***In this entry Id like to talk about something that may seem a bit boring… Business plans.
It sounds boring, however, It’s the time when you get to plan out how rich you’re going to become! That’s seems exciting to me!!
When I started out in this business almost five years ago I had a plan in mind “more, more, more!!” not a bad plan, kind of. As I developed and grew over time I found holes in the “more, more, more” plan.
Hole number one, taxes… There are few things people hate more than paying taxes. I’ve never met anyone that was soooo happy with the way the government distributed money that they were excited about April 15.
The more money I made the more taxes I paid. This makes sense to me, but I still don’t like it so I wanted to find another way around it.
Hole number two, Resources (time, labor and money) became harder to keep under control. Jobs were going over budget because I wasn’t riding herd on my workers backs every second of the work day. People don’t seem to perform as well when you’re not breathing down their necks, Imagine that!!
When you work for yourself you actually have to write a check to the government every year. My father says “if everyone had to actually write a check to the government instead of it coming out of their checks automatically, there would be a revolution!!” Its true, At the height of my “More, more, more” plan I could have purchased a very nice car with the check I wrote… yuck!!
This year in Nashville the prices have leveled off and people are coming back out of their shells to buy homes. Flipping is still a very viable option right now, however we’ve changed. In the last two months we have purchased homes for $11,600, $18,000, and $15,000. The after repaired values are relevant, however, Im going to tell you about a new way to look at house prices. Let’s do an example.
The home we purchased in Madison for $11,600 is a 2 bed 1 bath around 900 square feet. It needed a bit of work, so we spent about $10,000 on paint, carpet, a roof etc. So we are in the home for about $22,000. The home is now worth around $70,000!! Not bad!! If we list the house now and sell it we will probably net out at $40,000 profit and pay 25% in taxes on that gain that we take as regular income, plus both sides of Social security and unemployment tax, over $10,000 in taxes!! Once again, YUCK!! So instead, we are going to do this. Rent it!!
Here’s how it breaks down. We take out a mortgage for $30,000 on the property and put a few thousand dollars in our pockets right now (this money is not taxed since it is a loan, not Income. But it spends the same!!!) We have a note at 7% which is $175 a month (less than most car notes!) Plus taxes and insurance the total payment is around $275 per month. We have it rented at $650. This means we have positive cash flow of $375 per month. The house is in great shape since we just updated everything and we know it will remain that way because we have a very strong system of checking tenants out.
After one year we’ve made $4500 in cash flow by renting out the property. After one year the tax rate goes to 15% for long term Capital gains $6000 (15% of $40,000= $6,000). How much did we make over the year in cash flow? $4500 right? We should send the renters a thank you note for paying us 75% of the tax bill!! After their lease is up, we touchup any problems and list the house for sale after the one year mark.
This is one little trick that we are going to pull this year, and its 100% legal!! It might not seem to be a big difference with that one house, we only saved about $8500 in taxes, however… we’ve done this 15 times this year so far!! Do the math that’s over $125000!! I also did the numbers on the smallest deal we’ve ever done with those numbers!! We will save hundreds of thousands in taxes this way!! It takes a bit of planning, but its worth it. Now im supposed to tell you, Im not an accountant and I do not offer tax or legal advice. This is just one of the things we do!
BIG MISTAKE!!! Number 3. Spending too much on your rehab!!
One of the questions I had starting out was, “How do you know how much it will cost to do… that?”
The more work the house needs the more your budget can get out of whack. Out of whack means broke broke broke!! When you walk into a house the first time, think to yourself “how close to livable is this house right now?” If the answer is carpet, paint and a new roof, then that is a good one to start with. If the answer is demo to the studs, new electric, plumbing, roof, air conditioning, add a bath, add a dormer ADD A NIGHTMARE!! An easy rule of thumb is to start with a house built after 1978. Save the 1900’s craftsman for after you’ve built up a bit of a financial pad, you’ll need it!! Crawl first, then walk, then run.
My second flip was a great Stone Tudor in East Nashville built in 1910 (RUUUUNNNNN). It was almost perfect on the outside!! New roof, Stone had been re tuck pointed (new mortar in the joints between the stone. You’re learning already!!) The inside was another story… The previous owner had redone windows downstairs and redone all the drywall. Trim, Carpet and paint and it would be looking good! Except, they decided to put all the new drywall over
1. Old electric (old is when the plugs only have two holes instead of three, can be a hazard)
2. Old plaster that was caving in (plaster feels like cement, if you knock on it, like you would a door, it will hurt your hand. It doesn’t sound hollow, and its usually a bit bumpy)
3. Paneling that was like the duct tape holding the walls together. Lots of paneling was used in the 50,s and 60’s to remodel the older houses. I consider this a sin!
