Postmortem of My First Real Estate Financial Partnership
As a new investor with no real experience, but with some money available, I though being the financial partner in a real estate rehab to be a good way to both gain experience by working with a seasoned investor, and earn some money in the process. The following post is an overview of how the deal worked, and the results it produced. Let me know your thoughts, ideas, and any constructive critiques you may have.
The partner in question was someone who had approximately 10 years of real estate experience, and who had completed many profitable rehabs. We met at a local real estate investing association, and after several months becoming acquainted, decided to partner in a deal when an opportunity arose. The premise of the deal was he found the house, I bought it using my money, I funded the rehab, he managed the rehab, managed the sale, and in the end we would split the profit evenly. He would make more money than he would if he wholesaled the property, as he couldn't fund it himself due to multiple rehabs going at once, and I would be able to make money and learn in the process.
To begin, I had some money available, but not a huge amount, therefore, the house in question was a lower value home in an area of the city, that although itself was decent, was near the drop off point of where homes go from being majority owner occupied to majority rentals with a corresponding loss in quality. The house itself was a nice three bedroom, one bath ranch, all brick, with a two car garage on an alley. As it was brick the exterior was in good shape with minimal work required except on the trim and the garage, however, the interior had been updated for 30 years, so everything had to be redone.
Being that the house was in a marginal zone, the ARV was approximately $90,000.00. It was purchased for $27,000.00, so, using the 70% of the ARV rule, the rehab amount should be approximately $36,000.00. The goal was to clear $20,000.00 after paying all the commissions, pro-rations, title work, closing costs, etc, so, after splitting, each side would clear $10,000.00.
The about is how, in an ideal rehab, everything would have, turned out. Below is how it actually went, it was not a disaster by any means, but, it was not as profitable as desired.
To begin, the rehab was begun in winter, the beginning of January, which wasn't the biggest deal, since the vast majority of the work was done on the interior. The demo was done immediately, however, we couldn't park the dumpster in the yard due to a lack of room to maneuver the truck, so, street permit was needed, and since we only had a one week street permit, another dumpster was needed for other stuff later, so tack on $575.00 to the rehab cost. (a small amount I know, but this being a lower value deal, anything over budget will have a 50% greater impact on profits, than for example a $130,000.00 ARV rehab where you could make $30,000.00). The interior work went smoothly for the most part. The only real change was it was realized the furnace was older than initially though, and, since we were going to add central A/C, the HVAC guy was able to replace both for $2,400.00, a good deal, but still $900.00 more than the $1,500.00 anticipated for the A/C alone. Flooring was also more expensive than the initial $2/sq ft anticipated, so instead of $2,400.00 for a 1200 sq ft house, it was $3,100.00. After the interior work was complete it was time to move on to the exterior.
It was mid-February by this time, luckily it wasn't a brutally cold Wisconsin winter, so work could be done to the exterior. The principle exterior work was needed to the garage. The roof needed to be replaced, and it was initially though, the siding repainted. Unfortunately, we were only half right. The contractors realized there was significant rotting to the wood siding due to poorly maintained gutters, so the siding would need to be replaced instead of repainted, so, $1,200.00 for the shingles and siding plus labor for both re-roofing, instead of just re-roofing and paint. I'm not certain the exact amount this worked out to be, but probably $1,000.00 more. There was also a broken planter on the porch that needed $800.00 of repairs, which was $300.00 more than originally though. Over all this work went relatively well, and except for the additional garage expenses, no major problem. However, the weather decided not to cooperate, and it remained too cold for landscaping, then cold rain began, further preventing landscaping, for the ensuring month. So, add more holding costs (property taxes, insurance, utilities, etc) at ~$430/mo.
The weather finally cooperated, landscaping was done, and a few odds and ends were completed around the house. It was mid-April, the contractors all did good work, the house looked great, and it was time to hit the market. At this point I made the regrettable decision not stage the house since we were already over budget, and I didn't want to spend more. We also listed it for a bit more than $90k at $99k since it looked so nice, and we wanted room to negotiate a price to $90k. We received some initial showing, no offers. A week went by, nothing, We dropped the price a bit, a couple of showing, nothing, more time went by, another small price drop, nothing. After a month, and another $400.00 in holding costs, I became more inclined to spend the $800.00 in staging fees, and after realizing several other people did over the winter rehabs in the same location, thereby putting a glut of inventory on the market, and preventing anyone from getting a higher price on their finely rehabbed house, it was decided to list it at the original price of $90k.
After doing this, and getting new pictures of the staged house in the MLS, we had a flurry of showing, and an offer in two weeks. After a bit of haggling, a price of $88,500.00 was agreed upon with us paying closing costs, so we'd clear ~$85,000.00 before commissions and pro-rations. The offer used a VA loan which had a $1,500.00 funding fee, which the seller wanted us to pay as well on top of the other closing costs. The inspection came back, more expenses to the tune of ~$800.00. Closing time was 45 days, and at this time my partner in the deal had a serious health problem develop, which luckily he is recovering from. I belatedly realized though that I should have had a plan to deal with a circumstance like this ahead of time. Luckily it occurred after all the real work was completed, but a disaster could have ensued if it occurred earlier, so I guess the lesson is have a plan in advance should you or someone else become incapacitated in the middle of a business deal.
Finally it was time to close. After working out all the details of the closing costs, pro-rations, commissions, title work, etc. we cleared about $7,500.00, so we split $3,750.00 each, well short of the $20,000.00 goal, but profitable none the less.
Overall, the deal took 7 months to complete, 2 more than planned, 1 of which can be attributed to me for balking at paying $800.00 in staging costs (live and learn I guess), and one of which was outside anyone's control, and the bane of most rehabbers, the weather. It also only made $7,500.00 instead of $20,000.00, some of this was due to a lower purchasing price and more holding costs than anticipated. We ended up putting ~$41,000.00 into the rehab, instead of the $36,000.00 originally anticipated, a difference of $5,000.00. Some of these things should have been foreseen, others were outside anyone's control, some improvements we added on, the inspector wanted some repairs, additional closing and holding costs, and some of the estimates just cost more than originally though.
The deal was profitable, so I am not disappointed, I believe also I gained a significant amount of knowledge concerning the rehabbing business beyond the monetary gain. I also took a number of key lessons from it, particularly:
- Prepare for the worst, hope for the best. If the heath scare issue occurred a month of two earlier the entire project could have turned into a train wreck, so plan head, even if your partner looks young and healthy.
- On low value rehabs the 70% of ARV rule isn't going to work, you have less room for overruns, and unanticipated expenses than you would have on a higher value rehab, either buy lower, or don't do them.
- Try to do higher value rehabs, you'll make more money, you have more room for error, and cost overruns/price drops have a proportionally lower impact on your profit.
- Stage immediately.
- Price to sell.
- Watch to see if a bunch of other houses in the same area have sold for the same price, in the same area, at the same time that you bought yours. Some of these may have been bough by rehabbers as well, they will be your competition. You can check for some of this on the MLS, you won't see the private transactions, but it will help.
- Don't loose money, despite the fact that the deal wasn't as profitable as anticipated, we still spend significantly more than originally budgeted, took two months longer to sell, took on more holding costs, and sold for less than hoped, and we still made money.
If you made it this far, thanks for reading, let me know what you think.