What Do You See?

What do you think of when you see something like this? If your first thought is, “I wonder how I can use this location to make money,” you may be an entrepreneur.

This post originally appeared on the Hermit Haus Redevelopment website on 2017-04-25.

What do you see when you spot an abandoned building or a closed business?

The trick of being a successful entrepreneur, especially a commercial real estate investor, is to see opportunity where others see failure.

This fact was brought home to me by the recent closing of the Sonic Drive-In in the small town where I spend most of my time these days. This being a Small Town, the closure was a big deal and sent the small town grapevine into overtime. All kinds of reasons for the failure were floated until another business closed for failure to pay sales taxes to the state. (We know this because the state is auctioning off all their assets.)

But the one thing that nobody talked about in either case was: "What’s going to happen to the building?" Okay. Nobody talked about the loss of a handful of sub-minimum-wage jobs, either, and they certainly should have. Finding new jobs in a rural small town is no easy matter.

Spork intentionally reuses old Sonic locations to its special purpose niche. Photo source: Dallas News

In kind of a combination of those two thoughts, my initial reaction on seeing the sign at the Sonic (I learned about the other closure much later) was, "I wonder what kind of business could go in that location." You see, a drive-in is a very special-purpose building. There aren’t a lot of other options for using it. In fact, there are so few options and it is so costly to build that Sonic has a program to repurpose other commercial buildings as drive-ins.

So there aren’t many alternative uses for a defunct Sonic, but there are a few. I’m going to list some, and I invite you to add anything else you can think of to the comments. I’d like to figure out how to bring at least a few jobs back to the local economy.

• Another drive-in or eatery
  Okay. That’s kind of a no-brainer. I’ve seen several old Sonic locations recycled like this. There’s even a Dallas chain, Spork, that targets old Sonic locations to put in "high-end" drive-ins.
  But the question here, is why did the Sonic fail? Sonic, after all, has extremely well-honed systems and a national advertising budget. If a Sonic with these advantages fails in a given location, what are the chances of a one-off restaurant succeeding there? Restaurants have a higher initial failure rate that just about any other business. One reason may be that they are so easy and cheap to start. Like many mom-and-pop businesses, restaurants tend to be under-capitalized, making it difficult to survive until they can become profitable a few years down the road.
• A used car dealership or other business office
  As with any investment, having more than one exit strategy is key to success.
  I’ve seen this happen in South Texas. The used car inventory was parked under the awning, and the kitchen became the sales office. But that business eventually failed, and the location is now an insurance office with plenty of covered parking. The used car idea is also being tried again in Missouri.
• A flea market or art fair
  Wouldn’t this idea just be perfect, assuming you could get the location cheap enough to be profitable? Each stall could be a vendor’s booth. Customers could drive through the location and only stop if something caught their eye. Of course, parking might become a bit problematic if you had enough traffic.

There are reasons why I wouldn’t try any of these ideas myself in this location. Mostly because we already have more of each of these types of business than I believe the community can support. But I’m sure there is something that can be done. I just don’t know what it is yet. Maybe we can figure it out together.

Inflated ARV: Market Timing

Source: Austin Board of Realtors® It’s much easier to predict market cycles in real estate than in the stock market (where many would say it’s impossible), but you can still lose your shirt by assuming the market will always go up.

This post originally appeared on the Hermit Haus blog on 2016-10-24.

One of the easiest mistakes to make in renovating houses is to overestimate their After Repair Value (ARV). In this post, I’m not going to delve into motivations for inflating a house’s ARV. After all, I’ve done it to myself, so far be it for me to cast asparagus on anyone. I’m just going to talk about how it happens, and there are only a few ways:

• Use the wrong comps.
• Mis-time the market.
• Make the numbers fit the model.

I originally planned to talk about all three of these risks in one post, but I soon figured out it would be way too long. Click here to open all posts on this topic.

Mis-time the market

In the stock market, they say the fastest way to go broke is to try to “time the market”—that is to buy when the market is lowest and sell when it is highest. Real estate markets move much more slowly, and we have leading and trailing economic indicators to help us time the market. Some things to consider are:

• Special uses
• Seasonal differences
• Renovation time
• Market cycle

Special Uses

Unless you really know what you’re doing, owning a farm or ranch can be very expensive. For example, a gate won’t stand up to a tractor. Oops!

Special use properties make it easy to misjudge their value.

Farm land is cheaper in bulk; buying by the acre gets expensive. But farm or ranch land doesn’t produce any income unless you actively work it, and—while it does appreciate over time—you can be looking at decades to see significant improvement.

