This morning I got my daily fix out of the way quickly, talking with a very bright investor who’s been doing well in turn ‘n burn mode. Not 40 yet, he’s married with three young children. They’ve been pretty successful in buying REOs, rehabbing them, and doin’ it over again. They’re now liking the whole lease/option approach in selling these homes. ‘Bob’ and his wife ‘Marie’ have very good heads on their shoulders — smart folks.

However, they’re realizing that even though they’re making five figures a month between them, their job related retirement plans are ticketed to be a colossal failure. Also, they can now see the emerging script with their rehab success. They’ll make a lotta money, but since by definition, the strategy in place  must keep their capital churning, getting a reliable retirement income established will be problematic at best.

What to do?

Time doesn’t allow for a detailed exploration of all their options and the execution thereof, but here’s a quick outline of their main menu.

1. Separate literal turn ‘n burn deals from the buy/rehab then lease/option deals.

2. Make use of either/or long term cap gains rate — tax deferred exchanges — for the closed sales of lease/optioned properties.

3. Move the equity to long term purchases — tax deferred if indicated — the agenda being the development of retirement income.

4. Stop — as in ‘by around 4:30 yesterday afternoon’ — making contributions to both 401(k)s and the IRA they now own.

5. Divert those contributions to separate EIULs  – one for them to develop a second basket of tax free retirement income — the rest for their kids’ education costs.

6. The rest will be in a separate post showing exactly how their particular Purposeful Plan will be structured.

As is true with so many people with whom I talk, they have the potential for a retirement far beyond what they may have envisioned as possible.

Next week I’ll show what they might consider doing — the primary goal being retirement in 20 years or less — with retirement income well in excess of $100,000 a year.

I strongly suspect they’ll be able to retire before 20 years pass. I also believe they’ll end up with an annual income above what they ever made while employed.

This is gonna be WAY fun.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Long Term – Short Term – Real Life Term

“Would you like to super-size your value meal?”

Quite often the response is “Sure, it’s only eighty-nine cents.”  When people decline the offer it’s more often out of concern for their waistline than the bottom line. It’s such a trivial amount that you don’t really need to think about it from a financial perspective. For the fast-food establishments the “super-size” upgrade has had a tremendous impact on their profits. With a negligible effect on costs, an eighty-nine cent up-sell is a whopping 15% increase in gross sales if a value meal sells for around $6.

Other retailers use similar tactics. It is especially true with the large home improvement stores and that can greatly affect your profits if you are rehabbing or making repairs on a rental property. Take a walk down the plumbing aisle a look at how many different sinks, faucets, and toilets there are. Do we really need an entire aisle devoted to toilet seats? Compare the prices from one model to the next and you will usually see an added feature with a small price increase, another add-on with another little jump in cost. Carpet is another good example of small jumps for each step up. If you aren’t careful you can blow your rehab budget by purchasing things you don’t need because it was “only a little more.”

Watch the Pennies

When rehabbing a house you take great care in calculating the value once renovations are complete. After estimating the scope of work and related cost, acquisition cost, financing and selling and expected profit, that amount is subtracted from the selling price to determine what you can safely pay to achieve the desired results. When the project is done and sold you add up the profits and end up scratching your head – where did the money go?

While there may have been some unexpected expense that wasn’t accounted for, quite often some of your profits disappeared a few dollars at a time. That better faucet was only $10 more, the nicer sink just another $30; the better quality carpet was just a couple dollars more per yard. Frequently those nickels and dimes add up to thousands of dollars.

I often think back to someone I know who had a small rental apartment in his house. It needed a few repairs between tenants so he decided to fix all the annoying little things and do some minor upgrades. What should have cost less than $1,000 wound up being more than five times that. Why? Because he kept adding to quality as if he was the one living there. That apartment only brought in about $300 in rent each month.

Stick to Your Budget

When rehabbing, ask yourself a simple question before spending on a questionable upgrade:

Will this added expense result in a higher selling price or a quicker sale?

If the answer is “no” – don’t do it. Resist the urge super-size something if the regular item is all that’s needed. In the end your bottom line will thank you. You can use the added profits to super-size your next value meal!

Beware of little expenses. A small leak will sink a great ship. – Benjamin Franklin   

Photo: LWY

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Want To Super-Size That Rehab?

When Grandma spoke we listened. She was tempered steel wrapped in GrandmaSpeak. Tough? Around our family, nobody, at least out loud, claims real toughness, as the standard set by Grandma is something for which we only strive. One day I was whinin’ about an upcoming American History test. She asked if I was prepared to do well. My answer, that I hoped for a good grade — not the answer she was aimin’ for.

“Hope” she said, “is not a plan, it’s an excuse being nurtured in the mind’s womb. Unless you’re referring to faith, this family doesn’t hope — it does.”

Many years later I was watchin’ a movie titled, The Rock, starring Sean Connery. His character voiced the same sentiment, but in, um, more colorful language, which won’t be repeated here. Suffice to say, he wasn’t impressed with folks who ‘tried their best’. He called them losers. Grandma was tough, but never unkind.

She also taught me to know my limitations — without limiting myself — a concept it took her more than a short time to explain to a 13 year old eighth grader. The long ‘n short of it is that we absolutely can do pretty much what we believe we can do, just not by next Tuesday. Maybe not for a couple hundred Tuesdays.

Slow down — segue zone.

Don’t wanna be right about this, but it’s my opinion we’re headed towards many years of sustained high unemployment, and all it brings to the table. Unlike the early-mid 1990′s or the same period in the 1980′s, interest rates should remain WAY low for longer than most suspect. This bodes well for serious long term investors with solid plans. It won’t hurt the feelings of the quick-turn crowd either. And there’s the snake in the woodpile.

Rehabbers are soon gonna learn a lesson, at least those who’re not as knowledgeable as they fancy themselves, or those who are, but don’t sport pockets as deep as may soon be required, or both.

I expect sooner than later the extend and pretend M.O. of so many lenders will arrive at its inevitable end. When this happens, most, not all real estate markets are gonna be flooded, relatively speaking, with super low priced REOs. Combine this price hit with the ever tightening underwriting, and you have a recipe for quick turn hell.

Short term investors without deep pockets are like dinghies tied to a small dock attached to a large ocean — with a tsunami on the way. Their only chance for survival is to find themselves safely loaded on a trailer headed for an inviting driveway somewhere far inland. The alternative is to be bashed into a floating pile of splinters.

Much as those in formerly high appreciating markets (like my own in San Diego) thought the final chapter would never be written, rehabbers without big-time experience/expertise AND very deep pockets, will become just another splinter, floating anonymously among the wreckage. Not so for the deep pocket bunch, who’ll be smilin’ as they whistle their way to the bank. They’ll be multi-tasking while there — depositing cash flows and/or profits, while acquiring the next super bargain.

Yes, the value of real estate is gonna go down in most of the country even more — how much more is anyone’s guess, but mine is it’ll be easily more than a tad.

