Summary of Financing A Rehab

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
ARV  $ 149,900
Cost to Sell Total  $   11,992
 Closing costs 3%  $     4,497
 Realtor 5%  $     7,495
Profit before Rehab  $    59,323
Rehab  $    40,646
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.

Final Numbers

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
ARV  $ 143,000
Cost to Sell Total  $   10,880
 Closing costs 3%  $     3,730
 Realtor 5%  $     7,150
Profit before Rehab  $    53,535
Rehab  $    41,351
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!

17 Responses to Summary of Financing A Rehab

  1. bdub says:

    Glad to see you back! I probably wasn’t the only one who was getting a little concerned. In the future, maybe just a quick “Hey, I’m still alive just too busy to write” headline would be nice.

    Glad to hear your 1st flip went well. I’m not to this point yet but my father is looking at doing something like this. I will point him this way as I found the article informative.

    • Sorry about going AWOL. I honestly hadn’t considered people would worry about an anonymous blogger on the web. But after receiving quite a few emails through the contact form on the site I realized I needed to prove I was still alive. :)

  2. Krantcents says:

    Have you considered keeping the house and renting it out? You could lease it for a year and put it on the market then.

    • I thought about that, but I just wanted to make this a short-term learning experience and get my money back as soon as possible.

      Now I have that money back (plus $6K in profit before taxes) that I plan on using again. On my next RE investment, I plan on doing a lot of the labor myself and keeping the house longer term. Probably as either a straight up rental, or potentially as a lease-to-buy option depending on how the numbers work out.

      In the current housing and rental market in my community, I think I could live off about $300K in rolling lease-to-buy deals where I live off the income of the lease, and re-buy a new house each time the option to buy ends.

      For now, I’m hoping to buy a house where I can spend less than $100K on the house + rehab, then rent out for at lest $1K per month and probably a bit more.

  3. Paul says:

    I agree with Krantcents… I typically have a buy and hold strategy. I will never sell a home that I have owned for less than 1 year since I have to pay short term capital gains.

    • Yep, totally agree. As I said to Krantcents, this was just a short term deal with the intent of learning, knowing I’d pay a premium in taxes. In all my other investments, I always consider tax implications.

  4. Glad to see the deal worked out well. It’s too bad you didn’t earn as much as projected, but it was a great learning experience for you. Once you leave you day job, you’ll have a lot more time to explore this business. Good luck!

    • Thanks for the encouragement, Joe.

      As I sat all day at a coffee shop’s outdoor patio breathing in the fresh Colorado air while “working” today (with a brief break to write this post), I made about $500 from my corporate job. So it’s difficult to worry about squeaking out a few extra grand on the investment. I admit openly that I’m blessed that I can focus on the lessons learned in the real estate experiment rather than potential profits that I left behind.

      When it comes to “alternative income,” for now I don’t worry much about the returns on any individual investment endeavor, as much as I appreciate the learning of new skills and trades that will benefit me in the future. I predict that once I leave corporate employment, I’ll be much more careful and detail oriented, looking to maximize the profits and efficiency on all my alternative investments.

      This is why I love sharing my lessons with these alternative investments, since I know not everyone has the luxury of throwing away a few thousand dollars to learn these other ways to make side income. (Plus, writing about it forces me to step away and really think about it)

  5. Wow, congrats on your first flip! Mr. BFS and I are thinking about using the next 10-15 years to build up rental properties. Yay for real estate. :-)

  6. Great job! I think your attitude going in is a great way to get create a positive outcome. When you look at something as a learning experience and it doesn’t hinder on profit loss you open yourself up to a whole range of forward thinking conclusions.

  7. Shawn says:

    Success on many levels….Being paid while acquiring an education is the biggest benefit.

    Did any of you improvement contracts list materials versus labor? I would like to see what percentage of the budget was labor. Also, many times contractors will inflate the price of materials to underplay to the buyer the true cost of their labor or what they are “making” on the job.

    You gained acquisition skills with this deal. With the next deal, maybe you gain some valuable rehab skills that boost that ROI even more. Other benefits of not using contractors include the time invested in setting them up and triple checking their work.

    Your time is another element. You said it yourself with regards to the $500 from corporate salary. Soon you will have more time soon to deal with such real estate strategy but at what point should you just make a ROI from what you trained to do in the corporate world. I say this from personal experience. I am fortunate to make much more doing my “job” than I have on side jobs or business ventures where I have exposed my own capital. Unfortunately, more time in the cave is not stimulating.

    I realize that the education that comes along with such endeavours are the roots that grow the strong Renaissance Man. Doing deals like you just did will likely build a dividend stream over time. I have some experience with house flipping, rehab, and landlording. It is never easy or predictable. I struggle with the notion of re-entering real estate as part of early retirement. For me, there are currently easier ways to make money but I strive for a diversified income stream.

    Good to see you back!

    • Shawn,

      Regarding labor vs. material, I received a total breakdown from my partner on each expense. In all, it was about 50/50, but each job was different. For example, the house had popcorn ceiling that we removed – so that was a ton of labor and almost no material. The new roof was primarily a material expense. In all, I think that had I done the entire job myself and taken in all profits, I could have easily made $30K – or close to my entire annual budget for my family.

