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

Entrepreneurial Blues

A good entrepreneur finds balance. Image by: Bitmoji

This post originally appeared on the Hermit Haus Redevelopment website on 2016-04-05.

Warning: This post can be construed as whining. If I hadn’t promised to be as honest as possible about our journey, I wouldn’t post it. It sounds like whining to me, and I don’t like whining. Feel free to skip it. But if you want to know what it’s really like to run a small real estate redevelopment company, I guess I’m writing this for you.

When you’re getting started—and possibly even after you’ve been doing redevelopment work for awhile—you don’t have a huge staff to rely on. Some of the many tasks required to keep a company like this one working include but are not limited to the following (presented in no particular order):

Finding money Budgeting Plowing through the MLS Prospecting for buyers, sellers, contractors, handymen, etc. Reviewing contracts Signing contracts to buy, sell, and finance projects Keeping the books Finding money

Monthly, quarterly, and annual financial reporting Paying contractors, assistants, lenders, suppliers, etc. Communications (blogging, Facebook posts, one-off letters, advertising, etc.) Marketing, marketing, and marketing Crunching numbers Estimating repairs Finding just the right wine

Finding money Managing contractors and vendors Setting policy and defining procedures Negotiating with buyers, sellers, contractors, suppliers, etc. Record keeping (physical and electronic documents like permits, licenses, contracts, etc.) Envisioning, inspiring, and directing operations Finding just the right whine

I believe in job creation, but I also believe in profits. So there are only four of us working on this enterprise, and we each have unique roles and skills. To oversimplify: Russell works on finding deals and keeping the back-end systems running. Carol is our real estate guru; she keeps all of our preliminary numbers realistic, is our numero uno marketeer, and manages projects. Sue Ann is our social media expert, editor in chief, and networker. That leaves most of the boring business stuff to me. I love what I do, but...whine!

We do have assistants—virtual and otherwise—who handle most of our secretarial work: printing, copying, and mailing marketing materials. But the other listed tasks (and many, many more) fall to one of the four principle investors.

What set off this whine-arama is that I spent almost my whole day for the last two days chasing down random bits of paperwork for lenders and title companies involved in two of our current projects. In a perfect life, this would have been work I delegated to a file clerk. Unfortunately, I am the file clerk (technician level, in Kiyosaki’s quadrants).

Now you learn in investor school to prepare for this by keeping the most commonly needed documents in a folder on your desktop. This I do. However, each transaction we do adds to that list of documents. My “Commonly Needed” folder now runs just over 8MB, compressed. I’m waiting for some bank or title company technician to balk at looking though it and ask, “Why don’t you just send me the documents I need?” But so far, they always find just one more document to request.

My advice: Keep smiling and telling yourself it’s all a brilliant learning exercise that you’ll get through and eventually have it all down and a staff to delegate it to. That or learn to “play the guitar on MTV.”

Private Money Anxiety

Your lenders are people, too. When they have anxiety about lending money to you, understanding what drives that anxiety can help make your business more profitable.

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

You hear a lot in this business about private money and hard money—often lumped together as if they are the same thing. Both are alternative financing options to banks. There are advantages and disadvantages to using either private or hard money. Let’s start by talking about what distinguishes the two:

Hard money

Hard money is more bank-like. It involves dealing with a lender whose business is lending money to individuals or companies for the purpose of buying, renovating, and possibly selling real estate. Hard money lenders are “bricks and mortar” operations; they have a building, marketing and collections departments, and strict rules they must follow.

Private Money

Private money is money you borrow form individuals. They can be sophisticated lenders or novices. They can be your lawyer, car salesman, or coworker. They may even make their living by lending money to investors. But they aren’t regulated by the government because they aren’t in the business of lending money. That is they don’t have a building and staff to support.

Investors often lump hard and soft money lenders together, because they serve the same purpose: they provide the money you need to do your business without having to go through the qualification process, wasted time, paperwork, and financial nakedity of a bank loan. The price for this convenience is a much higher cost of money and a shorter loan term. Neither private nor hard money lenders are likely to give you a payback period longer than a year, and you’ll probably pay more points for the loan and a much higher interest rate than you would with a bank loan. For example, we have paid two points (two percent of the total loan) and twelve percent interest for private or hard money as opposed to one point and five percent for bank money.