Offices, industrial space, and recreational properties exaggerate swings in the local business cycles. You must have a really good finger on the local economy’s pulse to play in this park—or need the office space yourself. It also costs more to get into this game than standard housing. That said, there is plenty of money to be made if you find a property where the use is about to change—like along the perimeter of where a new Box Store is going in.

Seasonal Differences

We missed the sale window for this lake house because of a combination of factors. We’re now holding it over the winter and using it as a vacation rental to make the mortgage payments until we can sell it in the spring when people are thinking about life on the lake again. Always have more than one exit strategy.

Housing in general sells better in the spring and summer, but resort housing exhibits this behavior on steroids. Many fewer buyers even think about buying a lake house when it’s too cold to get in the water or a house on a golf course when the greens turn white with snow.

We also know that water frontage adds considerable value. But what happens when a drought sucks the lake’s shoreline a quarter mile out? During the last drought, the receding shoreline exposed everything from illegal sewer lines to missing persons still sitting in their rusting cars.

Renovation Time

This is a big one—and one that has bitten every investor I know. You expect a project to take 90 days, but it actually takes six months. Maybe you find unexpected conditions. Maybe it takes longer than anticipated to get permits. Maybe you contractor flakes out.

At a minimum, that means you have additional holding costs for each of those three months, and that can really add up on a big project. At worst, it means you may miss the selling season or even hold a property into a down cycle.

Market Cycle

Given time, real estate will probably appreciate. But never assume appreciation in your purchase decision. If you do, you may wind up holding the property for decades or centuries to recoup your investment. Just look at the Rust Belt or Detroit.

The rule of thumb in Austin is that we have a five year cycle. The market goes up for three years and slumps for two. But the market is unpredictable. As my friend Shenoah Grove likes to point out, “We are now six years into our five-year cycle.” While this prolonged up-cycle is being driven by bigger economic trends—growing population, strong economy, oil boom (yes, the price per barrel is down because we have so much production right now.)—the likelihood of an adjustment makes longer renovation project much more risky.

Given the human trend to assume an up market will last forever, I’d be extra careful about every buying decision.

What Is Reverse Wholesaling?

Reciprocity is the psychological word for fair play. When we do something for someone, they usually feel obligated to do something for us. It works both ways.

You can find blank assignment contracts on the Web. I recommend paying the money to have a good lawyer in your area draw one up.

This post originally appeared on the Hermit Haus blog on 2016-08-27.

I’ve talked about the benefits of wholesaling real estate on a couple of posts. In short, wholesaling is the process of getting a property under contract and selling that contract to another investor. (For a more in depth explanation, see “What Is Real Estate Wholesaling?” In “Marketing Pays Off!” Sue Ann discusses a double-close wholesale deal that brought us a needed cash infusion.

Today, I want to talk about a specific variety of wholesaling called “Reverse Wholesaling.” Now Reverse Wholesaling technically isn’t a different type of wholesaling. It’s really more of a wholesaling strategy. Simply put, it’s all about knowing who is going to want to purchase the rights to your contract before you make the offer.

Here’s how it works:

Let’s say you’re out Driving for Dollars (driving around looking for off-market properties you might want to buy). You find someone loading a U-Haul trailer, moving out of a house. So you stop to chat. You find out that they are going to walk away from the house for personal reasons (that matter a lot to them but not to this discussion). You walk through the house with them and realize that you can help salvage their credit score by buying the house. You make the offer and they accept. You now have a marketable interest in the contract to purchase the house.

So far, this scenario fits the wholesaling model perfectly. But what about Reverse Wholesaling?

You know this house is a good investment at the price you now have it under contract—just not for you. But your friend Samantha is looking for exactly this type of deal. You call Samantha and she’s thrilled you found the house for her. You assign the contract to her and collect your assignment fee.

How is that any different from traditional wholesaling?

It’s different because you never had to market the contract. You had a list of buyers, and you knew what they were looking for. You simply called one of the investors you already knew wanted to buy a house like this one.

I was involved in a transaction very similar to this one just last month. Eugene, a wholesaler, blasted a property to an investor group’s email list. I went to see the property and knew immediately that the deal was too thin for the Hermit Haus model, but I knew someone whose model it fit perfectly. I put my friend Larry in touch with the wholesaler, and Larry bought the house. I did not collect a fee because I had no equitable interest; I never owned the contract. But I earned goodwill points from both Larry and Eugene, who has since given me first dibs on several of his wholesale deals.

There are numerous tactics for building your buyers list, but that is the topic of a future post.

The Pros and Cons of Real Estate Wholesaling

When you have a property under contract, you have a marketable interest in that property: the contract. You can sell that contract in most states, but you can't sell the property until you own it. Talk to your lawyer.

