I don’t relate these actual occurrences except to help readers understand how things can sometimes go horribly wrong in real estate investing. In this case a very experienced and successful Student purchased a property for $185,000. He decided not to wholesale it for a quick $35,000 profit. Instead he believed he could get $330,000 if he rehabbed the property. I changed the prices to protect the innocent (buyer and Student). The Student was correct and he sold the property for $330,000 nine months later. However, let’s look at what went terribly wrong.
The property was a hoarder’s dream and took many dumpster loads to empty it out. As is often the case, the piles of debris tend to hide what can be serious issues. In this case the tile floor had to be replaced and the roof leaks were not visible originally. Unexpectedly the roof had to be re-roofed or replaced. To get a maximum price, the Student decided to go with a new roof and replace all the flooring.
The pool “developed” a leak or it had been hidden by the seller so another unexpected issue was fixing it along with replacing the pool pump and filter. The leak turned out to be inside the pool’s skimmer but it took a week to find. I can go on and on about exterior and interior doors, garage issues, etc. but frankly the Student had anticipated most of these issues. Finally the kitchen and two full bathrooms were remodeled and interior and exterior walls were patched and painted.
Because the Student had a fulltime job he decided not to try rehabbing this property himself even though he could have if he had the time. He got a referral to a local contractor who had done numerous homes for another rehabber. The Student interviewed other contractors but chose the one that was referred by the local successful rehabber. The work started about 60 days after closing. The roof permit took weeks to issue and weeks to get the final approval after it was completed.
Since certain repairs need to be done in a specific order it makes other tradesmen wait for the initial work to be completed. The highly praised contractor suddenly went “missing in action” for weeks at a time. The tradesman who should have followed one another also went missing when they were most needed. Literally seven months later the property was ready to market and only because the Student started doing some of the unfinished work himself. The unseen profit eater was the fact that the Student borrowed 100% of the funding for the project at current market rate of 3 points and 14% that was clicking away every day whether work was being done or not.
Instead of spending more time on what else went wrong I want you to remember that this Student had rehabbed many properties and was very experienced. He had a contract with his contractor. He controlled his costs but the bottom line is that his net profit was $12,000. The listing agent who brought him the deal earned 6% initially and three percent on the sale and earned $20,000. The hard money lender made over $25,000. The contractor made over $30,000. Everyone made money and they didn’t do any of the rehab work. Even the contractor delegated the work to sub-contractors.
In summary, the three things needed for a successful rehab are getting the best possible purchase price, hitting your exit target price and controlling costs. This rehabber had two of the three issues perfect and had cost overruns that can happen to anyone. His biggest expenses that weren’t obvious were his hard money costs $25,000+ and the agents’ commissions. Those commissions paid to the listing and buyer’s agent were approximately $30,000 making a grand total of over $50,000. As I said above, the Student’s net profit was $12,000 and an untold amount of aggravation. It could possibly happen to you even if you are careful.
To your limitless success,
Dave Dinkel