So why use private or hard money? When you find a profitable deal, you often have to close in a week or two. I have yet to find a bank that can make a decision in less than a month, even when you have an ongoing relationship—as if that meant anything to a bank. The added expense is just a cost of doing business. So what if you pay your lender $5,000 more than you would a bank if you’re still going to make $25,000 or more on a deal you would lose if you waited on a bank to act?

The people you borrow from have their own plans for the money they let you use. We always protect their money first. The lender is a named insured and gets paid before we do. Photo by: Suna

Which Is Better?

So which is better, hard or private money? The answer is it depends. Private money can make a decision faster, but it can also be more skittish. I have known private money lenders to back out at the last minute. I haven’t had that experience with hard money lenders. But because hard money is more regulated, they can take longer to make a decision in the first place, which can cost you the deal.

One thing to remember is that whether you’re using hard, private, or bank money, your lender is taking a bigger risk on your project than you are. You are risking their money, and the only assurance they have of getting it back is your word. Banks don't want the property that secures the loan. Hard money or private money lenders often don’t want it either, but they are in a better position to recoup their investment (plus a little) if you default than are banks.

When you use someone else’s money, you play by their rules. Be patient with them if they get skittish at the last minute. They are just trying to cover their assets. Help them overcome their anxiety and get the deal done. You’re going to protect their money better than your own; help them understand that.

Another thing to remember is that your lender is another set of eyes on the deal. They may see problems you missed or glossed over in your initial analysis. Anything that makes your lender anxious is something you should take very seriously once you uncover the root cause. For example, a private money lender we are working with recently got very nervous just before closing. (That’s usually the most stressful time for them.) They started by questioning our analysis, so we walked them through the deal step-by-step.

Then they asked the question that was really bothering them: “What about insurance? Will we be a named insured?” We always name the lender as an insured on our Buidler’s Risk policy. It’s only fair. But when I reviewed my checklist, I hadn’t checked the box beside insurance. Oops! My bad. Luckily, my lender reminded me a few days before closing. Now that box is checked and we’re moving forward.

Philanthropy and Networking

This ad will appear in the playbill for every performance by the Milam Community Theater this season. Consider sponsoring a community group in your area. It is “doing good” that does good for you, too.

This post originally appeared on the Hermit Haus Redevelopment website on 2016-04-02.

Sue Ann and I attended the Milam Community Theater’s (MCT) “Night on the Town” tonight. It included a nicely catered dinner of roast beast and veggies followed by MCT’s presentation of Agatha Christie’s The Unexpected Guest. I won’t comment on the play here, but Suna was asked to write a review for the local newspaper.

So why am I mentioning dinner out on a business blog? I wanted to point out the power of networking and advertising at these otherwise “social events.” For dinner and the play, we were seated with the Cameron city manager, the host of a local radio broadcast, and two other business owners. In the audience was our insurance broker, a real estate broker, a lawyer, and several other Milam County elites.

All of these local big wigs had at least one thing in common: we had all helped sponsor MCT’s season this year. And we got to mingle with them and revel in that commonality.

While this kind of networking inevitably brings about new business contacts, that isn’t why you do it. As our mantra says, “People first, profits seconds.” In large cities or small towns, relationships are how you get things done. You have to be nice to people first, and you have to be nice to them because they are people—not because of “who they are.” I actually enjoyed the company we were in and only mentioned our business when someone else brought it up. But now when people see my name on a permit application, they have a friendly face to associate with it. When they know someone who needs help selling or buying a home, they know someone who (I hope) made a good impression on them to refer.

And there is the sponsorship aspect. Our ad will appear in every playbill for the current MCT theater season. It is a very low cost form of advertising and networking.

The Win-Win Works

Proof of a Win-Win!!

This post originally appeared on the Hermit Haus Redevelopment website on 2016-04-01.

Independent proof of a win-win came through my Facebook feed today. The screen shot to the right is from the Realtor® who represents the buyers of the Blue Ridge property.

Love having my buyers come out on top in this crazy sellers market.

Those with a scarcity mindset might interpret McKinsey’s statement to mean that we sold too low. We didn’t. Even after negotiating with the buyer to establish a fair price, the house sold at the high end of the comparables. This is one of the best examples of a win-win scenario I’ve encountered to date.

We made money—just not as much as we might have had we not learned some valuable lessons about working with contractors. We can keep the lights on, pay the contractors, repay the loan to purchase the property, and put a little in our pockets.