I designed this infographic of the wholesale cycle way in the future. Too bad I don’t have it now.

This post originally appeared on the Hermit Haus Redevelopment website on 2016-07-21.

Many "experts" recommend real estate wholesaling as a quick, inexpensive, and easy way into the business. While it may be the lease expensive way to start out, wholesaling isn't all that easy. For a complete explanation of what wholesaling is, see "What Is Real Estate Wholesaling?"

Pros

You can raise money fairly quickly.

Because you use very little of your own money and you collect on your investment quickly, it is possible to raise money very quickly. The amount of money you can raise depends primarily on your skill as a negotiator. How cheaply can you put the property under contract? How little of your money can you tie up in the process?

Risk is lower than renovating or buy and hold.

Again, because you use very little of your own money, you risk very little of your own money. But there are other risks.

Cons

It is not without risk.

Wholesaling can be very close to practicing real estate agency. You have to be very careful of your practices and wording to avoid this risk. Further, you will probably have at least a little of your own money at risk. And you risk your credibility with your peers if you don't perform a fair amount of due diligence before marketing your contract.

It takes a significant amount of effort.

Wholesaling requires more effort than just about any other kind of real estate investing and sales. It is a full-time marketing gig with very little repeat business. No seller will ever sell you more than one house. How would that sound? "Hey, Lee. You bought my house when it was being foreclosed on a few years ago. Guess what?"

You have to be willing to invest in marketing.

Because wholesaling is lead-driven, you have to generate a lot of leads for every deal that comes along. This part really isn't any different than other parts of the investing game, but it is something you have to be aware of. That means you have to be prepared to spend money and effort to generate those leads.

You can't do it on the MLS.

I see a lot of novice wholesalers trying to re-market a house they found on the Multiple Listing Service (MLS)—or from one of the big real estate sales websites like Realtor.com. The honest truth is, if it's on MLS, it's probably a very thin deal—usually too thin—for any investor already. By the time you add in a wholesaling fee, it probably isn't a deal any longer—if it ever was.

The point of this post isn't to try to scare you away from wholesaling. I want you to wholesale. We buy a good chunk of our deals from wholesalers. My business would be much smaller without reputable, reliable wholesalers.

The point is for you to understand what wholesaling is, what you're getting yourself into. You can make good money wholesaling, if you work at it and maintain good relationships with your buyers. But you will get much more out of it if you understand the needs of the people you buy from and figure out how to satisfy those needs.

Eight Exit Strategies

Sorry. There isn’t an Exit 8 in Texas. Or, at least, I can’t find a picture of it. Photo by TBD

This post originally appeared in substantially altered form on the Hermit Haus Redevelopment website on 2016-06-17.
 

Seems to me

You don't want to talk about it

Seems to me

You just turn your pretty head and walk away

—Joe Walsh

I’ve mentioned “exit strategies” in a few posts. I thought it might be worthwhile to discuss the exit strategies we use at Hermit Haus Redevelopment, LLC (HHR). But first, let me define the term “exit strategy” as we use it in the redevelopment industry and more specifically at HHR. Simply put, an exit strategy is a way to get out of a deal once you’re involved in it. Each of the exit strategies I discuss here can be applied in various parts of the deal cycle.

Okay. Let’s get down to it. Here are the eight exit strategies we use:

Before Going under Contract

If you exit the deal before going under contract, you essentially have no risk, not even opportunity costs. You don’t tie up any of your funds. The worst that can happen is you find out a better negotiator got the house and made a killing. This has never happened to me. Yeah, right!

Walk Away from the deal.

Speaking of “walking away,” it seems like whenever we go hiking I spend a lot of time looking at receding butts. Am I just slow?

Believe it or not, walking away is the most important exit strategy you can acquire. Most of the deals you see won’t make you any money. You have to recognize these bad deals quickly and not just walk, but run away. And you can walk away at any point of the deal cycle. You just have to be aware of the consequences, especially if you have already taken title to the property.

Refer the seller to a Realtor®.

Many of the deals that come your way are really retail sales. There is little value you can add to the property, and the owners need more money than you can pay. Period. These deals can help you maintain a good relationship with your Realtor by referring the seller to your listing broker, who can help the seller get the seller get the most for their house. Since this is another form of walking away, you’ll only refer out a deal if you can’t do anything else with it.

Of course, if you are a Realtor yourself, you could always list the property as an alternate way of monetizing your time.

Under Contract but before Closing

Simply by going under contract you are incurring some risk. If you can’t sell the contract, you could lose your option money and your earnest money. Then there is always a chance the seller could sue for specific performance, however unlikely.

