Investor · Mechanicsburg, PA · Member since 2017 · 110 posts · 50 votes
Hello fellow BP'ers! Like any other newbie starting out, I too have a lot of basic questions. I am grateful to this community who likes to kick @$$ and make you get started. Its like having an older sibling that makes you learn things faster ;).
So, in the quest of finding opportunities and trying to make sense of what niche is better suited for my passive style of investing (which I see myself as), I came across this GC who does everything, even maintain books. He comes recommended by a very good friend of mine, who I could easily see as my mentor.
This GC guy wants to enter in a partnership (I don't know the detailed terms yet) and want to flip houses and was trying to explain the obvious to me that flipping is less risky than to maintain a long term renter and dealing with their hassles on almost a daily basis, making small profits for a longer duration compared to profit up front (if we really could make that happen!). This kind of makes sense to me and I couldn't come up with any argument to support why rent or even BRRRR would be a better option. Now considering that the terms of partnership are such that I procure capital and he puts in the sweat money, and we split the profits. Do you see any cons with this approach?
Real Estate Consultant · Whitestown, IN · Member since 2014 · 547 posts · 933 votes
9y
What we have done and is working out for us so far is as follows.
We pulled/raised/borrowed money to do our first rehab. We don't touch the profits at all. Once we built $300k in cash (the amount needed will depend on your market and goals) we kept a rehab as a rental. We continued to rehab properties and every time that we have over $300k in liquid cash, we keep a home for a rental. The point of the matter is as follows.
Rehabbing is faster money, but you cannot rehab forever. Eventually, I want to retire.
Rentals are slower money. I have to park the money that I have and set aside reserves before I consider cash flow. If your rentals yield 9-15%, you need about $1M in rental properties to make a 6-figure income. You have to build (or borrow as in BRRRR) capital to get there and rehabbing is a good opportunity for this.
Diversification is always something to consider as is short-term goals vs long-term goals. Rehabbing homes is not what I consider retirement, even when I am not doing any of the work. Retirement is travelling with friends and family or enjoying your hobbies. I don't care to babysit contractors and realtors until I die.
It may not be a bad idea to partner with someone experienced, but ensure that they are bringing some kind of equity to the table. Newbie investors get taken advantage of all of the time... some of it is a right of passage though. You are paying for someone else's expertise. Make sure that you are getting exactly what you paying for.
Welcome to Bigger Pockets. Make sure to listen to the podcasts. They are very informative, and contain ample information. https://www.biggerpockets.com/blogs/
Northern, CA · Member since 2014 · 674 posts · 444 votes
9y
Why not do a bit of both? I'm on my 2nd BRRR, waiting on seasoning to refinance. I plan to keep the best properties for my own rental portfolio and flip the rest. You could set some sort of number like keep 1 rental for every 4 that you flip etc. The problem with only flipping IMO is that there is no residual income, as soon as you stop so does the money not to mention taxes eat up a small chunk of the profits.
Investor · Mechanicsburg, PA · Member since 2017 · 110 posts · 50 votes
9y
@Tiffany S. Thank you. So as long as the contract terms are fair, flip might not be a bad idea.
@Lee S. I really liked what you said. It maybe that in the beginning you would want to try out how it goes and can take bigger challenges down the road. I am thinking flipping might be a good start for me to get feel of things and considering that there is an more certain 'out'. I'll make sure to educate myself enough to account for all costs involved before diving in!
Could anyone also comment on what an ideal contract in this scenario should look like?
Real Estate Consultant · Whitestown, IN · Member since 2014 · 547 posts · 933 votes
9y
What we have done and is working out for us so far is as follows.
We pulled/raised/borrowed money to do our first rehab. We don't touch the profits at all. Once we built $300k in cash (the amount needed will depend on your market and goals) we kept a rehab as a rental. We continued to rehab properties and every time that we have over $300k in liquid cash, we keep a home for a rental. The point of the matter is as follows.
Rehabbing is faster money, but you cannot rehab forever. Eventually, I want to retire.
Rentals are slower money. I have to park the money that I have and set aside reserves before I consider cash flow. If your rentals yield 9-15%, you need about $1M in rental properties to make a 6-figure income. You have to build (or borrow as in BRRRR) capital to get there and rehabbing is a good opportunity for this.
Diversification is always something to consider as is short-term goals vs long-term goals. Rehabbing homes is not what I consider retirement, even when I am not doing any of the work. Retirement is travelling with friends and family or enjoying your hobbies. I don't care to babysit contractors and realtors until I die.
It may not be a bad idea to partner with someone experienced, but ensure that they are bringing some kind of equity to the table. Newbie investors get taken advantage of all of the time... some of it is a right of passage though. You are paying for someone else's expertise. Make sure that you are getting exactly what you paying for.
Atlanta, GA · Member since 2016 · 44 posts · 9 votes
9y
I agree with Mark, listening to the podcasts will give you a general understanding of many different paths and help you specify what the WHY is in your decision. If you have someone you can world with as a mentor that would be a fantastic was to get your foot in the door and find your niche through first hand experience as well!