      I’ll freely admit that I couldn’t do most of the work myself with my current skills (read: none). But I’m looking forward to learning, and I’ve found most things can be learned pretty quickly. And… I’m hoping we can turn it in to a fun family adventure. What 4 year old wouldn’t love to run around an empty house with paint brushes and power drills?

      As for valuing my time, I agree – partially. Unlike my “job” which I no longer value beyond the paycheck and some occasional social enjoyment, I look at doing a house rehab as trading my time for money, education, adventure, and, hopefully, family bonding. Also, pride in my work and total control over my time and priorities. Those are things that are hard to accomplish working for a large corporation.

      I’d be interested in why you wouldn’t want to get back into any real estate in the future. Care to share?

  8. Shawn says:

    Most estimates that I have received or work that has been completed has always been made to look like 50/50 too. I would argue that that most jobs are at least 60/40 and likely 70/30 labor to materials.

    My point was that you could certainly do the labor, secure the materials and make much more money on such a deal. I am confident that you could complete any renovation job with some study, the right tools, and a bit of trial and error. My interest in your deal was that even though contracted all jobs out and split earnings with a partner, you still earned a nice profit. That is not a bad position!

    There are some jobs that simply will never be worth me doing. Replacing a roof is a great example. Roofing materials are fairly cheap and the labor is usually just as you mention 50 percent. My wife and I argue about drywall. My drywalling always looks as good or better than the “pro’s.” In fact, when I have paid for a job I usually go behind them after the final coat and touch it up before painting. (I almost never hire a painter because I am never satisfied with the quality or the pricing of their work) The downside is that I am slow compared to the multi man teams that come in and knock a job out in three afternoon sessions. Drywall is a messy undertaking and if it is knocked out quickly there seems to be less mess. Small plumbing jobs and electrical work that need not be inspected are where I have likely save the most.

    Completing the tasks themselves is very enjoyable. When I was trying to do these things I had WAY to many things going on and the impetuous nature with which I completed the jobs ended up being no fun. We did once have a rental. We rented a small house after we moved away from a town and it ended very badly as we did not use a management company nor were we close enough to manage it well ourselves. I do believe that in a more time controlled environment I would see more enjoyment in these undertakings.

    I actually am interested in returning to a position in some real estate with flips and or rentals. About 6 months ago I had a little meeting with my 9 and 11 year old and showed them how we could own a house, rent it, and make money. We spent a Sunday morning driving by houses that we had searched on the internet. We looked at houses that we deemed were prospects based on price, conditions amenable to a young family, and location to our home. The kids really got into it as we brainstormed ways that they could contribute and the earnings they could potentially receive. That weekend, the light came on for my 12 year old that a small amount of money early in her life could produce a lifetime of growing and dividend.

    My wife and I had a long talk about it a few days later. We both like the idea, but dont want to be caught in a time struggle as we both are still in the workforce. I think real estate or more particularly a few rentals will eventually be part of our permanent portfolio.

    • Shawn,

      As usual, it appears we share common opinions on this topic.

      By my calculations, I think I could have made about $30K on this flip had I done most of the work myself (given that I’m deathly afraid of heights, I probably would not have done the roof work). But most everything else could be learned and done by me. I also think I would have done a better job in several areas. For example, the house originally had 40 year old hard wood floors that needed to be sanded and re-finished. But the guys ripping out some walls ended up scratching the floors so bad that we had to cover it with some inexpensive carpet – what a waste! It ended up costing us more money to have a lower quality product.

      Of course, I know nothing about any of the labor involved. I’ve never hung drywall, put in carpet, or done any real electrical/plumbing work – but I’m anxious to learn.

      Assuming I could have made $30K, that is a pretty unbelievable number if you think about it. Currently, my dividends are paying out $22K/year without optimizing my account for dividend income. My expenses are about $36K/year. So that means I could flip a house like that once every two years and pay the differential of my expenses and dividend income. Alternatively, I probably could rent a house like this for a bit over $1000/month, in which case I could also cover the difference for an even longer time (forever). That’s the beauty of having reduced expenses!

      I enjoyed your short story about looking at houses with your kids. When my REI partner and I bought this house, the first thing I did was get a key and take my kids down to the house to see it. Unfortunately, there were a bunch of workers already there getting started, and some pretty unsafe conditions – but even still, the kids had a ton of fun seeing the empty house and understanding that daddy bought it. I really look forward to being able to do the work myself and bring the kids with me to “help.” Since I won’t be rushed to flip it and cash out, I’m hoping it will be slow paced work in a relaxing environment where I can let them be involved with the entire process – rather than a stressful task where I’m sending them home with mommy so I can focus on my work.

      It’s too bad you don’t live nearby, this would be even more fun with a partner. 😉

  9. Anthony says:

    It’s always annoying when you know more or can do something better than the supposed “professional”. Seems like unless you pay a high premium, things don’t get done right. I’ve had the experience in a number of areas.

    Can’t wait to hear about your adventure renting, if you choose to go that route.

    Big thanks for sharing this info.

  10. Before you quit, please consider doing a consultation with me. You’ve got time, and I am launching another FS Online Services this month. One of the specific products is coaching people how to negotiate a separation agreement.

  11. Olivia Moore says:

    Genuinely interesting piece of writing it is. I would like to give a single piece of suggestion. While doing the same. take a picture of the house. Note the address in a notebook. Make little comments and notes to help you remember which house this is. It’s going help people out a lot.

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