Long Term Investors

There are a couple ways to go here. REO type product, or well located/well built property in areas relatively unharmed by this ongoing, seemingly never ending saga are pretty much it. I prefer to remain in areas in which the market correction was but an irritating set of waves, doing little real damage. Those markets have been and are still flourishing, and promise to be remarkably resistant to this next set of waves — maybe tsunami.  Of course, flourishing these days often means holding their own, which beats morphing into a floating splinter every way from Sunday, right?

Those who’ve bought in these regions the last few years, are now comfortably rollin’ down the investment highway on cruise control. For those whose retirement is down the road, they’re morphin’ the cash flow into ever increasing equity via monthly loan balance reductions. Those fortunate enough to have even deeper pockets have combined their leveraged acquisitions with a cash purchase or three, so as to fund their drive to free ‘n clear the others with the massive cash flow.

They’ll end up 7-15 years from now, depending upon the original depth of their pockets, with more retirement income than they ever thought possible. As Grandma taught so well, it wasn’t hope that got ‘em there, it was eliminating their so-called limitations one by one over time. They replaced hope with doing — with knowledge, expertise, and experience — if not theirs, someone else’s.

The message I bring today is primarily aimed at those hard workin’ folks who aren’t yet playin’ in the Deep Pocket League. Simply put — either partner up with someone in that league, or tend to puttin’ your own financial house in order. If you opt for the ‘full speed ahead’ setting on your dinghy, the consequences could haunt you for quite awhile.

With apologies to Grandma, but not wanting to sound harsh or unkind — if you’re becoming fearful reading this, and not smiling with gleeful anticipation, put yourself on the sidelines — now.

As Grandma was also fond of sayin’ — “It’s much better to hold your place than to lose it.”

Think long term, at least for now — down the road, those are the folks who’re gonna be cruisin’ on calm seas. Without deep pockets, rehabbers may be headed for Splinter City. Those sportin’ pockets with impressive depth are about to kick some seriously impressive short term butt.

Again, as far as the new wave of foreclosures are concerned, and the subsequent drop in values, I hope I’m mistaken.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Short Term Long Term Deep Pockets and Dinghies On Small Docks

There’s a popular saying in the technology industry (an industry where I spent much of my career): “Better, Faster, Cheaper — Pick Two“…

Basically, the idea was that you can build something at 1) higher quality, 2) in less time, or 3) for less money — but you can’t do all three of those simultaneously. At best, you could could optimize for two of them, in which case it was generally the third that would suffer.

For example, building a new piece of software — you can build it better and faster, but it will cost more to do so; or you can build it fast and cheap, but the quality will likely suffer.

In my experience, this same principle applies to many aspects of business and life, and is certainly true when it comes to contractors and real estate renovation. While there are some contractors out there who churn out only high-quality work; and there are contractors who are tremendously efficient and always on-schedule; and then there are some very reasonably priced contractors; you won’t normally find a contractor who is all three of these things.

In fact, the “better, faster, cheaper — pick two” principle is very much alive and well when it comes to contractors.

Better, Faster, Cheaper: Applied to Rehab Contractors

With that in mind, it’s important to determine up-front which two of these three aspects of your renovation you are most concerned with, and then expect that you might need to compromise on the third. For example, in my case, I’m unwilling to compromise on quality, and with my margins being relatively small, I’m not willing to risk my budget on most projects. So, if I want to ensure that that I have my contractors focused on quality (better) and price (cheaper), I must be willing to compromise on schedule (faster).

This principle is always utmost in my mind when I’m interviewing and evaluating potential contractors for my jobs. I went through several General Contractors (GC) before finding my current one. I had some that wanted to cut corners, so I fired them within days of them starting. I had some that tried to jack the price up by telling me repairs were needed that I knew weren’t, and I ultimately got rid of those as well.

My current GC has some amazing qualities — he knows construction and building codes in great detail; his workers produce high-quality results; and his prices are tremendously reasonable compared to other similarly-qualified GCs (and he doesn’t tend to find “surprises” that cost me more). But, I’ve found that — because he likely has many projects going on at once — he is not very good at keeping on schedule. Sure, I could probably push him harder to stick to schedules and to meet deadlines, but I’m willing to trade that aspect of my projects knowing that I’m going to hit my budgets and the results will be top-notch.

Again, I’m willing to sacrifice Faster for Better and Cheaper…

My suggestion to anyone getting into house flipping or renovation — decide up-front which two of these three things are most important to you, and optimize your contractor selection to those two things. Then be prepared to compromise on the third, as you’re unlikely to find contractors who can deliver all three.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Better, Faster, Cheaper

It’s always been true, but since the correction the calls I get from those specializing in ‘quick turn’ projects, whether flipping or wholesaling, have more than doubled. The calls are predictable, usually coming within a few days after publishing a post about what their retirement will look like, given their long term M.O. — and that retirement ain’t part of a pretty picture. After their first reaction, usually anywhere from mild irritation to big time anger, denial often sets in. It’s after a few days of pondering the substance of the post that they settle down and call.

First, let’s define who they are, and the M.O. in question.

• They’re full time turn and burn types — and they’re good at it.
• They use profits to grow the business — now doing many homes at once.
• Their lifestyle has risen appreciably in response to their rising income.
• They’ve systematized their operation — boosting income yet again.
• Long term is defined as holding for a year so as to pay cap gains rates.
• They’ve earned their reputation as real pros, experts in what they do.

The age range of those calling is roughly 45-60. The older they are, the more you can hear the rising fear in their voice. Take a 53 year old guy who’s simply gettin’ tired of the toll it takes from him both physically and emotionally. Sure, he’s not doin’ much of the physically demanding labor now, but he’s still pitchin’ in almost daily. Combine this with all the day-to-day tasks a very successful rehabber/flipper/wholesaler must do, and you can easily understand why a 50-something guy/gal would begin to resemble the horse who’s been ridden hard and put away wet.

The #1 source of the rising bile in their throats is the realization that their acquired lifestyle is now their biggest problem. Their home really is their castle. They travel a lot, go on pricey weekend getaways, drive expensive debt laden cars/trucks, and maybe even have a nice boat or RV or both. Life is good.

‘Till it’s not.

The problem, of course, is a sorta good news/bad news joke. The good news? They’re rockin’ at what they do. The bad news? They MUST continue doin’ it ’till they drop, cuz they have zero, zilch, zip, nada that will do anything for them in terms of even a semi-viable retirement income.

In essence, as one of them put it so well, “I’ve become a very highly paid slave who must work or be financially ruined. I’m on a treadmill to the emergency room.” He was 52 when he said that, and a year later was diagnosed with very high blood pressure.

Sometimes I can help, sometimes I can’t. It depends upon how leveraged their lifestyle really is. I’ve concluded these guys aren’t exceptions, but the rule. I have no idea if that’s correct or not. I do know this though — their number is legion.

So, what to do?

If you’re under 45 or so, you should be able to add another basket to your portfolio — long term investment properties. Whether these props are local rehabs you’ve done personally, or you just found solid deals elsewhere, it’s imperative you start — now. In 15-20 years you’ll be able to retire with an enviable income. If you execute strategies I’ve outlined in previous posts, it’ll be even better.