The contract is what makes a deal real. This is the beginning of a contract where we bought a house from a wholesaler. In Texas, anyone acting as an agent (except, I believe, a lawyer) for another person is required to use a standard contract.

Wholesale the contract to another investor.

You have to have an equitable interest in a property to sell it without a real estate license. In most states, the contract to buy the house is an equitable interest that you can sell for a few thousand dollars. At this point, all you have invested is your option and earnest money. So if you have $100 down and assign the contract for $10,000, you can make a tremendous return on your investment without ever owning the property. A couple of caveats:

• Wholesaling is not legal in all states.
• It works best when you already have a list of buyers who might be interested in the property.
• In the states where wholesaling is legal, you must have a valid contract to sell.
• I recommend you always use an attorney when wholesaling.

You’ve closed on it. Now you own it. What are you going to do with it? This question is what exit strategies are all about.

After Taking Title to the Property

After closing on the purchase, there is no doubt that you have embraced risk. You own the property. Now you have to pay for it and the needed renovations. Unless you use the double-close method of wholesaling.

Double close on the property.

Although this is technically a type of wholesaling, you actually take title to the property. Because of the cost of closing twice, you would only want to double-close in a few situations:

• Traditional wholesaling is illegal in your state.
• You’re making enough money on the deal that you can afford the double close.
• You don’t want one or both parties to the wholesale transaction to know how much you’re making on the deal.

"Prehab" the property.

Prehabbing is doing the extreme minimal amount of improvements to a property needed to sell it to another investor. (Yes, you could call this another type of wholesaling.) We haven’t had the opportunity to prehab a property yet, but the most common example I’ve encountered of other people prehabbing is with hoarder houses. A friend of mine bought a hoarder house for $45,000. He then spent $500 to have the garbage hauled off and sold the house to another investor for $70,000, making almost $30,000. The investor who bought it put another $30,000 into the house and sold it for $150,000. In my books, that a win-win-win.

Rehab or redevelop the property.

This is our bread and butter. At this point, all of the properties you see described on this site is a rehab or a redevelopment project.

Buy-and-hold (and rent) the property.

Holding rental properties are a great way to build wealth. You use someone else’s money (mostly) to buy the property, and your tenant makes the payment for you. HHR doesn’t hold rental properties. We do, however, sell redeveloped properties to our sister companies to hold.

Owner finance the sale.

To owner finance the sale, you must have sufficient capital to absorb the risk. I have to say this is one of the riskiest exit strategies you have, and it is fraught with drawbacks. First, you have to pay taxes on the capital gains without having the income from the property to do so. Then you have to assume the buyer will continue making the payments you rely on either for income or to make wrap payments yourself. And finally, it eats the capital you would need to continue your investment business.

So that’s it: Eight different exit strategies to keep in mind on any deal. We use one of these strategies every time we look at a property. By far, the one we use most often is to walk away.

Another One Bites the Dust

Failure to do your own due diligence is a trap that can reduce your profits to single digits or even to a loss. Photo by Free Images

This post originally appeared on the Hermit Haus Redevelopment website on 2016-06-10.
 

And another one gone, and another one gone

Another one bites the dust

—John Deacon

We had to back out of another wholesale deal today, even though the numbers looked pretty good at first blush. I’ll call the wholesaler Dick for this post. You have to be really careful when dealing with professional wholesalers. They know the business well enough to know what you are looking for, and they can make the numbers look good—often by inflating the after repair value (ARV) or underestimating the cost of repairs. You have to do your own due diligence and trust your own numbers.

In this case, Dick was going to make enough money on the deal to require a double-close. That is where the wholesaler actually takes title at one closing and then sells the property to the wholesale buyer at another closing. These two closings can take place minutes apart, enabling the wholesaler to make a tidy profit in a very short time without disclosing the amount of that profit to either the original seller or the wholesale buyer.

Because a double-closing incurs two sets of closing costs—one when the wholesaler purchases the property and another at the sale—this exit strategy is generally only viable when the profit on the wholesale is at least $20,000. Now you may say that’s a lot of money.

Why wouldn’t I have a problem knowing the wholesaler is making at least $20,000? Because it all comes down to the numbers. If there is still room for me to make a reasonable profit, I don’t care how much the wholesaler makes. Dick found the deal, after all. If he hadn’t found the deal and sold it to Hermit Haus, we wouldn’t make any money at all. And 30% of something is better than 100% of nothing.