I’m also very glad the buyers got a good deal. “People first.” I hope they will be really happy in the house.

Lakeland Closes

We closed on the purchase of this lovely house today.

This post originally appeared on the Hermit Haus Redevelopment website on 2016-03-30.

We closed on the purchase of our second Hermit House redevelopment property today. It is a lovely two-story house in Pt. Venture.

The Lakeland house currently has a view of the lake only from one window in the master bathroom. In fact, you have to stand in the tub to see the lake. We hope to rectify that situation by adding a second-story deck that will be accessible from new doors out of the upstairs living area and a stair case from the existing backyard deck.

Our exit strategy for the property is currently in flux. We have several options, but all will remain on hold for the short term because Carol and Russell will rent the house for the short term. They sold their primary residence but haven’t found another suitable property. Investors tend to move a lot.

This house is an excellent example of a win-win. The previous owners needed to sell the house to move on with their lives. A previous attempt to sell at full market had failed. We were able to put cash in their pockets and enable them to pursue their life goals. And simply buying this house improves our balance sheet.

This is my favorite kind of deal: everybody wins.

People Matter

Heart makes [the redevelopment] business rewarding. Money only makes it possible.

This post originally appeared on the Hermit Haus Redevelopment website on 2016-03-22.

We like to say we are “redevelopers” instead of “flippers” for a couple of reasons:

1. We are not dolphins.
   By the most common measures of animal intelligence (brain weight and the ratio of brain cells to body cells), dolphins are probably more intelligent than humans are. That would make Flipper smarter than me.
2. Flippers have something of a bad reputation.
   Deserved or not, many people think of flippers as preying on the weak or just taking advantage of other people’s misfortune. After all, we buy below market and sell at the top of the market.

While some do take advantage, most of us want to do good in the world. We will even walk away from a deal if we don’t feel we are doing right by the seller. To that end, I want to share a story from a fellow redeveloper, Cheryl Thompson. I met Cheryl though FortuneBuilders, an investor group to which we both belong. She posted this story on the group’s closed Facebook page and gave me permission to reproduce it here.

Last week I got an opportunity to spend time with a woman who was selling her parents’ home. Three bedroom/1 bath. Amazing hardwood floors. She walked me through the impeccable and memory filled home that her father had built in the 1950s. The property in top condition would be worth $90,000. My MAO (maximum allowable offer) would have been $30,000 – $36,000.

She told me how her father had died four years ago, and she bought her mother a condo that would be easier for her to get around in after she had a stroke two years earlier. Now this kind and love-filled daughter had to sell the house. For most, this is the OPTIMUM opportunity. She explained how she was going to use the funds to keep her mom comfortable and safe in her condo with nursing staff and how she was managing all this single-handedly.

As I walked through the house, my rehab hat was making a detailed list of items that would have to be done to the house to get top dollar. My heart hat was listening to the woman’s goals and knowing deep down that I had to use my knowledge to help her, not to fatten my own bank account.

I stopped in the middle of the basement and said to her, “I can’t buy your house. You have too much capital here to be able to take care of your mother with. I’m going to show you how to get top dollar for this house and put the money in your bank account for your mom.”

The tears in her eyes said it all.

We started the walk through again and I pointed out exactly what she needed to do to be able to list the property with a realtor. I told her what to pay attention to and what to let go. I gave her my favorite realtor team’s name and number.

She mentioned that even though her parents had had insurance with State Farm for over 50 years that State Farm had dropped her because the house was now vacant. I asked her who was insuring it…she said, “No one.” I panicked. An uninsured vacant house. At that moment I begged her to call my company, who insures vacant houses before the end of the day. She had 1 hour and 15 minutes to get it done…and $90,000 to lose if something happened to the house while she was getting it ready to sell.

When I was getting ready to leave, we hugged and agreed to stay in touch. I felt like I had run a victory lap knowing that this woman was going to be able to take better care of her mother for at least 1-2 years because of our 30-minute meeting. She would insure it, get it ready for sale, hire a realtor, and feel a little bit less overwhelmed because our paths had crossed.

This is one of the most beautiful things about FortuneBuilders. We have knowledge (lots of it) that we can put to work for great good.

I love deals. All kinds. But the best deal you can ever make is one that will make another person’s life a whole lot better.

