I do rehabs in Baltimore and have done about seventy in the last six years. I read Jonathan Mednick’s Rehabbing Houses Top Ten Tips, and thought I’d chime in with my perspective. It was generous of him to take the time to share his views. Here are mine:
1. Estimating rehab costs
I work with mostly older (50-100 years old) homes, and most of them are brick, city row homes. The construction tends to be similar from house to house. The process I use to estimate repairs is very simple.
Sometimes, when I’m looking at a listed junker, another investor comes through while I’m there. Invariably, he has a flashlight in one hand and nothing in the other. (Somehow he’s doing a repair estimate without writing down a single note.) I use a simple one-page form that forces me to consider the things I want to estimate.
It takes me five or ten minutes. I count the number of windows I need, the number and type of exterior doors, number of interior doors, and a rough guess for the overall cost to replace the roof, kitchen, baths, electric fixtures, electric service update, plumbing, HVAC, and carpet. I don’t count light fixtures, outlets, switches. I don’t measure for carpet.
Ron Legrand says to take a quick look and estimate within the nearest $5,000. Most of my rehabs are $20,000 – $25,000. I suppose I could pick one of those numbers and save the five or ten minutes, but I don’t want to be off by several thousand dollars.
If my repair estimate is $5,000 too high, my offer is likely to be uncompetitive. If it’s too low, I don’t make my target $20,000 (gross) profit.
I stay away from houses with serious structural problems. The majority of junkers here don’t have them, so I haven’t felt any need to master them. I do look for termite damage, but I only care about the most serious damage. Minor damage is simple to fix.
I start my repair estimate with some basic numbers (eg., $2,500 to replace a kitchen), and I adjust them up or down based on the situation. If the kitchen is large, I might add an extra $500 for some extra cabinets and flooring. I don’t count cabinets; I don’t count square feet for flooring.
I don’t spend a long time on the estimate, but it is usually close to the ultimate repair cost. It’s good enough that I rely on it to evaluate the bids I get from contractors.
Since I usually use the same contractors over and over, I normally don’t get multiple bids. If they come within my original estimate, they get the job. If they don’t, I press them to explain the price higher than I expected.
2. Handyman or no handyman?
Jonathan seems way too involved in the construction part of the process. I go to Home Depot a couple times a month for something out of the ordinary. All my jobs require the contractor to provided material and labor.
I’m not going to Home Depot; I’m not giving them Home Depot gift cards. I’m not reviewing their receipts looking for extra sheet rock or screwdrivers. I hate Home Depot. It is a real time killer. I’ve had short-term situations when I was paying directly for materials, and I quickly learned to hate my time there.
Here are the contractors I use:
Licensed roofer: He can do a good job and provide me a roof certification, which is usually required when selling a house with a flat roof
Licensed HVAC guy
Licensed electrician and plumber
Window company, carpet company, and carpentry guy (whom I think of as my general contractor).
The carpenter has a crew of three or four, and he does all the walls, ceilings, doors, cabinets, floors, vinyl tiles, and exterior work. He’s the guy I spend the most time with because his work varies the most from house to house and involves the largest part of the overall project.
The others involve little more than a single phone call from me. I’ll talk more below about licenses and permits. With each of these contractors, we set a price up front for materials and labor, and I rarely have overages. They know going in that I hate to pay for extras at the end. My scope of work says:
“We are working on old homes and major rehabs. Invariably, we will come across things that are not addressed in the scope of work. If they are small things, I expect the contractor to fix them and move on. If they are big things, I understand that stuff happens. We must discuss them and agree to additional charges before the work is done.”
As a result, I rarely pay for extras. My contractors know to build a little into the initial price to address small surprises, which we always find.
3. Logistics, supplies, and expenses
Since, my contractors are responsible for materials, they do need money from me up front to pay for materials. I usually pay my guys in three to five draws, depending on the job. I give them the first draw up front to cover materials.
If it’s a new contractor, I still give him money up front for materials, but I give him less than someone who’s been working for me a while and whom I trust. New contractors are a craps shoot. Some are good, and many are lousy. Some are honest; some are not. I’ve lost money many times on new contractors who were dishonest (occasionally) or incompetent (more often the problem).
Licensed guys tend to be more honest because their license is on the line if they cheat you, but they tend to be expensive. The trick is to find licensed guys who are competent and reasonably priced.
My carpenter/general contractor is my biggest risk. He really has to know what he’s doing to handle big jobs on old houses. In Maryland, the state requires them to have home improvement licenses. Again, the licensed guys tend to be really expensive. Most investors can’t afford them.