It all had to be torn out!!! Big bucks!! To make a long story short, this was just the start of what turned out to be a money pit. I spent twice what I had originally budgeted!! Luckily, since I had purchased the home well, I still made a little bit of money. A very little bit… I could have made more flipping burgers instead of houses.
You do not tell a house what it needs to be redone. It tells you! It is your job to ask the house the right questions. If you cant, then it is your job to hire someone that can. Get 3 General contractor bids and average them. This should be done when you have the house under contract WITH AN INSPECTION CONTINGENY.
Ill be more in depth on specifics of what we pay for things in 2011 later on in the blog. This should be enough to scare you away from the money pits!!!
BIG MISTAKE number 2. Not getting the ARV (after repaired value) correct.
You’ve got this great house! It’s fully rehabbed and you’re in it for $100,000.00 You think its worth 135,000, this is a pretty good looking deal! But, its only worth 115,000… wah wah. Your good deal just turned out to be a nice hobby that you made 5 grand from after you pay 6% in realtor fees and 3% for the buyers down payment (and you will in this price range). How to avoid this.
Realtors have a lot of resources that help them determine this information. If you are in an area where homes are all built within 10 years of each other and have homes that are similar in square footage (within 200 sq ft) it should be easy to compare, or comp (industry slang, we’re cool like that!) You look back over the previous 9 months, not 15, not 24, 9. 9 is how far back appraisers will go to determine value as well. That’s why we use that number.
If you see 15 houses that have sold that are similar to yours it should be a pretty easy comp, congrats!! You can move forward with the deal fairly certain that you will create a superior product and be able to sell it in that market.
East Nashville is the best area in Nashville, in my opinion, to mess an investor over!! Comps can literally change by $50,000 from one street to another!! Put the same exact house on street “A” and its worth $200,000.00 put it on street “B” and it might be worth $150,000.00 and it takes twice as long to sell!! This is where a good realtor that is very familiar with the area comes in handy. They can point you to the good deals and help you avoid the bad ones.
A little common sense goes a long way! Drive the area. If your street feels much much worse than the street behind it, IT IS!! It wont comp the same in the mind of a buyer just like it didn’t in yours.
I recommend that you leave these areas to do later on. Find the places that are easy to comp. This business is hard enough with ALL the info… why guess?
Next Ill cover an area that is near and dear to my heart, Renovation budget!! Asking the house what it needs done to it, and actually listening!! See you next time!!
Ive spent the last few entries telling everyone about the mistakes that I have made in real estate throughout my career thus far. In this entry im going to share with you one of the things that I am actually good at!! Cohesive design throughout the home to create the feeling of “I have to have it!!” Ill focus on Hardwood floors for this entry.
Every house has a style to it. My job is to either enhance the homes natural style or change that style without making it a jarring departure from its intended use.
One of the finer examples of this was a home I purchased a couple of years ago in south Nashville. The neighborhood was all 1950’s ranch style homes. Ive really grown to appreciate this style of home. When I first moved to Nashville I thought they were dull and boring. Ive since realized the potential they have to be spectacularly laid out. Much like Frank Lloyd Wrights prairie houses they can be converted and upgraded to beautiful horizontal masterpieces that blend into the landscape!
This home was 2300 square feet all on one level, which is large for a 50’s ranch. The previous owners had done a funky addition on the back of the house that brought the list price from $160,000 all the way down to $80,000 over a year. People have a very hard time envisioning floor plan changes, so they tend to shy away from them. These can be great buys if you have vision!!
We took out walls all over the house fixing the floor plan and creating a great open plan that allowed you to be in the kitchen and see the living room, den, dining room and sitting room.
I do Hardwood floors whenever possible in homes. I love the durability and the warmth they bring to a space. We used Ebony (almost black) 3 inch wide plank in this home. The baseboards, door moldings and window trim in 50’s ranches are generally very understated so we painted them black to make them jump out. Black floors and baseboards?? Seems dark right? Nope!! They seemed to drip up the walls anchoring the very light colors from the walls and the white Kitchen cabinets.
Hardwood coloring is very important!! I love very dark wood but It doesn’t always make sense in certain spaces. You must not force the home to be something so different that its distracting to potential buyers. Remember when choosing color that the floors will be a focal point for the space. They can tame down crazy wall and trim choices, or they can spice up plain and boring. Provincial is a nice redish brown for taming. Ebony and Jacobean are very dark and have a lot of variation with the way the wood takes them. They are more risky and I generally put them in homes with a very contemporary design. Ive only used light flooring a few times. Most of it looks cheap to me, but in a very airy space, natural or birch can add to the weightless feeling.
