financial institutions, often over short terms with higher interest rates.
Seller carrybacks – if the seller is amenable, they may finance some of the flip to reduce your upfront capital needs.
Reinvesting profits mid-project – also known as a cash-out refi during construction or interim refinance, it allows flippers to extract equity that has been created by the renovation process in order to:
- fund the remaining construction
- help purchase a new project
- pay off hard money debt
- reduce holding costs
Risks and red flags
Not understanding the risks or identifying signs of over-leveraging is what transforms a flipper into a gambler.
And gamblers never win.
Here are the situations to avoid:
High Combined Loan-to-Value (CLTV) Ratio – if the total borrowed funds exceed 80-85% of the property’s current or projected value, you have over-leveraged. If the market dips or renovation costs rise, you could be left without a profit or even worse, left owing more than the property’s resale value by mid-project.
Short-term debt without matching timelines – Using a six-month hard money loan for a renovation that could take 9-12 months is a rookie error because it may force rushed work or a panic sell. Loans should be drawn with a worst-case timeline in mind.
Stacking expensive mezzanine loans – If mezzanine debt is costing upwards of 15%, lenders are unsecured or require personal guarantees or you are using borrowed funds to pay interest (capitalising interest) you are stretching your capital to breaking point.
No clear exit strategy – Ensure you have a plan B if plan A goes awry. Know who has to be repaid, from what source (sale proceeds, long-term refinance or partner buy-out) and by what date. If you are relying on a market upturn to stay afloat, you have already drowned.
Relying on unrealistic ARVs (After Repair Values) – Cooking your own books is just kidding yourself and inevitably bites hard. When establishing ARV, always use sold rather than active listings, never assume that value will rise during your hold and build in a 5-10% margin for error.
No contingency fund – Don’t budget for every borrowed dollar going towards purchase and renovation. Leave 10-15% spare for market shifts and unexpected surprises.
Ignoring holding costs – Sometimes you can’t renovate or sell a property as quickly as planned. If your projected profit is less than 15% of the total cost, unforeseen delays can see holding costs such as taxes, insurance, utilities and staging fees quickly accumulate.
Conflicting liens – Ensure every lender knows their place in your capital stack with clear documentation. Conflicting liens not properly recorded, too many interdependent loans and mechanics’ liens from unpaid contractors could end up costing you everything. Keep it simple!
Personal guarantees – Avoid stacking personal guarantees on multiple layers. You risk becoming over-leveraged and exposing not just your entire project but your personal assets as well.
Negative cash flow between draws -If you can’t pay interest between draws, you have undercapitalised. Always keep 2-3 months worth of interest payments in reserve.
Get finance and support today
Stretching your capital is a perfectly viable strategy to build your flipping empire.
But without financial acumen and employing commonsense principles including ample financial buffers, your capital stack could come tumbling down.
That’s why it makes such good sense to have an experienced mentor AND funder in your corner.
And Equidy is precisely that.
Equidy has an intimate and personal history with all aspects of property development in California and has done so for more than 40 years.
They are not only vastly experienced working with flippers keen to scale their business, they actively encourage stretching your capital to realise your dreams.
But they will help you do it in a way that maximizes the return on your investment with multiple exit strategies and without putting yourself at unnecessary financial risk.
The best part about Equidy is that they are a private money lender who are known to finance flippers and developers in as little as 48 hours.
They stand by their core belief that anything is possible and they are determined to prove it every single day.
Even in difficult economic times, they love to reward entrepreneurship and strive to help their clients realize their wealth creation dreams.
Equidy enjoys long and established relationships with serious investors, sellers and real estate professionals while leveraging their reputation and trust, using clear communication to minimize the risk to all parties.
Contact Equidy today to book your free strategy call.