Licensed guys are not likely to cheat you and are more likely to be better skilled. Since I can’t afford them, I run a bigger risk of getting cheated or getting lousy work. I have to be very careful with new guys, and I take good care of the guys who stay with me. I make a point of having their next job lined up, so they don’t need to look for work elsewhere.
4. Keep a low profile
I don’t believe in keeping a low profile. I insist on getting the outside of my jobs done quickly, so I can put a “for sale” sign out front. The sooner I have a sign out, the sooner prospective buyers start calling me.
I don’t show my houses until the work is done, but I collect a long list of prospective buyers while the work is going on. I want buyers to look in the windows and be impressed with the work going on. (See #6.)
As for code enforcement, I’ve been there, done that. In the beginning, I didn’t pull permits. One day, a disgruntled contractor (yes, I do fire guys) faxed my property listing flyer to the city inspector and told him I don’t pull permits. I got six stop-work orders (and six $150 fines) in one day. Now I pull permits and don’t fear the home inspectors.
5. Permit issues
Here in Baltimore, you have to pull permits for plumbing, electric, gas, HVAC, and general construction. I pull all permits and put up with all inspections. It does cost money and it is a pain. I do it for a couple reasons.
One, I do a professional, quality rehab. Pulling permits is consistent with professional work.
Two, I don’t like fearing surprise visits from home inspectors. I advertise my houses with flyers out front that list all my properties. If a home inspector finds one of my houses, he has the map to all the others. If I get burned on one, I’m likely to be burned on all.
Three, I encourage my buyers to get home inspections. If they have been inspected by the city, they are more likely to pass the home inspection. Also, the home inspector is less likely to be critical if he sees the inspection stickers from the city.
Fourth, I’m less open to a lawsuit from a disgruntled buyer if I’ve done everything properly, including pulling permits.
Fifth, and most importantly, I want to limit my personal liability on my jobs. I don’t want someone to be seriously injured down the road because of faulty electric or HVAC work. If I don’t pull permits, I am very vulnerable to claims of shoddy work.
Additionally, I buy property and liability insurance on all my jobs. My insurance policies say that my work must be done legally. If one of my houses burns down in five years and someone is hurt or killed, I want my liability insurer to protect me.
I’ve been told that the first thing they will do is ask for my scope of work and proof of city permits. If I don’t have them, they will automatically deny coverage. Big problem. This brings me to a related issue–insurance. Some rehabbers try to protect themselves with homeowner’s or landlord insurance.
These insurance agents will take your premium money all day long and give you a policy. If you read it, that policy says that the house cannot be vacant more than 30 days. If your house burns down, they will immediately send an adjuster to look at it. If he sees evidence that it was vacant, they will automatically deny coverage. Again, big problem.
Be sure to get the right insurance, which is builders risk coverage for the property and commercial liability for the bodily injury (and damage to others’ property.)
6. Sign on yard
Like I said, I want my sign up immediately. As soon as I can get the outside looking good, I put a sign up. I hang a brochure box from the sign post. I put two-sided, brightly colored flyers in the brochure box.
The front page of the flyer lists all the houses I have available (even the ones without a sign in front). It gives a brief description of the houses, the price and an estimate of the monthly payment.
It also refers them to my website, where they can see photos of some of my houses. This list of houses is very effective in selling my houses. Buyers pick up a flyer in front of one house, then they go on a driving tour of the others. I frequently sell a house because of the flyer they picked up in front of another.
The back side of the flyer has FAQs. This info is intended to screen out buyers with lousy credit or people who want to rent or rent-to-own. It cuts down on my useless phone calls.
There is a brief credit application form. They complete it and drop it off or mail it to my office (along with an application fee). It gives me permission to pull their credit report, which I do myself. I don’t delegate it to a loan officer who doesn’t have the $20,000 incentive that I do. I don’t show houses to people whose credit I don’t know.
7. Negotiating with homeowners
I usually don’t list my houses. About 20% of my buyers are represented by agents, but the agent didn’t bring the buyer to my house–the buyer saw it and brings the agent. I do co-op with these agents (3%).
I don’t negotiate with buyers. Like I said above, I get calls from prospects. When a house is completed, I hold 1 ? hour open houses on the first two following Saturdays. I call every buyer prospect to tell them about the open houses. I list the open houses on my flyers, my web site, and a sign I stick in the yard.
I usually have 15-20 buyer prospects to call. Typically 5-6 will show up at the first open house and a couple more at the second. Usually, one of them will buy it. If a buyer has completed one of my loan application forms and their credit looks okay, I don’t make them wait for an open house. I jump on them with both feet. I’ll show them anything they want to see–today.
