Risk Reduction Strategies for New Rehabbers
By Tod Snodgrass
If you think education is expensive, try ignorance.
--Derek Bok (past President of Harvard University)
Tens of millions of homes in the US are more than 40 years old. Every year, thousands and thousands of houses are rehabbed because they need it. However, where there is opportunity, risk is a factor as well. If you are thinking about getting into the buy/fix/sell business, hopefully the following will prove helpful.
1. Get all the knowledge you can. Attend meetings at your local REI affiliate group. Take courses (local college or online). Ask gurus. Get mentoring. Do an apprenticeship with a rehab pro, for low or no pay. Go to websites where the pros write about their experiences. You may even want to consider getting a real estate license. See the end of this article for a list of online resources.
2. Do some flips first. Getting several successful wholesale contract flips under your belt (three minimum is a good rule of thumb) is a good prerequisite for success as a rehabber. For example, it puts cash profits in your pocket; it also helps you learn the real estate ropes quicker than you might otherwise. Flips can be turned over at much faster clip, and with much less financial risk than rehabs.
3. Reverse engineer how much profit you need to earn (say 20% net to you). Then work backwards until you wind up at the price you should be bidding for a property, not the seller's asking price. Profits are made (or lost) the day you buy the property, not when you sell it. Reason: Buyers will pay market price, and not a nickel more for the property you are trying to sell, post rehab. See No. 4 below about cost factors. In other words, do NOT acquire a property unless and until there is a clear path to the profit number you require.
4. Fully understand ALL the costs involved: a) Property Acquisition Purchase Price; b) Closing Costs (double ended: when you buy and when you sell in a few weeks or months); c) Liens, back taxes, HOA fees; d) Carrying costs: hard money points and interest, EMD fee costs, gap funding fees if any, holding costs, etc., e) Insurance; f) Contractor fees (if you hire one); f) Supplies and other repair-related costs including paint, primer, tiles, light bulbs, etc.; g) Misc: keys, bookkeeping costs, staging, site cleanup services, appraisal, inspections; h) Major replacement costs: HVAC, plumbing, appliances, etc.; i) Utilities (initial hookup, monthly costs until you sell the property); j) Selling costs (broker's commission, marketing/advertising, etc.); k) Ongoing maintenance costs; l) Permits, architectural, if any, etc.
5. Line up your financial resources well in advance of need: This is key. If you don't have the required funds, when and where they are needed, that can make the whole rehab enterprise problematic. As the old saying goes: Money talks and bullsh*t walks; true then; true now. For example, you may have to come up with "skin in the game" cash for say a down payment, because the hard money lender may not front it. You should also have a reserve fund for unforeseen extra expenses; they always seem to arise.
6. Have a team pre-assembled that you will have at the ready when a "hot deal" comes along. These may include: contractor, realtor, escrow company, hard money lender, EMD funds provider, insurance agent, gap funder, rehab guru (if this is your first time at the rodeo), etc.
7. Know your market and where it is heading. What is selling and what is not? Are you better off doing three small projects during the next year, two medium-size or a single large one? You need to anticipate where the market is going, with the help of an investor-friendly realtor for example, and try to have your property finished and ready to go to meet the needs of where the market will be then, not necessarily where it is now. Reading future trends can pay big dividends down the road.
8. What type of business structure should you have? Sole proprietorship? LLC? Corporation? Ask your mentor, CPA and others whose opinions you respect. There are risks and costs involved with each. LLCs do establish more credibility with some, corporations with others. For example, lenders may prefer dealing with a business entity vs. a single individual.
9. Learn the lessons of others. Too often rehabbers believe their own propaganda. They get caught up in how attractive the property is, how good it will look when they are done fixing it up. Keep in mind that this is a business you are getting into. Done wrong, you can easily lose money in a rehab deal. Profits can be elusive. Competition can be fierce. Before doing your first rehab, go out of your way to solicit the advice of other rehabbers who have "been there and done that".
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