Investor · Mechanicsburg, PA · Member since 2017 · 110 posts · 50 votes
9y
@Ross Denman your comments are really insightful and provide helpful perspective. You are right on with your point about raising capital thru flips for further investment in rental property! So maybe I am on right track to start it out with flips, and further expand as you are suggesting. I guess it is also in line with some of the comments, blogs I have read here to get expertise in one area before moving on to other niches.
@Andrew David Evans I do have a mentor, but he has most of his experience with rentals, and is contemplating trying flips.
I still need to get my team together, but I cant believe that I am already taking steps, even though I am part of this community for less than a month and have no prior experience! It makes you believe in yourself :)
Atlanta, GA · Member since 2016 · 44 posts · 9 votes
9y
I would get as heavily involved with what your contractor is involved with and continue your search for someone that is successfully flipping houses in your area. There is no knowledge like hands on experience and it sound like you have some great resources. Best of luck and keep us up to date with what you eventually decide to do!
Harrisburg, PA · Member since 2015 · 43 posts · 52 votes
9y
@Amit G. - We are located in your market, Central PA, and do rehabs from Carlisle to Hershey. We are self funded and do everything from purchase to property management. I have a similar situation in that I have contractor partners that provide sweat equity as their buy-in capital. Our corporate setup is somewhat different than most REI LP or LLC and is more like a Tech Start-up which is heavily scaled to dividends, stock options and long-term recurring revenue. The corporation is setup as an undivided interest and the properties are just "inventory" assets of the company. This allows us to add partners at any time and allow them to participate in a diversified asset base.
The model of having a contractor as partner works IF they are also the ongoing maintenance and facility management of the property (if BRRR). They also need some skin in the game so they don't just skip out when things go sideways (and they will). You also must work with the GC partners just as you would an independent GC or you may get a different result than you wish for. A good GC doesn't necessarily know what needs done to properties for the best sales potential and/or ROI maximization.
There are not many established contractor flippers in our market so it's interesting to me that you have one that needs capital for projects. As you probably know, the issue in our market is that there are too many wana-be novice flippers that tend to bid-up distressed properties to unreasonable prices. I'd make sure of the credentials, history and experience of your contractor.
Regarding flipping vs. BRRR - I'm surprised no one has pointed out the number one issue with flipping ... taxes. Figure on losing up to half of your profit from flips on anything not held at least a year. This swings the deal for us, we only do buy/rehab/rent/hold.
The other problem that is market specific is that Central PA has a very competitive and tight flip margins. Expect to max at about 20% upside on a distressed sale purchased. This holds true for REO, Pre-F, auction and private. I have yet to find a legitimate wholesaler in this market (I'm open if there is one, contact me).
The margins have become so tight that even the big turnkey guys seem to be lessening the depth and quality of their flips. The problem is that the public is now educated on what is a cosmetic flip and what is a true renovation, so the cosmetic "lipstick on pig" flips sit vacant while the truly renovated homes in the $150K range sell in under 4 days for ask+.
So, 20% margin, less partner cut of 50% and tax/close cost of 50% leave 5% margin for flips. This is why the BRRR strategy may work better, and we believe it does for us.
This locale is a tough market and the hardest part is finding properties with margin. Sales are great and good rentals go quickly to good tenants. Good luck with your project!
Investor · Mechanicsburg, PA · Member since 2017 · 110 posts · 50 votes
9y
@Cooper Bert It's nice to see south central penn investors active on this site! I don't know the GC personally but through my mentor who I have known for a long time. It's not that he has some properties ready and is looking for investment. From what I understand, he has been doing it for a very long time, i.e. managing properties and enhancing rental values through additions and other means to be able to raise rent for my mentor's properties. Of course, I have to do my due diligence to vet him out before I can trust him and vice versa.
Tax on flip is a bummer! I am glad you pointed it out. But aren't there any ways to legally bring it down?
Regarding your startup model, is it something similar to Fundrise but local to south central PA?
@Cooper Bert It's nice to see south central penn investors active on this site! I don't know the GC personally but through my mentor who I have known for a long time. It's not that he has some properties ready and is looking for investment. From what I understand, he has been doing it for a very long time, i.e. managing properties and enhancing rental values through additions and other means to be able to raise rent for my mentor's properties. Of course, I have to do my due diligence to vet him out before I can trust him and vice versa.
Tax on flip is a bummer! I am glad you pointed it out. But aren't there any ways to legally bring it down?
Regarding your startup model, is it something similar to Fundrise but local to south central PA?
There are ways to offset taxes on a flip (your account & tax lawyer will be happy to charge you by the hour to explain!) but the only way to reduce the actual tax on the flip is to hold it for a year and declare it a rental. Disclaimer - I'm not an accountant and there is some minor disagreement on the time period.
A good way to do this is to fix up a property, move into it for a year while you fix up the next one, sell property A, move into property B, Fix up property C ... rinse & repeat. OR, just BRRRR.
Regarding our biz model - We are kind of like the inverse of Fundrise. I don't know much about Fundrise but it appears to be a glorified REIT that relies on crowdfunding. This is the new millennium version of penny stocks, now $1K stocks. My main investment vehicle is the equities market so I'm very familiar with the REIT & MLP sectors.
