Background

I have learned a lot from people on the BiggerPockets boards and I wanted to offer some of my experience in the hope that someone else could find some useful information.

I started following the real estate market in California from an investment mindset in 2003. At the time I was working a full time job, I was building up my capital base, and I could never find any houses that cash-flowed. In retrospect it would have been a good time to jump into the market from an appreciation basis, but I owned my primary residence (bought in ’01) and so I had some exposure to a rising market. The key point is that I waited and did not buy.

I continued working and spent a couple of years overseas with a large financial institution. I came back in 2008 just after the financial market crash and at that point I probably should have started investing but again, I waited. I got another job that I soon tired of, and by 2010 I was finally ready to pull the trigger on a real estate investment. I started looking in San Francisco, but I found better cash flow opportunities in Sacramento, near where I grew up. I looked at some single family home homes, but I decided that if I was going to buy out of my area (2hr drive) I should try to do it at a scale where I could pay for help running the place and not evaporate my earnings.

Learn the Building Process

Eventually I found an 18 unit REO apartment complex in a good neighborhood of Sacramento. There was substantial deferred maintenance (a couple of moldy units) with bad roofs, bad HVAC units etc.. I knew that the purchase price was only the price of entry and that I would have to spend more.

I paid all cash for the property. Within a year I had all of the units rehabbed, the property stabilized and I was able to turn around borrow back from the same bank (Was Washington Mutual, absorbed by JPM Chase) 90% of what I had paid the same bank for the property when it was distressed. This was an important year because I took a very hands-on role in my apartment rehabs. I quit my job about 1.5 months after buying the place and I spent my time more or less as an errand boy for my skilled labor (tell me what to buy, I will go to Home Depot and buy it). I had paid about 50K per door for the apartments and I would spend about 10K on each rehab. Split usually worked out to 50% materials, 50% labor. New baths, kitchens doors, hardware, often flooring.

This was great and got me a stable asset with a pretty narrow equity slice, but after 5-6 apartments, I realized what a hassle it was to actually rehab a living unit, and that if I was going to go to the brain damage of remodeling a place, there was a strong argument for doing it once, doing it right, and then taking the money and running. In other words, development.

Buy Carefully, Buy Smart

So, I started looking at fix and flip opportunities. I was also tired of driving back and forth 2 hours each way to Sacramento from my home, so I narrowed my search to properties close to me in San Francisco. I educated myself about the Foreclosure process. I bought dummies books on Amazon, I read up on chain of title actions. I also got my California RE Agent’s license and found the courses extremely useful.

The environment in San Francisco is very politicized and participating in foreclosure auctions during this period meant tuning out crowds of protesters who were attempting vainly to disrupt trust deed auctions to ‘save’ the borrowers. Provided you were able to tune out the noise, it was great, because it thinned the number of participants and you could get better deals.

In early 2012 I paid cash ($520K) for a 2br 1 bath 1910 house near my neighborhood. After the trustee sale, occurred, I waited for my deed to arrive, I recorded it, and then contacted the occupant. I knew who she was beforehand, had googled her and knew her work history, could imagine her situation and had some expectations about how she would act. For the most part I was correct. I treated her with respect and courtesy and negotiated a $2K cash for keys agreement. It took about 2.5 months to get possession.

At this time, very little building activity was going on in San Francisco, so after putting an ad on Craigslist I got a great number of solicitations from Architects to help me consider my development.

The house was in poor shape. I knew that I needed to spend some money to make it safe (rotted rear porch etc.) so I was in for some spending regardless. The question was, do I keep it as a small house and fix it up to sell, or does it make sense to try to make it bigger?

So much in real estate valuation comes back to (IMHO) to square feet * price per square foot. I had purchased ‘the smallest house on the block’ in a pretty good neighborhood. I spent some time at the SF planning department and learned all the setback requirements and rules, so I was well informed when I interviewed my architects. In the end I decided on a path to radically expand the size of the house from 920 square feet to approximately 3200 square feet.

It took a couple of months for my architect to develop the plans. Then the planning department reviewed the plans for about 8 months. Then my neighbors had the chance to weigh in for a couple of months. All told, from the time I had possession of the house, until when I had approved plans to build took well over 1 year.

By the time I was bidding the construction work it was early 2013 and the building market was starting to come back, but it was still slow enough that I was able to get (by San Francisco terms) some good pricing. I wound up contracting my expansion/renovation for about $750K.

At this point, I suspect someone is thinking “Three quarters of a million dollars to expand a house? I could build a dozen houses in my neighborhood for that much.” You’re right. You could. It doesn’t make sense and San Francisco is a good market to be an experienced contractor. I solicited real bids from about 5 contractors and the bids ranged from 1.1mm to 550K. I picked an experienced guy who had my architect’s faith.

We began construction in summer of 2013. I was glad a chose an experienced guy. He did a good job.

During the same time period, the real estate market was racing ahead, so all of the stress and sweat of the preceding 18 months were looking like a better bet.

I hired an interior designer to help me, and she did somewhat, but in the end I chose everything myself. I had a clear idea from the outset who I thought my buyer would be (5 bed, 4.5 bath traditional neighborhood with good schools, parks, safety, parking) and I stuck to it throughout the process.  I was building a nice big house for a family with money.  

In the end, my contractor took longer than he was supposed to (surprise!) The only strife we had was when I started to lean on him at the end when he was so overdue. Liquidated damages (essentially per day late charges) would have been the contractual answer at the outset, but after waiting 18 months to build, my eagerness overcame my thoughtfulness on this point. If I were starting the same project today, there is so much work available, a contractor would laugh off any attempt to put liquidated damages in a contract.

I financed the construction costs through a private loan. I paid 7.5% on a line of credit.

I had earned my RE license and the sale price and attendant commission was such that it made sense for me to do “the work” of listing it myself. I listed the house for 2.5 in the fall of 2014 and sold it for 2.64 within 6 weeks.  

The numbers then were (approximately):

520K purchase

5K Acquisition (legal, cash for keys)

80K soft costs (permits, architecture, structural)

900K construction costs (750K contract, change orders, fixtures)

50K financing

10K insurance

85K closing costs (66K to other agent, staging etc.)

$1,650,000 all in costs

$2,640,000 Sale price

$990,000 Profit

A good portion of my profit relates to the rally in home prices during the time my project was in process. I could not find the same deal on a fixer or on a skilled contractor today. I probably could have held onto the house in the condition I bought it over the same time period and cleared 400-500K. Was the extra work worth it? Well, I’m taxed at long term capital gains rates, I know a lot more about building and entitlements. It made getting my agent’s license worth while, and I set 2-3 other projects in motion over the same time period, so yes, the effort was worth it many times over.

This was my ‘first flip’ but I had learned from rehabbing my $50K apartments a great deal of what I needed to know to turn my $500K house into a $2.6mm house. 

Keep chipping away and be prepared to be patient.

Good luck and if you buy now, make sure you have a good reason. It seems like most of the cheap deals are gone, especially in California.