I know I sound a bit like a hippie, but let the overall home design dictate the colors you choose. Let the home talk to you and tell you what to do!!
Now that I’ve got the basics out of the way, I will continue with the public humiliation!
Getting started I would always ask other investors/ contractors what their biggest mistakes were so that I could avoid them. Lets go back to the first house I ever did and Ill give you a lesson that I still haven’t seemed to learn all the way. Even though I’ve been told, and told myself a thousand times not to do it!!
NEVER HIRE PEOPLE THAT ARE NOT QUALIFIED TO DO THE WORK!!!!
Example: I knew from laying hardwood floors previously that it is very tedious, and hard work. Your back will hurt for a few days and odds are the final product will not be quite what you were hoping for. I didn’t have a lot of square footage to lay, so I wanted to pay someone to do it.
Where to find this person to lay the floors? How about the kind-of-sketchy looking guy in the flooring isle at Home Depot that says he will do it for $2 a square foot (that’s a fair price to pay, though we pay $1.50 right now just to lay the pre finished floors). DONE!!
He followed me to the job because he could start right then!! I thought this was great! It is, however, not great at all. He was in the Home Depot in the middle of the workweek with no other job for the rest of the week. Logically, it makes sense that a good sub contractor would have stuff to do the rest of the week and I would have to book him for the future.
We got to the house and we agreed to the price. NO MONEY WAS PAID BEFORE HAND!!! This is the saving grace in a bad sub contractor situation. If they do not have materials to purchase, DO NOT GIVE THEM MONEY!!!!! And, if they do have materials to purchase, you call in the payment to the supply house directly. I cannot emphasize this enough. Ask me how I found this out…
An hour or two into the guy being there, his “team” showed up. The kid that must have been no older than 12 started to clean up the debris and the fluffy haired guy (that I kind of recognized) started pulling up the tack strip. The “fluffy haired guy” was a top 10 American Idol Contestant!! He was the guy that supposedly had a “relationship” with Paula Abdul. Yeah, laying hardwood floors. It was wildly obvious that this was not what he wanted to be doing. Nor was he good at it!!
The job that my guys would do in a half day, drug out over 4 days with this sub!! Time is money. At the beginning of each job I figure my carrying costs (interest, taxes, utilities, assoc. fees etc.) Normally its like adding another guy to the payroll each day!! He finished and the job was done poorly. I begrudgingly paid him.
I will admit that to this day I take recommendations from people that I shouldn’t. it’s always tempting to hire the hourly guy that’s 8 bucks an hour, but you’ll pay WAY more in the long run (in actual dollars for the b.s. and time lost) There’s generally a reason that person isn’t demanding $20.00 an hour or bidding the jobs the way they should be bid. It’s a very hard cycle to break free from. DON’T DO IT!! Find the guys that do it the right way. Get recommendations from others, or check out references.
More to come from Brandon’s wide world of real estate mistakes!!
So… Jason wants me to write about all the mistakes I’ve made in my real estate career for a blog. Embarrass myself publically forever and always on the internet, SURE!! Why not.
The first few of these entries are all equally important. If you do 2 of the 3 well, you’re still screwed… So do a great job learning all of the first 3!!
In the beginning was a deal, and the deal was not very good…
First mistake: I paid too much… for a house right from the start. The issue with paying too much for a house is starting out behind the eight ball. No matter how cheaply you get the work done, how discounted you find your tile, hardwoods, and a fancy new Ebay Vanity, you started out on the wrong foot.
Purchase price $89,000
Rehab budget $10,000
Sold on the first day we had it listed for 125,000!!!
Everything worked out for the best, but I still paid about $15,000 too much for the house!! DON’T pay too much.
The reason I paid too much.
There’s a formula that real estate investors try to live by called “MAO” Maximum Allowable Offer
It’s a simple math equation (if it wasn’t I wouldn’t be able to do it, so don’t freak out)
After repaired value ($125,000) x .7 = $87,500
$87,500.00 is not what you want to pay for the house, however.
The next step is subtracting your estimated repair budget. In this case it was $10,000.00.
The most I should have paid for this home was $77,500.00
If I had lived by this number I would have offered less and would have retired already. Ok, maybe not, but I’d be closer to it!!
That’s how we calculate offers today. It gets more difficult when you get into the homes that are higher priced to use this formula. The profit margins get so HUGE that people are willing to take a bit less for them and you are always getting outbid.
For us little fish it’s very dangerous to overpay. One or two price drops, holding costs, Realtor fees, and closing costs can completely wipe out everything you’ve done. That’s what I will cover next. How to come up with the After Repaired Value!