We are self-funded at this point so we aren't looking for investors; although our charter is setup for future investment should be decide to go that route. That gives us great latitude to run the company for the long game. The partners are the skilled craftsmen that we invite to become full-time owners of the company in exchange for their services. These are typically contractors that I've known over the years and used in my CRE business. Many times they were financially devastated in the financial crisis and are looking for ways to fund future retirement. Everyone is aware of the distressed properties from the recession but not many people realized the distressed craftsman that became available and were looking for opportunity.
From the partner selection forward, everything functions just as a large corporate entity. All assets are owned under one corporate umbrella and payouts are determined by shares of stock owned by each partner/owner/stockholder.
Granite Falls, NC · Member since 2016 · 46 posts · 13 votes
9y
There are obvious benefits to both and many have named them here on this thread. I think the key here is that you mentioned wanting a passive style of investing. Flipping house (especially as a newbie) isn't remotely passive. Even with everything contracted out, you're going to be intimately involved in managing the project and managing your contractors. To me rental properties make the most sense for building long term wealth and for lifestyle design, if that's what you want. You can make it as passive or active as you like.
Investor · Mechanicsburg, PA · Member since 2017 · 110 posts · 50 votes
9y
Thanks @Cooper Bert and @Jesse Holshouser for your inputs! I am meeting the GC next week and will try to gauge the expectations to make a hopefully wise decision!
Real Estate Agent · Mechanicsburg, PA · Member since 2014 · 529 posts · 217 votes
9y
@Amit G. I don't understand what are you bringing to the table? If this guy is already experienced and does this full time, why does he need you? How much capital are you bringing? Do you have a couple hundred to invest or just enough for a down payment? Despite what the GC is saying, flipping is hands down more risky. Even if you bought a POS rental, chances are in 20 years it will look like a smart investment. If you buy a POS flip and lose 30k, you might be sitting on the sidelines for a while. As mentioned earlier, there is a lot of competition in central PA. Deals are hard to come by. There isn't much on the MLS that's for sure.
If someone is already proposing a partnership and you don't even know the guy I would be very skeptical. Even if your best friend recommends him, why doesn't your best friend do flips with him. Too many red flags for my liking. Be careful!
Also, you should come to the CARPOA meetings in camp hill. Check out our meet up page or reach out and I can give you more information.
Investor · Mechanicsburg, PA · Member since 2017 · 110 posts · 50 votes
9y
@Christian Bors Thanks for your comments! I am not going to try to defend the people involved here as I don't know the GC personally but obviously I am not planning to go in this partnership blind. That's why I was trying to understand what the contract terms should be.
From your comments, I get an indication that sticking to rentals for our area is safer, is that correct?
Real Estate Agent · Mechanicsburg, PA · Member since 2014 · 529 posts · 217 votes
9y
@Amit G. I think you can see some very good returns in this part of the country for rentals. I just sold my first flip a couple of weeks ago and bought another last week. I plan on doing several more flips this year, but I prefer the rentals. Everyone always talks about the midwest as places for great rentals. I think this area gets over looked very frequently. Especially on the west shore. Good schools, decent taxes, hard working people, and government employment. Sounds like a stable place to have rentals.
Harrisburg, PA · Member since 2015 · 43 posts · 52 votes
9y
West shore is definitely more tax friendly than Dauphin County. You can count on up to $1K savings for mid-priced SFR in Cumberland County just in taxes. Avoid Harrisburg city properties like the plague it is! Taxes going up in the bankrupt city, services being cut and home prices going down make for a money loosing investment!
My issue with this area is that rentals seem to have a ceiling at $1250/$1300. That makes sense based on the mid middle-class, white-collar state worker salary. However, SFR rentals are going up in price.
As distressed SFR are harder to find and new homes cannot be built under $200K retail, there is going to be a huge shortage of middle-class "starter" SFR in the $150K range. This will squeeze the rental margins because the renters won't be able to afford more rent regardless of the cost of the rental SFR.
So if my above analysis is correct - rental SFR inventory will be harder to acquire, rents will stagnate, SFR values will rise and cash flow margins will narrow.
The moral of this analysis being that if you have a good "flipped" SFR, with low expected CapEx, that has a ARV less than $150K, that will rent for $1250/mn or more, in a suburban area that shows good appreciation potential .... HOLD ON TO IT - BRRRR!
Thanks @Christian Bors. so what is the expected cash flow like in this area for rentals?
Loaded question. But I would say its not too difficult to achieve the 1% rule in this area. I personally would not buy anything less then 1.3% I try to aim closer to 2%
And getting harder. The days of finding these on the MLS appear to be over. Even REO properties that come outwith the ask priceat distressed price get bid up to close to market.
Unfortunately, I've never been able to find a real wholesaler in Central PA that consistently finds below market SFR. The last wholesalerI spoke with tried to sell me a Mountaindale property that I had passed on two months earlier and $20K lower. And the wholesaler didn't know that about 1,200 sq ft of the home was termiteinfested (present tense) and the well had a sulphur smell so strong it would know you down (utilities were turned off).