Since we started Hermit Haus Redevelopment, I have not had the opportunity to help someone like this. The people we have talked to have many reasons for just wanting out of the house. Either they don’t have the money to do the rehab themselves, or they don’t have the time, energy, and patience an extended rehab requires. Giving these people what they want is not taking advantage of them. Sometimes they see the what’s in their best interest in terms other than financial gain—like my father did when he sold the house he and my mother had lived in for $20,000 less than its “as-is” value. He felt it was worth $20,000 to move out of a house with too many memories and move where he could begin to rebuild his life after Mom died.

If you know of someone who wants out from under a house that has become a burden for them, we are happy to help by buying that house. If you know someone who wants to know how to get top dollar for their house, we can help with that, too.

How the Win-Win Creates Wealth

Larry, Lee, Sue Ann, and Valerie at an event in Houston. If you live life with a service mentality, everyone you meet is your partner.

Sometimes despite best intentions, rehabilitating your house turns out to be more than you are up for. We can help.Dominic’s company found a very sad house in one of the best neighborhoods in Temple, but it was too far north for them to manage the redevelopment. So they sold the contract to Hermit Haus and made a tidy profit on the deal!

This post originally appeared on the Hermit Haus Redevelopment website on 2016-03-16.

We at Hermit Haus Redevelopment focus on finding situations where everybody wins. I’m often asked how that can work. “Doesn’t somebody have to lose out?”

The answer is that not everybody measures their success in financial terms. When my mom died, Dad just wanted out of a house with too many memories. When he sold it for 70% of what it was worth in its as-is state, he was ecstatic to be free of it. He could put money in his pocket and start living life on his own terms.

Here’s how a group of people can work together to improve a neighborhood, create wealth, and build a situation where everybody benefits:

• I will admit that I wasn’t involved in the original transaction. So I don’t know what the original seller’s motivation was, but I’m going to assume their best interest was served by selling a house that was too much for them to renovate for sale. Maybe, like my dad, they were happy to sell the house for more than they paid for it, even if it wasn’t what it would have been worth if they worked to rehabilitate it.
• Another redeveloper Larry met at the Houston Summit last month is financing the project in return for two points (2% of the money he’s lending) plus 12% APR on the note.
• I put the project together, will manage the finances and be responsible for the mortgage, and will front most of the renovation budget not covered in the initial mortgage. In return, Hermit Haus will retain half of the profit at sale.
• Larry’s contractor friend will do most, if not all, of the work—or rather, his company will. He will retain a fair profit on what currently stands at a $70K redevelopment budget while his employees benefit from a living wage.
• Larry’s company is responsible for managing the day-to-day operations of the redevelopment project. It keeps the other half of the profits at sale.
• The neighborhood where the house is located gets a nice home where there is currently an eyesore that isn’t currently habitable. Everyone’s property values should increase as a result of this project.

Number Three

Temple (magenta circle) is pretty far north of Hermit Haus’s focus area (magenta glob).
 

Here is the house with the pile of ashes featured.

This post originally appeared on the Hermit Haus Redevelopment website on 2016-03-11.

My mentor Phill Grove always says, “Your Net Worth equals your NetWork.” Here’s an example.

A few days ago, I got a call from Dominic G, another redeveloper working in Central Texas. He was checking references on a General Contractor with whom I’ve worked for many years. As we chatted, we found out we have a lot in common, including the back office system both our companies use. Then Dominic mentioned he had a house under contract in Temple. Since Temple is well outside of his normal range of operations, he wanted to know if I would be interested in buying the contract from him.

Now Temple is also pretty far north for Hermit Haus to go. We don’t usually get much farther north than Georgetown. But the numbers looked good on the surface, so I said I was.

Last month, I met yet another redeveloper at the Houston Summit who has done roughly 20 houses over the last 20 months in the “Greater Temple” area. We’ve been chatting a bit, so I called Larry and asked if he’d like to JV (form a joint venture) with Hermit Haus to get the deal done. He did. We did an onsite evaluation with Larry’s lead contractor, revisited the numbers, and came to an agreement on how to proceed. Hermit Haus is now under contract to buy its third house since December.

We’re calling this project “The Ash House” because the previous occupants appear to have heated the house with a lovely wood-burning fireplace for several years. Unfortunately for the neighbors, they just dumped the ashes in a flowerbed until the pile is at least 36 inches tall and a couple of feet in diameter. One of the first items to clean up on the list!