If you’re in your late 50′s or over 60, you may or may not have a real problem. Last year two such men had to tell their wives that going back to work for a few years was the only way they’d be able to create a more or less job free retirement. Women who’ve been enjoying life without having to go to work, generally don’t receive this news, um, well.

Some of the turn ‘n burn contributors on this site have addressed this topic with sage advice. They set the example by having a stand-alone portfolio of ‘keepers’ — properties which will provide for them in retirement. You should listen to them carefully. They have seen the future without long term investments, and discovered the light at the end of the tunnel was a freight train comin’ their way.

Secure a long term real estate investment expert. It’s far to late to be gettin’ advice from those who’re merely a few chapters ahead of you in the book. Think you can do it yourself? Really? Maybe — but ask yourself THE question.

How much is a solid, reliable income worth to you in retirement?

Go ahead, take your time, no pressure.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Why Many Wildly Successful Flippers and Wholesalers Will Face Bleak Retirements

As a real estate investor — and especially if you’re a house flipper — you will no-doubt be hiring a lot of independent contractors to support your business. And I’m not just talking about the people who will be working on your houses; your real estate agent, your attorney, your CPA, and most of the other people who support your business day-to-day will be independent contractors (ICs) as well.

While it may be clear in your mind that these people are ICs and not employees, it’s very important that the IRS agrees with you. If the IRS determines that the people who are doing work for you are employees, it could end up costing you dearly. Not just in terms of extra tax payments — which would amount to about 15% of the total amount paid in wages plus responsibility for unemployment wages — but also in terms of risk to your business.

For example, if a roofer working on one of your properties falls off the roof, as an IC he is responsible for his own medical costs; but, if the courts determine that he was actually an employee at the time of the fall, you might be responsible for paying his medical costs, disability and even potentially death benefits to his family!

So, what can you do ensure that the IRS and the courts also recognize your workers as ICs and not employees? Keep in mind that the IRS and the courts will use a number of different criteria to subjectively make the determination, so your job is to ensure that you do as many of these things as possible for your independent contractors:

• Independent Contractor Agreements: First and foremost, make sure you have a contract that specifically calls out the independent contractor relationship you have with your contractor. If you plan to hire a lot of ICs, it’s probably worth the time and cost of getting a contract attorney to create a sample agreement that you can use for all your projects and all your contractors. In fact, I’ve written a couple previous posts on contracts and independent contractor agreements — feel free to check them out.
• Separate Entity: Encourage your ICs to set up a separate corporate entity under which they do business. If they have their own LLC or corporation under which they provide services, they are less likely to look like your employees to the IRS.
• Invoices: Have your ICs invoice you at regular intervals, from their corporate entity. Being able to show invoices to the IRS will support your claims that the workers are ICs and not employees.
• Sub-Contractors: Independent contractors are allowed to hire out the work you contract them to do. If you specifically state that your contractors must do the work themselves, you are likely to be viewed as their employer. Your ICs can hire subs, bring in additional labor, etc.
• Work for Others: If possible, ensure that your ICs do contracting work for someone (or better yet, many someones) other than yourself. If a worker receives 100% of their income from you, they are more likely to be classified as one of your employees by the IRS.
• Tools: Ensure that your contractors provide all their own tools for the job. If you provide the tools (or other materials, for that matter), the IRS will be more likely to look upon you as an employer.
• Instructions: Employees are required to adhere to instructions about how, when and where to work; independent contractors are not. If you tell your workers how to do their job and when to do their job (i.e, you require them to work 8am – 4pm daily), they may be classified as employees.
• Right to Fire: Make sure that if you “fire” an IC, you do so for a reason that has clearly violated your Independent Contractor Agreement. You can fire an employee for any reason, but you can only fire an IC based on contractual obligations and responsibilities.
• Training: Never provide any type of training for your ICs. While employees are permitted to receive training from an employer, if you provide training to your ICs, they will look like employees to the IRS.

This is just a sampling of the criteria that the IRS and the courts will use to determine if your workers are employees or independent contractors. For more information, check out the IRS documents that address this issue specifically.

And remember, determination of employee vs IC can be subjective, so while you may not have to follow all the rules to get the classification you want, it’s in your best interest to follow as many as possible.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Are You Sure Your Independent Contractors Really Are?

I was talking to a real estate dabbler the other day. He is neither a wanna-be nor a real investor, he just purchased acouple of rental properties several years ago.  He is a classic example of being lucky rather than good. He wanted to try his hand in the real estate game and was fortunate enough to be referred to an investment savvy agent that kept him from making rookie mistakes. He came to the conclusion that real estate investing wasn’t his cup of tea. He sold one property at a small profit and is still earning a positive cash flow off of the second. He plans to sell that one the next time it becomes vacant. It may be a while because he has an excellent tenant who has been there for several years already.

Our conversation centered around an upcoming talk I was going to do about rehabbing.  He couldn’t understand why anyone would want to be rehabbing real estate now. Puzzled by his attitude, I asked him what he meant.  His mindset was that this isn’t a good time because the real estate market isn’t appreciating so you wouldn’t be able to make money.  Though I didn’t say so, I had to agree that it’s a good thing he decided that real estate investing isn’t for him.

The Wrong Time

By his thinking the best time to rehab would have been in the middle of the real estate bubble.  My thinking is just the opposite. In late 2003 I moved to Las Vegas where the market was just starting to go crazy.  I had successfully rehabbed for years on the east coast and I planned to do the same in Nevada. After I got settled in my new home I began to search for investment opportunities.  I quickly realized that the inmates were running the real estate asylum.

I have always been a value investor.  I would look for something priced significantly below the current market.  That was an impossible task in Las Vegas at that time.  I would look at one house that only needed minor work and another that needed a major overhaul – and they both were selling for the same price!  Like any classic bubble the market had reverted to the greater fool theory – it didn’t matter what you paid because an idiot even bigger than you would gladly pay more.  I put any idea of investing in Las Vegas on hold and searched for a better market.

The Right Time

One thing that has always appealed to me about rehabbing is that you make your money when you buy. Rehabbing will work in any market where value can be determined. That’s why a bubble market is so problematic, how do you determine true value? Once you determine what the value of a property is you can easily figure out if the deal will work or not.  Look at your anticipated selling price, subtract your cost and desired profit, and pay no more than the amount that remains. 

Simple enough, right? Of course not.  There are so many variables and a certain amount of risk.  It is impossible to avoid risk but it can be minimized if you manage it right.  Rehabbing is not for everyone, but if it is your cup of tea it can be extremely rewarding.

Life is inherently risky. There is only one big risk you should avoid at all costs, and that is the risk of doing nothing. – Denis Waitely

Photo Credit: eye of einstein

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Right Time to Rehab Real Estate?

It’s been a relatively tough real estate market for rehabbers/flippers for some time now, and with the home-buyer tax credit getting ready to expire at the end of this week, it’s likely only going to get tougher.