Hail damaged shingles can be difficult to spot unless you climb up on the roof yourself or hire an inspector to do so. Photo by Home Standards Inspection

In this case, the numbers worked only on the surface, and this is another reason why I recommend hiring an inspector on every house you buy. The inspector’s job is to find hidden problems. In this case, the problem wasn’t so much hidden as missed. The roof looked fine: 30-year architectural asphalt shingles in reasonably good condition to my eyes. But the inspector found signs of hail damage, which would require replacing the roof before any bank would finance it for the new seller.

The estimated cost of the roof was about $10,000. That would move the deal from a fairly reasonable profit range to the danger zone. There would be no contingency repair budget left, given the ARV. We have learned to never go into a deal without a contingency budget of at least 10% of the repair estimate. We could be placed in a position of either having to cut corners or lose money, neither of which is in our vocabulary.

When confronted with the bit about the roof, Dick said, “That’s a good roof. I don’t have to replace it. Nobody can make me replace it.” We all agreed. But there are two things to consider:

1. A new roof is the single best investment you can make in a property. It relieves new buyers of an expensive contingency to their purchase, making them feel safer about the purchase.
2. And while banks don’t require a new roof to finance a property, they do require an undamaged one. If you want to sell a house with a damaged roof, you had better fix it.

Since we couldn’t come to terms with Dick about the roof, we backed out of the purchase during the option period. It’s not that I expected him to replace it; I simply needed to have room in the deal to replace it myself.

Replacing the roof was the right thing to do. I believe in doing the right thing. In this case, scrubbing the deal was the right thing for us to do. We could have gone forward if we could renegotiate the purchase price downward to account for the unforeseen cost, but that didn’t happen. And Dick may still be able to sell the house to an inexperienced, unsuspecting purchaser, but we won’t be put in the position of choosing between taking advantage of someone or losing money.

It’s Not Always a Nail

If all you have is a hammer, pretty soon everything starts to look like a nail.

This post originally appeared on the Hermit Haus Redevelopment website on 2015-12-31.

This post is my take on the situation that spawned Sue Ann’s post yesterday. We came across a prime example of a deal that is not a good deal for everyone, but we were still able to find a good solution for a distressed seller.

Carol knows a frustrated landowner whose last tenants left his house unlivable when he was forced to evict them. He wants out of the renting business but is willing to owner finance the house.

There is a reason it’s called “property management.” Despite my series of posts extolling the benefits of rental ownership, renting houses is a business. It’s risky, and it’s not for everyone.

Russell, Carol, Sue Ann, and I all evaluated the house to determine what we would be willing to pay for it. At the same time, the owner asked Carol to show the house to another investor who had approached him. Sounds weird, huh? We’re looking to buy a house, and the owner asks us to show the house to a competitor. And we did so without hesitation. Carol is a Realtor®, so that gives us one more tool to help distressed owners find an acceptable solution. So, no problem.

It turns out that the other investor was willing to pay slightly more for the house than Hermit Haus was, because he focuses on that particular part of town. But he still wasn’t willing to pay what the owner wanted for the house. The owner didn’t see either our offer or the slightly higher offer from the other investor as beneficial enough for him at the time.

So what is the best win-win solution?

This trashy image from HuffPo symbolizes the house we evaluated. It isn’t that the problems were so bad, just that there were so many of them.

Let’s step back and look at the house. It’s a four bedroom 2.5 bathroom brick two story with a two-car garage. After renovation, it will be a perfect home for a growing family. Unfortunately, there is that thing about the house not being livable right now. That means a family will have trouble finding a bank willing to finance the house in its current state. But that’s okay because the owner doesn’t want to sell the house outright; he wants to finance it. We can also help the right buyer find funding to rehab the house and increase their equity in it—kinda like what they do on Fixer Upper, but we don’t to the rehab. Luckily, we can put the right buyer in touch with the right contractors, as well as the money to fix it up.

In investor language, that’s called having “multiple exit strategies.” In Hermit Haus terms, it’s called “having the right tools to find the right solution for the problem.” The old saying is holds that if you only have a hammer, everything starts to look like a nail. At Hermit Haus Redevelopment, we pride ourselves on being able to look at the actual situation and find the right solution, not just the one that fits the tool at hand. Depending on the situation, we will take one of six positive actions to help any distressed owner:

• Buy the house ourselves and renovate it to sell
• Buy the house and renovate it to as a long-term hold (rental)
• Wholesale the house to another investor
• Refer the house to Carol to list as a Realtor^®
• Advise the seller on other methods of getting out from under the property
• Walk away from the house and nothing but good wishes for the seller

In this case, our solution was for Carol to list the property as an owner-financed fixer upper. When she finds the right buyer, we will have a good set of solutions for them, too.