If It Were Easy….

Even when you have an established relationship, just getting contractors to show up in a hot market can be a challenge.

Weather has a way of overcoming your systems. It has been one of our biggest uncontrollable expenses this year.

When squatters, vandals, or thieves break into a project, the best you can hope for is to replace a broken window or two. When you’re working to turn a neighborhood around, break-ins will happen.

The discovery of knob and tube wiring at St. John’s cost us more than 100% of our contingency to rewire the house and bring it up to code.

Brody reminds us that the first rule of investing is vigilance. Keep an eye on everything.

This post originally appeared on the Hermit Haus blog on 2016-08-20.

If it was easy everyone would do it

If it was easy everyone would be in Clover

If it was easy I'd be the first to do it

If it was easy I'd gladly go back through it

—Lynn Anderson, Ed Bruce

This year, most of our redevelopment projects have run way over schedule. Running long is a bad thing because it always involves extra costs that eat into your schedule—if nothing else, your holding costs mount up. So I wanted to take a look at the reasons why we’re taking longer to complete projects than we thought we would. I also wanted to figure out what, if anything we could do about them. Here’s some of what I found:

Contractor Work Load

The projects that have run longest have all been in hot markets. When a market is hot, it can afford more redevelopment/remodeling work than softer, cooler markets. Contractors, even those with whom you have established long-term relationships, have more work than they can handle, and they often prioritize higher paying retail jobs over maintaining a close relationship with investors, who typically negotiate lower prices than retail customers. Even if you enforce schedule penalties in your contracts, your contractors may decide paying them—or walking off a project—is better for their short-term financial picture than meeting your deadlines.

Unfortunately, the only alternative I see is simply to plan for longer projects up front. If you plan for a six month project that completes in five, you are in much better shape than if you plan for a three month project that completes in five. The net result of your projections being tighter is that you will probably do fewer projects because you have to buy them at lower prices.

Weather

I’m not going to complain about all the rain delays we’ve had this year—not after the drought and wildfires of previous years. But we’ve had plumbing inspections on the Villa Park project delayed by months and leveling St. John’s house put delayed by weeks because of standing water. So far this year, I estimate the rain delays have cost us more than $10,000.

As Charles Dudley Warner famously said, “Everybody talks about the weather, but nobody does anything about it.” All you can hope is that you have large enough reserves to survive the short term so you can reap the long term benefit. You also need to insure your projects with builders’ risk policies that cover any storm damage that may occur, especially if your project is in a flood zone.

Vandalism and Theft

When a redevelopment site sits vacant, unsavory people eventually notice, especially if you’re working on a property that has been vacant for a while before you start your project. We’ve encountered vandalism on the St. John’s house where people broke into the house to party and sleep it off over a holiday weekend. I also mentioned the dumpster full of engine oil there. And finally, one of our contractors had all of their tools and 30 gallons of paint stolen from the Villa Park project back in February. All of these events took time and money to repair.

The good news is that our insurance covered at least part of the costs we incurred here. Our contractor’s insurance replaced most of their tools. The jury is still out on whether the insurance will cover any of the oil disposal costs. When you encounter vandalism and theft (and you will if you’re in this business long enough), insurance can be the difference between making an losing money.

Unplanned Repairs

“You never know what you’ll find when you open a wall” is a truism in this business. Here are some of the things we’ve found in walls, in ceilings, and under floors this year:

• Knob and tube electrical wiring 
• Illegal electrical splices 
• Undisclosed WDI damage 
• Broken pipes 
• Inadequate sewer ventilation 
• Inadequate engineering

Luckily, with all of that we haven’t found mold or asbestos.

But these things are why we always have a contingency built into every reconstruction budget. Our contingency is usually about 10-15% of the overall reconstruction budget. On houses built before 1970, we can include as much as 10% of the purchase price. So far, we have never failed to use at least 100% of our contingency on any project.

The Bottom Line

The bottom line for all of this is that redeveloping, renovating, or whatever the scope of your project is a risky business. Like farming, many of the factors that affect your economic survival are far beyond your control. You can’t even know about a lot of them when you commit to a project, but we have a duty to provide a safe home for our buyers. We place people first (above profits), and so should you. If all you want is the money, you’ll develop a reputation that will make it unattainable.