That said, for smart rehabbers who know how to buy right, rehab right, and sell right, there is still plenty of opportunity to make money in this market. My business is proof of this — over our past 10 rehab projects, our average DOM (days-on-market) before our first offer was under 10, and our average sale price was 97% of our list price. Given that the average DOM in my area is over 100 and average sales price somewhere around 85% of original list price, that’s not too shabby.

Do I have a secret? Nope. Just common sense and the will-power to stick to doing what I know is right and not doing what I know will be harmful to my business.

With the new homeowner tax credit getting ready to expire, and with the relatively large number of buyers that have been shopping the past few months likely to go away, I thought now would be a good time to recap an article that I wrote last year, “The 8 Rules of Flipping in 2009.”

I’ve updated a couple of these rules for 2010, but for the most part, the rules are the same. If you’re a house flipper (or plan to be in the near future), here are some tips that you’ll hopefully find very useful.

1. Best Condition & Best Price: It used to be that — to be successful — a house flipper needed to focus on having either the nicest house on the block or the lowest priced house on the block. With the number of houses on the market currently outnumbering the number of potential buyers by a very large margin, house flippers must now focus on having the house that is BOTH in the best condition AND the lowest priced among comparable homes.
   
   I’m sure a lot of people who are considering this are thinking, “How can I offer the nicest house at the lowest price and still make money?” It’s a great question, and the answer is simple –- only consider fantastic deals when you’re buying. As the old adage goes, you make money when you buy. This is especially true in today’s market; if you can’t buy low enough to put the house in great condition and still sell below market, you shouldn’t be buying.

   The nice thing is, now is a great time to pick up these deals. Between the glut of foreclosures that are likely to hit the market soon, the banks willing to take a loss by doing short sales, and the sellers who missed the tax credit boat and are desperate to get out from under there properties, motivated investors should have no problems finding great deals that will work as successful rehab projects.

2. Know Your Buyers: I was at a Real Estate Investment group meeting last year, when an investor who focused on rental properties asked me, “How do you expect to flip any properties? I had a friend who was buying properties worth $300K and trying to sell them for under $200K, and couldn’t sell a single one!”
   
   I’ll tell you what I told him –- in my current local market, there are very few buyers who are looking for properties over $150K. Sure, there are some here and there, but for the most part, today’s buyers are first-time home buyers looking for move-in-ready properties in the $90-130K range. Why is that? It’s because these are the only buyers who are able to both qualify a loan and come up with a down-payment. (they are getting FHA loans that only require 3.5% down).

   So, it’s no surprise that this guy’s friend wasn’t able to sell his $300K houses for $200K — there just aren’t enough buyers at that price-point, regardless of how good the deals are.

   Knowing your buyer base will allow you to appropriately focus your rehab and resale efforts – if the available buyers are looking for move-in-ready houses in the $90-130K range, you should be offering move-in-ready houses in the $90-130K range, nothing more and nothing less. I’m not saying the buyer base in your market is the same as it is in mine, just that you need to figure out what you buyer base is, AND FOCUS ON SELLING HOUSES TO THEM.

3. Multiple Exit Strategies: Wanting to flip a house is great. Finding a house that can be successfully flipped is even better. But, in today’s market, any deal you consider should have multiple possible exit strategies — not just the possibility of a flip. And not just multiple potential exit strategies, but multiple strategies that you are convinced will work, if necessary.
   
   For example, I like to have at least 3 of the following 5 possible exit strategies before I consider a deal:
   
   
   • Wholesale to Another Investor
   • Minor (or No) Rehab and Rent
   • Minor Rehab and Sale to Investor
   • Minor Rehab and Flip to Occupant
   • Major Rehab and Flip to Occupant

   
   
   If you can’t find at least two different exit strategies for a property, don’t buy it. Because in this market, there’s just too much chance that your first strategy won’t pan out, and if that happens, you want to have alternatives.

4. Know Your Comps: With the market changing on a daily basis, this is no time to trust something as important as comps to unreliable sources. That means you shouldn’t be using tax appraisals (those guys don’t even go inside the house to get their estimates), you shouldn’t be using websites like Trulia and Zillow (they may be right on, but they may also be very high or very low), and you shouldn’t be trusting your real estate agent unless they actually give you the data to verify for yourself.
   
   The only real way to find comps is to pull actual MLS (or tax record) data, and sort through it yourself. You’re looking for similar properties (pretty much same style, same # of beds and baths, same lot size, same condition) that have sold in the past 3 months within the same subdivision (or .5 mile radius). Don’t go back 6 or 12 months (the market has changed since then), don’t look at properties that are nothing like your own, and don’t look even 2 miles away (market conditions can vary drastically over even short distances).

   Your agent should be able to pull all the comp data you need, but it’s YOUR responsibility to make sure the data used is applicable. Too many agents will give you data that supports a high ARV, just to get you to buy the property. Trust the data, but only if you sort through it yourself. And if you can’t find any data for your area, ask yourself why that is? Is it “out of the way?” Is it a bad neighborhood where buyers don’t want to buy if they have an alternative (and these days they do)? Or is it such a desirable neighborhood that nothing has even been listed for sale in the past year (this is a good thing)? Even lack of data is an important piece of data when it comes to comps.

5. Location, Location, Location: While this has always been a key maxim in real estate investing, the difference between then and now is that today, you need properties that will get a lot of potential buyer traffic through them. This means buying in the front of subdivisions, buying on well-traveled (but not too busy) roads, and buying in areas near shopping and other amenities that draw crowds.
   
   Many buyers these days are finding houses because they drive past them and see signs; they may not have even been on the market previously to buy, but they stop into yours and they fall in love. If you buy in locations that will only get foot-traffic if an agent brings them in, you’ll get a lot fewer potential buyers through the house, and today, it’s all a numbers game. You need to get lots of buyers to at least look at your property, and just listing on the MLS and waiting for agents to bring potential buyers though isn’t going to accomplish that goal.




6. Staging: I’m a huge proponent of house staging. And I firmly believe that while staging may not get you a whole lot more money for your property in today’s market, it will certainly increase your likelihood of getting offers if your house is priced correctly. While buyers aren’t likely to increase their spending limit in this market (they don’t have to), they will most certainly be drawn to houses that they can imagine themselves living in.
   
   Staging accomplishes this by allowing your buyers to make an emotional connection with your property — by allowing them to associate it with a home, not just a house. A house without any furniture is just a faceless property…a nicely decorated home provides a feeling of warmth, comfort and security. And not only does staging create an emotional connection, but it allows those buyers who aren’t very imaginative (read: MOST BUYERS) to get a better feel for how the house will look once they move in. In fact, if a house is staged well, it will give your potential buyers ideas for how to make their next home (this one!) even better than their last.




7. Know The Rules: House flipping is a lot more complicated than it appears on TV. There are lots of rules, regulations and roadblocks that — if not heeded — will hinder your ability to make money in this business.
   
