First off, I apologize for the hiatus on BNL. Despite no longer being financially dependent on my corporate job, I’m still unable to consciously under-perform at my job. Hence, for the next 13 months or so until I quit my paid employment, as long as duty calls I’m stuck working very hard in short increments. April was one of those times. And that means less time for writing…. But enough of that, let’s get back to business.
Many of the readers here weren’t around back in November 2011, so you may want to go back and read this post where I discuss my first ventures into real estate investing via financing home rehab projects. Since I had plenty of capital but lacked experience, I decided I would buy myself a pseudo-apprenticeship. The basic deal was this: My partner does the work (finds the house, contracts out the rehab work, sells the house), and I finance the work while also learning from her. Once the house is sold, we split the profits 50/50. To cover the unlikely but potential result of a net loss, our contract also had us also splitting any losses 50/50. Many readers viewed this as risky and unwise, but I saw it as a chance to learn the ropes of real estate and foreclosure rehab. And if I made some money along the way, all the better. After all, that money was sitting in the cash portion of my Permanent Portfolio, so I wasn’t in need of high returns – I mostly just wanted to avoid a loss.
Well, it turns out I did make some money, but more importantly I learned a lot. Let’s summarize:
Original Forecasted Numbers
|House Price||$ 78,000|
|Loan Amt||$ 131,000|
|Cost to Sell Total||$ 11,992|
|Closing costs 3%||$ 4,497|
|Realtor 5%||$ 7,495|
|Profit before Rehab||$ 59,323|
|Net Profit||$ 18,677|
|BNL Profit||$ 9,338|
|Partner profit||$ 9,338|
|ROI for BNL||7.8%|
My hope was to close the deal in under 6 months, resulting in roughly a 16% net annualized return on my investment, but I knew all these assumptions were filled with optimism. Still, $18K profit between the two of us left us with plenty of margin of safety so I was willing to take the deal and see what happens. I knew 18% NAR was unlikely, but since that money was sitting in cash as part of my Permanent Portfolio, anything above 0% was a net gain.
As expected, my profits were not as good as the optimistic forecast, but I still consider it a net success. Let’s look at the numbers, then we’ll net out the experiment as a whole.
|House Price||$ 78,000|
|Loan Amt||$ 119,000|
|Cost to Sell Total||$ 10,880|
|Closing costs 3%||$ 3,730|
|Realtor 5%||$ 7,150|
|Profit before Rehab||$ 53,535|
|Net Profit||$ 12,184|
|BNL Profit||$ 6,092|
|Partner profit||$ 6,092|
|ROI for BNL||5.1%|
Originally I had planned on posting images of the house after the rehab, but unfortunately I never made it to the house when all the work was complete. Let’s just say it looked a heck of a lot better than the images in my original post.
There were three variables I considered to be optimistic in the original forecast and, as expected, all three ended up being just that. First was the sale price: rather than getting $150K for the house, we only got $143K. We probably could have held out for more, but we were both ready to cash in and move on. The second variable was the cost for rehab. Actually, we ended up pretty close to our forecast on this one, only a few hundred dollars over budget. The third variable was the time to sell. Instead of taking 4-6 months, we ended up taking closer to 8 months from the time I invested the money to the time that I get paid. This doesn’t affect the ROI, but it does affect the annualized return. All in all, I received a NAR of about 7.8%. Financially, I consider this a moderate success.
Since the stock market is up 20% since I made the investment, it’s easy to view this as a financial failure. But I don’t believe in market timing, so I don’t view it this way. Instead, I consider the fact that the money would have been sitting in cash as part of my portfolio allocation, so this is $6K I wouldn’t have made otherwise. Further, since I saw the investment as low risk with plenty of margin of safety (unlike the stock market that is subject to the short term whims of Mr. Market), I think 7.8% NAR on a short term investment is not so bad.
But more important than the financial results, I gained a lot of knowledge about real estate investment and I met some people that can help me in the future. Let’s walk through some of the side benefits of this experiment.
I learned about other investment types
Through my partner Julie, I learned about other investment methods that I had not previously been aware of. I learned about investing with an SDIRA and I learned about some pretty successful Private Equity Real Estate firms, something I’ve already capitalized on and have turned it into a steady $267 per month income into my IRA. I also learned about hard money lending, something I may try out soon. My partner in this experiment, Julie, also does rehab projects with hard money, so I may do another investment with her as a hard money lender.
I learned a lot about how to choose a house and when to buy it
When I agreed to invest with Julie, I explained that I wanted this to be a learning experience for me. As part of our agreement, I was a silent partner but I was also free to join in on any parts of the project at my choosing. Essentially, I was paid a 7.8% annualized return to be an apprentice. As part of that agreement, I voluntarily attended the house closing and met the brokers and agents that she worked with. I met some of the contractors, and asked them many questions about the process of rehabbing houses. I even met some other investors I could look to partner with in the future. I had no idea how many people are involved in the process! Now, I’m much more educated.
I also learned about the importance of timing when it comes to rehabbing a house for a short-term flip. It turns out, buying a foreclosure in late Autumn in Colorado is unwise timing. For example, the yard needed a lot of “curb appeal” improvements, but that’s not possible heading into the Winter. We couldn’t add sod or seed the lawn and we couldn’t plant flowers. Additionally, there’s very few houses selling in January relative to Spring/Summer when school is ending. So while we had the work done on the house in January, no one was buying. As soon as the snow melted, we saw a huge increase in interest and subsequently sold the house as soon as traffic picked up.
I built confidence to try this out myself
I won’t lie, I knew nothing about the process of buying and fixing up a beat-up foreclosed home. Besides having no carpentry/plumbing/eletrician skills, I also didn’t know how to look for the right kind of house in a lower price range, how to value it for eventual sale/rental, or how to gauge the cost of labor and materials. I did the basic homework on contracts and partnerships to make sure I was legally covered from getting screwed by my partner, but I knew little more than that. My learning style is not to read about things, but rather to get in there and do it. Now, I have the knowledge and confidence to try another rehab on my own.
In fact, my wife and I have already made arrangements to meet with a real estate agent on Thursday to start looking for our own home to rehab and rent out. Of course, I’ll document that project here, so stay tuned!