Builder's Risk Insurance

The backyard of the Ash House was grown wild for a number of years. I don’t think we can save the dog house, maybe the greenhouse.

The amount your builder’s risk policy will pay out in the event of a total loss varies with time (shown as weeks above), even if you insure (as I do) up to the full after repair value (ARV). Keep excellent records of what you have invested (blue line, shown in thousands of dollars) and how that investment affects the property value (orange line) to help get the most out of your insurance if you have to make a claim.

This post originally appeared on the Hermit Haus Redevelopment website on 2016-04-08.

We closed today on our joint venture project in Temple, TX. As you might guess from the last few blog posts, there were a number of last minute details to work out with the private money lender and title company. But we got them all done.

And I learned something about Builder’s Risk insurance in the process.

What Is Insurance?

Let’s start with an overview of what insurance is and isn’t. Insurance is a financial product where the insurance company agrees to indemnify you in the event of a loss. For insurance to work, three conditions must be met:

• You have to feel there is sufficient risk to justify paying for the policy. (In redevelopment, there always is.)
• There must be a sufficient number of policy holders that need the coverage to interest the insurance company in writing the coverage.
• The insurance company must believe there is a profit to be made by indemnifying you, generally by spreading the risk over the “pool” of insureds.

Like the name implies, with buider’s risk the insurance company agrees to indemnify the builder (you and me) against specific types of loss during the process of building or remodeling a property. The word “indemnify” screws up many people. All it means is that the insurance company will pay you a specific amount of money if you suffer harm or a loss, up to the maximum coverage. That is, the insurance company will make it financially as if the loss never occurred.

What Will It Pay?

The question that makes builder’s risk insurance interesting is, “What is the amount of the loss?” You suffer less damage if a tornado levels your project the day before you start redevelopment than if the same thing happens the day after you complete it. And it is different on any day between those two points. I’m using a tornado in this example because a total loss is much easier to define than a partial loss, such as a minor fire.

So let’s say you bought a house for $70,000. You expect to spend another $70K redeveloping it over the next 60 days. When you’re done, you expect the house to be worth $180K. The beginning and end points are fairly clear. If the tornado happens on day one, the insurance company would pay you about $70K. If it happens after completion, you could justifiably expect (but might not receive) $180K.

But the amount of harm you suffer would vary at any point along the way. Let’s say you spent the first week cleaning up a jungle that had grown around the house. You spent $2K. That investment might not be counted a loss because it wasn’t spent on the structure. But if you spent $8K replacing the roof the next week, you have improved the value of the structure by at least $8K. The insurance company would probably pay you at least $78K of the $80K you have invested.

The same holds true for demolition costs. Do they actually increase (or possibly decrease) the value of the property and, therefore, the amount of loss you suffer? You could argue that you’re still out the money for demolition, and you’d probably win, but….

Document everything!Image by Bitmoji

What the insurance company pays in the event of a loss depends on the amount you have invested and the actual loss you suffer. Both of these depend on you keeping squeaky clean records with receipts and all sorts of other documentation. I wouldn’t expect the insurance company to cover anything over your actual costs unless the project is complete or so close to completion that you are actively marketing it. Even then, it depends on how your policy is worded.

The take-aways:

• Always carry builder’s risk insurance on your redevelopment projects.
• Make sure you understand how the insurance company will determine the value of a loss before you sign the contract.
• Document everything.
• Don’t expect the insurance company to pay more than you can prove you’ve spent.

The first three of these take-aways hold true even if you are a regular homeowner instead of an investor. Then the last one that the insurance company probably will not pay more than actual market value, no matter what you think you home is worth. They have not emotional attachment to it.

Caption Photo by: Suna

Uninsured and Unacceptable

Nonelderly Adult Uninsured Workers by Firm Size, 2006

This chart shows that even larger employers are not providing health care for their employees. Small employers just can’t afford to do so.

Source: Cover the Unisured

“Texans without Insurance” is a really scary story. It is also why I urge everyone to vote against John McCain this election. The Republican health care initiative will only exacerbate the current situation.

According to the article, two-thirds of people without insurance in Texas also work. This number includes both Suna and I. Finding insurance as a contractor that costs less than a catastrophic illness is a daunting task. The Republicans just don’t get it.