   For example, many rehabbers don’t realize that once they purchase a property, while they can sell now sell their property to an FHA buyer within 90 days, it requires jumping through hoops and finding a mortgage broker who can get that kind of deal done. I can’t tell you how many people I’ve met who had a plan to buy a property, slap on some paint and carpet, and resell to a retail buyer in just a couple weeks, and then got caught by all the extra FHA regulation that surrounds a quick flip. So, instead of selling in a couple weeks, they end up having to hold onto the property for three months, increasing their holding costs (and tying up their cash) while they wait for the opportunity to sell to their FHA buyer. And in some cases, the buyer didn’t want to wait around and the deals fell through.
   
   To be successful, you must know the rules — this includes buying rules, selling rules, lending rules, construction/permit rules, etc.




8. Build A Strong Team: The difference between a successful real estate investor and an unsuccessful one is the team she surrounds herself with. A real estate investor is only as good as his CPA, attorney, real estate agent, inspectors, contractors, title company, etc. When it comes to pulling off all the other rules I listed, you need a strong team to be successful; if you don’t have that strong team, you can bet your competition does.
   
   A weak team will cost you time, money and headaches that you can’t afford. All it takes is for your agent to negotiate poorly, your attorney to miss a contract loophole, your inspector to miss a structural problem or your contractor to screw up to turn a profitable flip into a big loser. A couple of those can quickly end an otherwise successful real estate career.

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

The 8 Rules for Flipping in 2010

As any investor who has ever sold a property to an FHA buyer knows, there is at least one mandatory FHA inspection that must be completed by the lender prior to the closing of the property.

I often get asked what types of things do FHA inspectors/appraisers look for during these FHA inspections, and what types of things will cause a property to fail an FHA inspection. I’ve had that same question in the past, so I asked an FHA underwriter that I have worked with on several occasions if he could clue me in on the types of things that are flagged during these inspections.

He was kind enough to forward me a full list of “minimum FHA property requirements,” which essentially translates to the FHA inspection checklist. While this list is by-no-means a formal checklist followed by FHA inspectors, it’s a good set of guidelines. Just because you meet all these requirements doesn’t mean you’ll pass an inspection, and just because you may not meet one or more requirements doesn’t necessarily mean you’ll fail an inspection. That’s up to the inspector/appraiser/underwriter to determine.

In other words, don’t put too much faith in this list, and don’t blame me if your inspector has other criteria that he uses…

In fact, as the document itself explains:

This list is for reference only and does not guarantee compliance with FHA Minimum Property Requirements. Minimum Property Requirements are to insure the health and safety of the occupants and/or the marketability of the property.

That said, here is the checklist/guidelines:

Site Hazards and Nuisances

Presence of the following may indicate unacceptable property condition:

• Sinkholes
• Active or planned gas-drilling within 300 feet
• Within 75 feet of operating oil/gas well with no visible mitigation measures
• Abandoned oil or gas well within 10 feet
• Slush pits
• Excessive noise or hazard from heavy traffic area
• Dwelling or improvements within 10 feet of easement for high-pressure gas or petroleum line
• Dwelling or improvements within fall distance for overhead towers (high-voltage, radio/TV, cell phone etc)
• Excessive smoke, fumes, offensive noises or odors
• Stationary storage tanks with more than 1000 gallons of flammable or explosive material

Soil Contamination

Presence of the following may indicate unacceptable property condition:

• Surface evidence of underground storage tank
• Proximity to dumps, landfills, industrial sites that could contain hazardous materials
• Presence of pools of liquid, pits, ponds, lagoons, stained soils or pavement

Grading and Drainage

Presence of the following may indicate unacceptable property condition:

• Grading does not provide drainage away from structures
• Standing water near structures

Individual Water and Sewage Systems

• Presence of the following may indicate unacceptable property condition:
• Private sewage system show evidence of system failure
• Separation between well and septic drain field less than 100 ft, (75 ft may be acceptable if local authorities allow.)
• Separation between well and property line is less than 10 ft. (If local authority requires greater distance that requirement must be met.)
• Property lacks connection to public water (Lender/jurisdiction may require water test and connection to public water if feasible)

Wood Destroying Insects

• Presence of the following will require a termite inspection and treatment if infestation is present:
• Structure is ground level and wood is touching ground
• House or other structure show obvious evidence of infestation
• Local jurisdiction requires inspection
• Inspection is customary to the area

Private Road Access

Presence of the following may indicate unacceptable property condition:

• Property inaccessible by foot or vehicle
• Property accessible only by private road without permanent recorded easement

Floor Support Systems

Presence of the following may indicate unacceptable property condition:

• Significant cracks
• Evidence of water damage
• Evidence of spongy/weak/rotted flooring

Framing/Walls/Ceiling

Presence of the following may indicate unacceptable property condition:

• Significant cracks
• Visible holes in exposed areas that could affect structure
• Damaged plaster, sheetrock, or ceiling materials in homes constructed before 1978
• Significant water damage

Attic

Presence of the following may indicate unacceptable property condition:

• Inadequate access
• Evidence of holes
• Support structure damaged
• Significant water damage visible from interior
• No ventilation by vent, fan, or window

Basement

Presence of the following may indicate unacceptable property condition:

• Blocked or inadequate access
• Evidence of significant water damage
• Significant cracks or erosion in exposed areas that affect structural soundness

Crawl Space

• Presence of the following may indicate unacceptable property condition:
• Blocked or inadequate access
• Space inadequate for maintenance (recommended 18 inches)
• Support beams not intact
• Excessive dampness or ponding of water

Slab

Presence of the following may indicate unacceptable property condition:

• Significant cracks that could affect structural soundness

Roof

Presence of the following will require a roof inspection and possible repair:

• Missing tiles, shingles, flashing etc
• Signs of leakage

Furnace/Heating System

Presence of the following may indicate unacceptable property condition:

• Unit does not turn on
• Heat is not emitted
• Unusual noise
• Smoke or irregular smell
• Significant holes or deterioration on unit

Electrical System

Presence of the following may indicate unacceptable property condition:

• Electrical switches don’t work
• Outlets don’t work
• Presence of smoke or sparks from outlet
• Exposed frayed or unconnected wiring

Plumbing System

Presence of the following may indicate unacceptable property condition:

• Significant drop or limitation in water pressure
• No hot water
• Toilets don’t function or have been removed
• Toilet leaks
• Sinks/bathtub/shower leaks (very minor leaks may be acceptable)
• Sinks/bathtub/shower does not work or have been removed
• Swimming pools not operational, in bad repair or not maintained

Paint

Presence of the following may indicate unacceptable property condition:

• Chipped or peeling paint on interior or exterior of home and/or structures and improvements if home built before 1978.
• Chipped or peeling paint on exterior surfaces if finish is unprotected (ie, bare wood) if home built after 1978.