Everybody wins!

Sad Houses and a Service Mindset

I still try to live by the words of cultural icon and personal hero John Lennon, who said, “There are no problems, only solutions.” Photo by: Unknown

This post originally appeared on the Hermit Haus Redevelopment website on 2016-03-09.

Hermit House Redevelopment approaches every unique situation with a service mindset. We ask the question, “How can we help,” and we put our mission statement out there on everything we do:

We buy sad houses and make them happy again.

What does that mean? Or as one of our private money lenders put it, “Lee, what the hell is a sad house?”

A sad house is one that is not living up to its true potential. As with people, lots of things can make a house sad. Between the four of us on the Hermit Haus leadership team, we’ve probably seen them all at least once.

It all comes down to how you look at things. There are no opportunities without problems. You can focus on the problem or the solution. Granted, sometimes the solutions require more resources than you have. That’s where we come in. At Hermit Haus Redevelopment, we specialize in finding the resources that enable us to provide solutions.

Without going into too many details, here are a few examples:

Neglect

A couple of our recent projects involved deferred maintenance—repairs that were put off so long that their volume became overwhelming. One house stood vacant for more than a decade. Another was ignored by its owner until there was more wrong with it than he cared to address, even though he had the money to renovate it before he sold it.

In both of these cases, we gave the owners what they wanted: a quick sale without having to go through the trouble of dealing with contractors and hoping they would get the money the spent on renovation back out of the house.

Changing needs

We are currently acquiring a beautiful house, one that I would be happy to move into without doing any renovation whatsoever. The owners tried to sell it once before, but couldn’t get any traction in a down market. Now their needs have changed. and they don’t have time to wait for it to sell, and they were leery of trying given their previous experience.

What the owners of this house wanted most was to be out from under it. Even though we couldn’t give them what the house was worth (at least in their eyes), we could free them from a crushing two-hour commute to work after a job chance and the worry of another failed attempt to sell the house.

From personal experience, I know that if someone I’ve talked to loses their house to foreclosure, I have failed them.

Financial problems and foreclosure

As Carol and I have both mentioned, foreclosure is only the start of a nightmare that can last more than seven years. The consequences of foreclosure can sometimes return decades after the event.

Although we’ve purchased bank-owned houses, we haven’t been as successful in helping people avoid foreclosure as we want. After hearing the saddest sentence in the English language too many times, I’ve made it my mission to help as many people as will let me help them. If someone I’ve talked to loses their house to foreclosure, I have failed them. I obviously haven’t explained how I can help well enough.

Probate

We bought a house Sue Ann and I plan to homestead after it had been tied up in an estate for more than 20 years, vacant for much, if not all, of that time. During all those years, the estate had paid almost $10K each year in real estate taxes and more than $200 each month in HOA fees. I have no idea how much the insurance on the house ran. Luckily, the house was owned free and clear, so the estate didn’t have to make mortgage payments on an empty house. Even so, the estate spent almost $250K maintaining a house nobody wanted to live in. To be fair, there was an easement encroachment that scared off many potential buyers and their banks.

We freed the estate from future expenses on this house and paid cash for the house. In fact, we got the house even though our offer wasn’t the highest because the estate’s attorney realized we would be less likely to back out of the deal than buyers without our experience. Since then, we spent more than a year working with the City of Austin to resolve the easement issue and are in the process of finalizing the renovation so we can move into the house. I know the people moving into this house will be proud of it because they are us and we are proud of all the work.

Sometimes you have to tear something down to make it right again.

Poor workmanship

Another of our current projects involves an almost complete teardown and rebuild. The original owners did things on the cheap without regard to quality. We had to completely jackhammer the foundation and start from scratch. In the process of demolition, we found only three pieces of rebar in the original foundation. We also found electrical runs that were spliced together with electrician’s tape in the walls—a fire waiting to happen.

We bought this house from an estate, thinking that we were helping the heirs divest themselves of a property nobody wanted to manage. Instead, our primary service turns out to be making the house safe for anyone who lives there in the future.

Some people have said it sounds like we’re preying on other people whose problems have gotten the better of them. We’re not, but there are those in this industry who do. We don’t want to be vultures picking at the corpse of failure. We really do approach every deal with a service mindset. There is no Kobayashi Maru. We will buy your house or help you find some other solution. We want you to be as thrilled with the solution you choose as we are.