If I have nothing ready and still available (which is typical), I’ll show them a house that is completed and under contract. That whets their appetite. Then, if another house is near completion, I’ll take them through it. I will not show them a house that is still in poor condition. They usually don’t have the imagination to make the leap from a junker to the rehabbed house they’ve seen.
Currently, I have two buyers in process for houses that aren’t completed. They’ve seen my houses that are done and they are waiting for others to be finished. In the meantime, they are working with my lender to get their loan processed so that they’re ready when I’m ready. This is the best case scenario.
I said that I don’t negotiate with buyers. My buyers are usually renters who see my house in progress, and it looks nice to them. They pick up a flyer and check my web site that gives them the feeling that maybe they can stop paying rent for their dump and buy my beautiful home. They aren’t working with a realtor looking at dozens of competing houses.
As far as my buyers are concerned, I’m the only source in town for a house to own. If I don’t have one ready today, they’ll wait until one if ready. They almost never ask for a reduction in price (and I never ever agree to a reduction in price). Sometimes, I’ll bend and throw in a fridge.
8. Seasoning, corporate sale, and taxes
Frankly, I don’t understand the corporation and tax issues that Jonathan talked about. I buy every house in a trust. The beneficiary is either my C corp. or my IRA. The buyers (and their lenders) only know about the trust.
I pay short term income taxes on my sales out of my corp. (The IRA is a Roth that pays no taxes.) I’ve never had an issue with lenders or buyers when selling out of a corp. or trust.
Seasoning is an issue. Most of my buyers are FHA buyers, and I do have to conform to the recent FHA seasoning requirements. That means we don’t sell houses within 90 days of our purchase, and we pay for a second appraisal if the we’ve owned the house 91-180 days.
I don’t like to work with mortgage brokers. They tend to be more expensive for my buyers, and they have a looser relationship with the ultimate underwriter/lender. Less control. I like to use regular banks where the lender works every day with the underwriter. Each of them knows and trusts the others. Fewer surprises, fewer disappointments.
Baltimore City was a hotbed of fraudulent flipping, so lenders are especially wary here. Nevertheless, most lenders will lend here on legitimate flips. Often, the lender and/or the appraiser will ask for a scope of work.
Occasionally, they will ask for receipts. I resist giving receipts because I don’t want them doing the math. I think I’ve relented and given receipt three or four times. (Each of those deals went through.)
9. Buying from wholesalers
I would love to buy from wholesalers, but almost never do. The market here is probably like yours, very competitive. It’s hard to find truly good deals.
Wholesalers can get others to pay more than I will. New investors will almost invariably pay more. They overestimate ARV, underestimate repair costs, or are simply willing to work for a smaller profit than I will.
I can’t and won’t compete with newbies for the wholesaler deals. I find my own. It takes more effort, but I net $5k-$10k more per deal that I find myself. I think it’s worth it.
10. Using hard money and financing
Since I first began, I’ve used my own cash reserves and a home equity line of credit on my personal residence. I was fortunate to have these resources, so that I didn’t have to share a big chunk of my profit with a hard money lender. I am about to get a new line of credit that will be collateralized by several rental properties I’ve accumulated over the last two years.
I’ve paid cash for those rentals, which has hurt my available funding for rehabs. Since I want to step up my rehabbing, I’m adding this new LOC (line of credit.) Terms will be 80% LTV and prime plus 2 points. I’ll have to pay for appraisals for these rentals, but will be able to simply write checks for funds in the future.
Finally, I wholeheartedly agree with Jonathan about this business being tough. It’s hard to find junkers that are priced right. It’s tough dealing with contractors. It’s hard to find qualified buyers. Seasoning adds a whole new problem.
Often, new rehabbers take comfort in dealing with wholesalers who can give them guidance. Like I said above, I think most wholesalers are either incompetent or liars or both. Their numbers and guidance cannot be relied upon. So, newbie rehabbers frequently get overpay and get burned.
When I started in this business, there was one investor club in Baltimore and the number of attendees had dwindled to 40 per month. Now, there are four clubs that draw 125-200 people each. Many of the folks want to be rehabbers; most won’t ever buy a house. Many of those that do do a rehab deal will be sorry.
I get many calls from disappointed rehabbers that are in over their heads and hope to just unload it for what they have in it. Problem is, they have way too much in it. I don’t like competing against these folks for deals, but I have to work around them. My only comfort is that they won’t be around for long. On the other hand, it can be very profitable?for those that do it right. Hopefully, these thoughts will build on those offered by others.