Other

Presence of the following may indicate unacceptable property condition:

• Missing or inoperable exterior doors
• Broken or missing stairs
• Absence of built-in appliances
• Absence of free-standing stove (Santa Ana HOC only)

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

FHA Property Inspection Checklist

Last week, my blog post discussed my method for determining the maximum purchase price you can offer for a property that you plan to rehab/resell or wholesale. In the formula I presented, I referred to “Fixed Costs” and I mentioned that I know my Fixed Costs to be about $17,000 on a typical project.

I wanted talk about how I calculated my typical Fixed Costs, and also give new investors an idea of what they should be thinking about when they try to calculate their Fixed Costs number.

Fixed Costs are compromised of the various fees, commissions, and costs associated with all parts the investment project (outside of the actual rehab costs). You may have heard the term “Holding Costs,” which generally applies to things like: Mortgage Payments, Utility Payments, Insurance, etc. These are costs you incur during the rehab portion of the project. Fixed Costs include Holding Costs, but also extend to the costs incurred during the other phases of the project: Purchase and Sale.

That said, I break Fixed Costs down into the following three categories:

1. Purchase Costs
2. Holding Costs
3. Selling Costs

And then each of these categories can be broken down in more detailed expense line-items. Below I’ll discuss the most common Fixed Costs I run into, and approximately what I spend on them for a typical project…

Purchase Costs

Purchase Costs refer to those fixed expenses that contribute to the purchase of a property. For my projects, Purchase Costs can specifically be broken down as follows:

• Inspection Costs: In general, I have an inspection for each of my properties prior to purchase (at least I did when I first started rehabbing). I use the same inspector for every inspection, and for the most part he charges about $400 for a full inspection of a typical property.
• Closing Costs: Each purchase comes with a fixed set of closing costs paid by the buyer. In Georgia, and for REO purchases, this generally includes a title search, attorney fees, courier fees, recording fees, state taxes, document review fees, etc. Basically, all those ridiculously inflated costs charged by the closing attorney to ensure clear title and recording of the new deed. Across all my purchases, these costs generally come in around $1000.
• Lender Fees: For the most part, I use the same lender to finance each property purchase. The lender charges a set of up-front fees to fund the loan, including a Loan Origination Fee, appraisal, underwriting fee, flood certification, document preparation fee, processing, fee, credit report fee, etc. (again, all those ridiculous and inflated fees that contribute to the lender’s bottom line). While every investor and every lender will have a specific sets of fees — and while these fees are somewhat tied to the purchase price of the property — for a typical acquisition I do, these Lender Fees total around $2000 per property.

You may find you have other recurring Purchase Costs, such as Appraisal Fees, Survey Costs, Bird-Dog Fees, etc. If so, add those into your Purchase Costs.

Holding Costs

Holding Costs refer to those expenses that add up between the time I acquire the property and the time I sell the property. For my projects, Holding Costs can specifically be broken down as follows:

• Mortgage Payments: On a typical project, my monthly mortgage payment will be about $500. And a typical project — from purchase to sale — will generally run between 4-6 months. So, during that time, I’ll generally make about $2500 worth of mortgage payments to my lender to keep the property.
• Property Taxes: On the properties I purchase, the typical yearly property taxes are on the order of $1400. Again, if I hold the property for 4-6 months, this will average out to about $600 in property taxes per project.
• Utilities: While performing rehabs, I like to ensure that all utilities (electricity, water and gas) are turned on. This is both for the convenience of my contractors as well as to help diagnose any issues with the property. Because the seasons in Georgia tend towards extreme temperatures, I’ve found that my utilities in my properties generally run about $200 per month for the duration of the project. Again, over 4-6 months, this averages about $1000 per project in utility costs.
• Insurance: Typical insurance costs for my properties is about $350-400 per year. On average, I pay about $200 in insurance costs for each project.

Again, you very well may run into additional Holding Costs, depending upon how you do your flips. For example, you may have costs for: Lawn Mowing, Rental Income, etc.

Selling Costs

Selling Costs refer to those fees and commissions that must be paid in order for me to sell a property. Again, different investors will use different marketing mechanism to sell their houses, so selling costs for each investor may be quite different. For my projects, Selling Costs can be broken down as follows:

• Commissions: Because my wife is our real estate agent, we save about half of the commissions we would otherwise incur when selling a property. That said, if our buyer has their own agent — they generally do — we must pay about 3% of the purchase price to that agent at the sale. A typical property of ours sells at about $120K, so that 3% comes out to about $3600 paid to the buyer’s agent at the sale of our property. Add to that the fees my wife pays to her broker, and the total commissions average about $3900 per property sale.
• Closing Costs: In this market, most buyers ask the seller to pay some or all of their closing costs. On our sales, we’ve been asked to pay anywhere from $2000 to $6000 in closing costs for the buyer. On average, we’re asked to pay about $4000 in buyer closing costs, and because it is a buyer’s market, we generally agree to it.
• Home Warranty: Most first-time home buyers (the type we cater to) request that the seller purchase a home warranty as a condition of the sale. We always expect to do this (and almost always have), and this adds about $500 to the cost of the sale for us.
• Termite Letter: In addition to the home warranty, many buyers (and/or their lenders) require us to provide a proof of termite inspection at the sale. This generally runs somewhere just below $100.
• MLS Fees: Because my wife is our agent, she is required to pay a fee to the local MLS for listing the property. This generally runs about $100.

Depending on how you sell your properties, you may have more or fewer expenses associated with the process. For example, while I don’t calculate it as part of our Fixed Costs, we generally receive about $5000 in commissions (between the purchase and the sale of the property), which goes right to our bottom line. It wouldn’t be unreasonable to subtract $5K from our Selling Costs (and therefore from our total Fixed Costs), though we prefer to account for this elsewhere in our analysis.

You may also have expenses associated with: Direct Marketing, Partnership Payments, Bonuses, etc. If so, add those into your Fixed Costs.

As you can see above, buying, holding and selling a property can cost a lot of money in fixed fees. Let’s see how these add up on a typical project of mine:

And there you have it — it costs me about $16,500 in commissions and fees just buy, hold and sell a property (which I round up to $17K to make my calculations easier and to have a margin of error). Many investors ignore these costs when calculating their potential profit on a deal; but, consider that if you plan to earn about $15K on a typical project, these costs can actually mean the difference between earning your desired profit and losing money!

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

Calculating Fixed Costs on a Rehab, Flip or Wholesale Real Estate Deal

[Big Disclaimer: I am not a lawyer and I don’t play one on TV.  The information I provide below is just my opinion based on my experiences, and shouldn’t be construed as anything more than that…it certainly shouldn’t be construed as legal advice.  If you have any questions about the legal aspects of what I write, I highly recommend you consult a qualified legal professional who no-doubt will know more about the subject than I do.  Now, on with the post…]

As someone so focused on building scalable systems in my business, you might guess that I’m a big fan of contracts.  And you’d be right!

So, in this post, I want to discuss the most common type of contract that I use as a rehabber – contracts for my contractors.  I’ll also touch on a few common misconceptions about contracts and at the end of this post, I’ll even provide a sample contract for your review.

