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.

What Is Real Estate Wholesaling?

This is a very large sad house offered to us by a wholesaler. We will see…. Photo by: Suna

This post originally appeared on the Hermit Haus Redevelopment website on 2016-05-23.

Yesterday, Carol, Russell, Sue Ann, and I went to look at a prospective wholesale deal we’re calling either the Antelope House or the Home on the Range because of the toy deer in the front yard. This was a frustrating trip. The wholesaler didn’t have the three things you expect a good wholesaler to have when asking you to meet at the property:

• The keys
• A firm idea about what he wants to sell the house for
• An understanding of the redevelopment business model

But there are newbies in everything, and I’m going to put down his performance to a lack of experience rather than to a lack of respect for the business or us.

In real estate investing, wholesaling is a process whereby the wholesaler:

1. Finds a (hopefully good) deal on a sad house
2. Negotiates with the current owner to establish the purchase price of the house
3. Signs a contract to purchase the sad house
4. Markets the contract to other investors at a premium
5. (Hopefully) finds another investor who is willing to pay the price the wholesaler needs for the property
6. Assigns the contract to the new investor who actually closes on the deal

Some people will tell you this process is illegal if the wholesaler is not a licensed real estate agent, It is, in fact, illegal in some states unless the wholesaler actual takes title to the property. This strategy is called a double-close because the title changes hands twice: once when the wholesaler buys it from the original owner and once when the final investor buys it from the wholesaler. In Texas, sale and assignment of the contract is legal because the wholesaler is marketing an equitable interest in contract itself, not the real estate.

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.

In this case, Sue Ann and I drove 40 miles each way (Russell and Carol drove farther!) only to waste our time with a wholesaler who was at best unprepared. He offered us the contract at nearly full retail prices without giving us the opportunity to look at the inside of the house. He said it would take about $15-thousand to repair the house, which would place the total cost of acquisition just north of what we could expect to sell it for—if his numbers were right. He said he would fix every flaw we found on the exterior of the house.

Now, there are ways to make an offer on a house sight-unseen. To do so, you must know your market extremely well. You can make the offer based on average cost per square foot of a sad house and your average cost to repair. Then you add in an allowance for worst case.

Also, never trust the wholesaler to make the repairs for you. There are two reasons for this:

• You are responsible for the quality of the repairs that the wholesaler makes without having any control over costs, materials,contractors, or corners cut. What’s the old adage? “If you want something done right, do it yourself.”
• The profit of a redevelopment company comes from the difference in value before and after redevelopment. Needless to say, allowing the wholesaler to reap these profits makes the deal too thin to think about.

The wholesaler wants us to meet back at the house on Thursday, at which time he promises to have the keys. If he still wants to sell us the house and act as a contractor, he will have read our contractor materials by then and understand the way we do business. If not, we will have other things to do on Thursday.

The bottom line is never be afraid to walk away from a “deal.” As my friend Larry says, “Some of the best deals I’ve done are the ones I walked away from.” It’s always better to walk away than to lose money.