Why I Use Them

I flip about 15-20 houses per year, and on each flip, I use an average of ten contractors.  That adds up to about 150-200 contracts per year that I need to write!  I could probably save several hours of time by not writing contracts, but one major dispute with a contractor that ends up in court could easily eat up twice as much time (and quite a bit of money as well).  So, in my opinion, writing contracts are worth every minute that I spend doing it.

By using contracts consistently throughout all my projects and with all my contractors, I sleep better at night knowing that I’m pretty well protected, both legally and financially.  Of course, no contract is bullet-proof, and anyone can sue me for any reason, but having a contract in place makes it all the more unlikely that that will happen; and if it ever does, I’m happy to take my chances in court.

And, not only do the contracts I use protect me and my business, they protect my contractors as well.  They know what I expect and they never have to worry about me trying to take advantage of them by adding work or “forgetting” payments.  Contracts are a two-way street that – when used properly in this business – can provide a peace-of-mind to both the investor and to the contractor.

But, I’m not going to spend any more time trying to convince you to use contracts for your contractors…instead I’m going to talk a bit about what a good contract looks like…

Contract Myths

Before we jump into the details of what a contractor contract should contain, first let’s dispel a couple common myths about contracts:

Myth #1:  Contracts need to have a lot of legalese and/or be written by a lawyer to be worthwhile.

A lot of up-and-coming investors will decide that, because they can’t afford to hire an attorney to write their contracts, it’s not worth even having one.  While getting a contract written by (or even just reviewed by) an attorney will go a long way towards ensuring that your interests are protected, it’s much better to have a self-written contract than no contact at all.  While judges are trained to interpret contracts very literally, they also are reasonable enough to take common-sense and intent into account when resolving a contract dispute.  So, don’t forego a contract just because you don’t have a law degree or can’t afford to hire an attorney.

Myth #2:  It’s better to have long/complicated contracts than to have short/simple contracts.

We all know that stereotypical contract that’s dozens of pages of small print that covers every possible contingency in gory detail.  But, while one purpose of a contract is to protect your (and the other party’s) interests, the other purpose of a contract is to ensure that both parties are on the same page with respect to the transaction at hand.  Plenty of contract disputes arise not because one party is looking to “take the money and run,” but instead because the parties never really understood what the other party was agreeing to.  Sometimes, all it takes is a couple sentences to reasonably describe each party’s rights and responsibilities, and is enough for both sides to really understand what they’re agreeing to before it’s too late.

Myth #3:  You don’t need a contract for a small/inexpensive job.

Just because a transaction only involves a small amount of time and/or money doesn’t mean that a contract isn’t important.  Hiring a handyman to screw in a lightbulb for $2 may seem pretty straightforward, but if that handyman electrocutes himself in the process, having a contract may mean the difference between you visiting your handyman in the hospital and you meeting your handyman in court while he’s suing you for everything you’ve got.

Elements Of A Contractor Contract

With those things in mind, let’s talk about the key components of a contract you might use with a contractor who is working on one of your properties.  Remember, these are things that many investors feel are important to have in a contract, but this is by-no-means a complete list of contract issues that might be included in your contract.

Ultimately, you’ll need to decide what things are important for you to have in your contract, and while most of these things below will probably make the cut, that’s for you (and perhaps your attorney) to decide.

Independent Contractor Status: One of the most important things most attorneys will recommend you include in your contract is a very clear declaration that the contractor is an “independent contractor,” and is not your employee.  This is important for several reasons:

• From a liability standpoint, you may be required to carry certain forms of insurance for your employees.  If your contractor gets hurt on the job, and can make a case that he is an employee of yours (it’s not as far-fetched as you might think!), you may be on the hook to cover his medical expenses and other claims.
• From a tax standpoint, you are required to withhold taxes from paychecks and also to pay certain employer-related taxes.  If the IRS deems your contractor an employee (again, it’s more likely than you might think), you may be on the hook for taxes and penalties.
• From a benefits standpoint, if after a job is complete, your contractor claims to have been an employee of yours – and if the unemployment office agrees – you could be on the hook to pay his unemployment benefits.
• From both a liability and from a financial standpoint, it’s extremely important that you clearly define your contractors role in your business – and that role is as an independent contractor, not an employee.

Also, keep in mind that the IRS has a number of tests to determine if someone is an employee or an independent contractor.  For example, if you provide the tools to the worker, the IRS will be inclined to consider that worker an employee.  Likewise, if you direct the worker as to how the job will be completed, when he must show up and go home, etc, the IRS is more likely to determine that worker is an employee.

For this reason, these sorts of things should be called out specifically in the contract.  For example, your contract probably should state that the contractor will provide his own tools.

Scope of Work: Perhaps it goes without saying, but just in case…  Your contract should call out – as specifically as possible – the tasks that your contractor is being hired to perform.  Don’t be afraid to go into gory detail if you think there is any possibility of confusion or miscommunication.

Will your contractor provide the materials for the job (or maybe some of them)?  Will your contractor be required to clean up each day before he leaves?  Will your contractor be required to coordinate his schedule with other contractors?  Whatever it is, make it clear in the contract.

Compensation: Again, it probably goes without saying, but your contract should define how much and when your contractor will get paid.  Perhaps the contractor will get paid based on milestones he surpasses (i.e,. 25% complete, 50% complete, etc).  Or perhaps the contractor will get paid upon completion of specific tasks (i.e., 50% upon completion of exterior work).

However you plan to pay your contractor, spell it out clearly in the contract so that there is no confusion once the project has started.

Insurance Requirements: I highly recommend that you require your contractors to carry insurance – both general liability insurance and workman’s comp insurance.  Assuming you do have these requirements, make sure it is in the contract.  Along with having the contractor agree to carry insurance, I recommend having the contract specify that the contractor will provide proof of this insurance prior to work commencing.

Deadlines and Penalties: One of the most frustrating aspects of working with contractors (in my experience) is that they are happy to drag their feet if you let them.  While it’s can be painful to have to argue with a contractor over whether he was supposed to finish this week or next, why argue?  Whip out your contract and prove to everyone involved when the work was supposed to complete…and more importantly, what the penalty is for the work not completing on schedule.

I always give my contractors plenty of extra time to complete their work, and also make it clear that if the schedule slips (for reasons not outside their control), they will pay a weekly penalty.  I’ve never had to impose that penalty, and I’m guessing it’s in large part because my contractors know what they’ve agreed to and know what the penalty is for missing their dates.

Other Stuff: There are dozens of other terms and issues you can address in your contract that I won’t go into detail on here.  To touch on a few:  indemnification against liability, arbitration in the event of dispute, rights and responsibilities to terminate the contract, required use of lien waivers, etc.  Again, you must decide what’s important to you in a contract and then ensure that it’s adequately covered.

Sample Contract

This topic wouldn’t be complete without a sample contract for you to review to get a better understanding of how all these pieces fit together.  In this case, I’ll be providing a template of the exact contract I use for every contractor and work task performed on my properties.

Before I provide a link to the contract, a few notes/disclaimers:

• While this contract has been reviewed by my attorney (he wrote much of it), it is specific to Georgia state law and to my needs.  You are welcome to do with it what you like, but keep in mind that it may or may not suit your needs and may or may not hold up based on the laws of your state.  Who knows, it may not even hold up based on the laws of my state…luckily I haven’t had to find out…  J
• The contract I use (and provide below) has two parts.  The first part is the “Independent Contractors Agreement” and is signed by each and every contractor before the first time they do any work for me.  The contractor only signs this part of the contract once, and it stays in effect forever (or until it’s terminated by either myself or the contractor).
• The second part of the contract is the “Scope of Work” and is specific to each project.  This part of the contract lays out the work items to be performed by the contractor for a specific project, the compensation, deadline, penalty, etc and is completed and signed for each new project that the contractor undertakes.  The two parts together form the basis for a full contract between your contractor and you for a specific set of tasks at a specific property.
• I’ll reiterate one last time:  Don’t assume that this contract will protect you without reviewing it with an attorney to ensure it is applicable to the laws of your state and to ensure that it meets your specific legal needs.

All that said, here the contract templates:

Part 1:  Independent Contractor Agreement

Part 2:  Scope of Work

Enjoy!

This Article is Copyright © 2004-2011 BiggerPockets, Inc. All Rights Reserved.

What’s in a Contract? Almost Everything You Need to Know About Contractor Contracts

How do you pick someone (a contractor) to take care of your REO, foreclosure, or other home improvement or rehab needs?

Do you base it on:

• the nice shiny truck they came to visit you in?
• the neatly pressed uniform they are wearing?
• the sharp penmanship on the estimate?
• the jokes he or she cracked about the weather?

What is it? What are you basing your decision on? You really need to take a second and reflect on what has been your deciding factors on choosing a contractor for your job.

Don’t base your decision on emotions!

Never let emotions get in the way of good business practices. Now, I’m not saying to be a robot but don’t let the fact that the person coming over to give you an estimate loves the same things you do and is such a cool person. Countless people including me have fallen into this trap and end up with shoddy results because of it.

So, how should I base my decision on picking a contractor for the job?

 
The following is just a simple list of what you should ask before picking a plumber, painter, carpenter, electrician, or other contractor:

1. What do you specialize in? (What did you do the most in the last 12 months) This is a super important question that must be asked. Many contractors can do just about everything there is to do in home improvement/construction but can they do your job beautifully and within budget? I had an experience once where I hired a carpenter to do tile work on my house. This person specialized in wood work but said they can do tile as well. This person beat out all the other estimates I got but in the end the results of his work were lackluster. Don’t ask a Burger King cook to whip you up a soufflé.  Get my drift?
2. Will you be personally doing the work? Ask if the person giving you the estimate will be performing the work? These are important questions because sometimes, the person coming out to do the estimate is not the person that will go out and do the work. You will just be wasting your time explaining to the estimator all the tiny details of what you want done only to find out you have to repeat them all to another person that ends up showing up at your door.
3. Will you be sub-contracting work out? This is a MEGA super duper important question to ask because many contractors sub-contract out work to someone else and never actually do the work themselves. The caveat here is that, lets say you pay the main contractor in full but he never pays the 3 sub-contractors that came and performed work on your property. The main contractor picks up shop and moves to Jamaica.

   Guess what?

   In most states you are responsible to pay those sub-contractors regardless of the fact that you paid the main contractor in full. Sad but true. The sub-contractors can slap a mechanics lien on your property thus clouding the title, and you cannot move forward with your deal because you have to go to court to fix this mess you could have avoided had you opened your lips and asked “WILL YOU BE SUB-CONTRACTING OUT ANY WORK?” If they do and you are comfortable with it,  make sure you put in place a way to know that these sub-contractors are paid timely or see if you can withhold monies until work is completed, etc. Demand proof the sub-contractors were paid. Plain and simple.

4. Do you have insurance and are you licensed? This is self explanatory. Ask if they have current insurance and that you you want to see a copy of it along with license information. Go to your local state contractors licensing board online and check on their number to see if the license is active and if there are any disciplinary actions ever taken against the contractor. The last thing you want is one of the contractors workers to fall off a ladder and then you find out that the contractor is unlicensed and uninsured. You might get dragged into court because the guy wants to sue you for not having a level floor on which his ladder stood. Crazy but it happens.
5. Will you clean up after your work? You will be surprised how many contractors do not clean up after themselves. Don’t let this be a cherry on top of your sweet sundae of a remodel project. Make sure you find out if they will clean up after themselves, and if they will be charging you extra for disposal of scraps, etc.
6. Where will you be performing your work? Ask this question if you do not want your green lawn turned white. Lets say you need some tile work performed on a house. The contractor brings his cutting table. This table requires lots of room and running water. When tiles are cut it produces a chalky milky discharge. If they set up shop on your front lawn guess what. Your grass is screwed. If you have painters painting your house. Ask where will they be cleaning their tools etc. They most likely will wash their brushes and buckets over your lawn and screw your lawn for months. This is another important question.
7. Do you guarantee your work and parts? Find out how long they guarantee their labor and the parts they have installed.  Don’t be surprised later when the new shiny faucet the plumber installed, sprung a leak and they only guarantee their labor and not installed parts. Don’t get caught off guard. Be a sharp investor/home owner.
8. Do you repair or replace places of access/entry? This is a great question to ask. Let me give you a for instance. A while back we contracted a plumber to come replace the hose bibs (the faucets where you connect the garden hose to)  in the front and backyard because they sprayed water all over the place no matter how tight you put the hose on. Now normally the hose bibs can be twisted off and replaced easily but in our case they were welded on so they had to be sawed off and new ones welded on. In order for the plumber to get a good weld they had to bust the stucco around the hose bib in order to get to the underlying pipe. Now who is going to repair the hole in the wall once the hose bib is replaced? Plumbers are plumbers and 99% of the time they will not repair exterior or interior walls. They might need to bust apart tile in your restroom in order to get to the pipes or the concrete of your driveway to get to the irrigation system placed underneath. You might think that the estimate they are giving you covers this repair but I bet it does not. Please ask this question.
9. How long will the project take? This is an easy one; I am sure you will ask it. Some people don’t and get caught off guard.  A good variation to this question would be to ask what will happen if the contractor does not meet your timeframe? Will you be credited for your time? Will they extend the guarantee on parts and labor?
10. When is payment due? Some contractors want the money due all upfront. Some want it broken down into 3 parts: a percentage to start, a percentage half way and the remainder at finish.

These are just a basic set of questions to ask when picking a contractor. Make sure to always get 3 estimates no matter how nice the person is. Smart investors/home owners always get 3 estimates and ask the questions I laid out before you. You also want to work with someone that is very knowledgeable about the field of work you need done to your property. Listen to that voice inside and you should be ok!

I look forward to your questions, comments or concerns about my article.

Good luck in all you do America! Let’s make 2010 our best year yet.

Photo: kyz

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How to Pick the Best Contractor for your REO, Foreclosure Rehab, or Other Remodel