Real Estate Consultant · Houston TX · Member since 2021 · 125 posts · 93 votes
Margins are thin right now. That means every decision on a project has to be right the first time.
The way I approach every deal starts before the bid is signed. I read the scope the way a contractor writes it, looking for what's missing, not what's there. Missing line items don't show up as problems until demo starts and walking away isn't realistic. By then the number has changed and you're absorbing it.
On a recent commercial repositioning the bid looked clean. Competitive number, professional presentation. Structural supports for the parapet addition weren't in it. Roof modifications the parapet required weren't in it. Both mandatory. Both code. Both absent.
Found it before the contract was signed.
On the construction side I don't wait for inspectors to tell me what's wrong. I've caught foundations with wrong measurements for the prefab metal building going on top of them. Roofs missing rubber gaskets on every screw, which means water infiltration nobody finds until it's a gut job two years into a lease.
Inspectors check boxes. I look at the project.
The difference between a deal that works long term and one that bleeds out slowly is usually caught or missed in the first thirty days. That's where I focus.
What systems do you use on the front end to protect your margins before construction starts?
If you can bring a rehabbers eye and you are on the ground, that is huge. No one can lie to you or exaggerate or cover up. That's a big plus. I've seen it all. I had a reputable construction company try to tap into knob and tube wiring instead of ripping it out. Got caught in an inspection.
Any new investor who has that 40k - 60k starting capital and they are forced out of their home market by price or demographics, they almost have to look at that capital as education they will pay for.
I'm out there looking/underwriting/sourcing properties all the time. ARVs are so inflated, constructions bids are low to win the job, days on market drag on.
Everything from this process is survivable except contracting. If the loan terms are a little high, you can beat that, if the ARV is off 10% you can beat that, but if you go through 2 contractors and are working off draws and have peeled through 70% of the draw money and yet only 30% of the work is done and you'd think, how does that happen? It's cause the inspectors and the GCs usually walk together and they get a song and a dance from the GC about "being done tomorrow' and waiting for this or that. And you'd think lenders would protect the funds better, but they don't. They do give them to you the borrower though and I really suggest never handing them over unless you see with your two eyes video and pictures.
What do I do to protect myself?
1) I buy at discount venues. Cash buys. Mostly auction, some direct from seller. I build consulting teams in markets I want to target, I have relationships with private capital that funds non conventional deals from auction, foreclosure, short-sale. What have you. So I get in at a steep discount only. Most properties I buy are at 50%/60% their FMV. Lots of time I flip the houses as is to the local investor pool. On my team is always a local wholesaler/agent with big reach.
2) If we get in a property and it's not that bad, juts a little dated and with some lipstick (15k - 20k) I can get 2x my investment. That kind of wholetail strategy I will do on the right property. I manage that through my boots on the. ground. It's floors, paint, maybe central air. Tasks like that. Not working from the studs with some GC who claims to have labor and know-how and blah blah blah. That strategy does not work.
I just bought a house yesterday at the auction using private money. 321 Lawnwood Ave in Brentwood/Pittsburgh. 73k. Good area. Good schools. My team already visited it and took videos. I think it is a 3/1 brick house with a front and big back. Community is all well kept and very upper middle classs. Last as-is sale in the neighborhood was a few months ago. It listed for 110k and went for 130k. The ARV is 249k. Rent is 1800 - 2000.
When the deed comes in, I have multiple exits:
1) List for like 99k and attract offers right away and probably make a quick 25k (20k after all closing costs let's say)
2) If we get in and this is just dated and only need 30k to bring it into comp range, I can ask my PM for the money do the lipstick and be in for 100k - 110k and list it for 239k and take the first 220k that walks in the door.
3) I can put the lipstick on it, be in for 100k. When done rent it out for 2k/month and refi. I can either go for the max and take 75% of 250k and get 187k back and pay off the 100k and get 87k in tax free cash but only cashflow maybe a few hundred per month OR I can take like a 50% DSCR refi and get 125k out. Pay off the 100k and pocket 25k and my cashflow would be like 800/month.
Strengthening your buying power leads to built in equity which leads to options for exit which leads to protection on your investment.
I've been through 40+ deals doing it the way you think it is supposed to be done. Find a good agent, contact some contractors, get the hard money lined up, etc. But when you overpay, the contracting goes sideways, and holding costs sky rocket, and the exit is 20% lower than the comps you were shown - you will scratch your head and say maybe it was the deal or it was a fluke or anything that could've went wrong, did. I'm telling you, Murphy's Law is alive and well in rehabbing houses for resale.
I made a hard pivot on how I invest and how I advise others on investing.
You've lived it. That contractor section is the most accurate thing written on this site in a while.
The draw problem is exactly what it is. Inspectors and GCs have a relationship that has nothing to do with protecting your money. Nobody wants to hear that but there it is.
Buying at a steep discount is the only way residential rehabbing makes sense. You already know that. Most people figure it out after they've donated $40,000 to their education like you said.
Where I landed after doing it the way you're supposed to do it, agent, contractor, hard money, cross your fingers, was commercial and repositioning. Not because it's easier. Because the math is fundamentally different.
On the residential side you're fighting ARV inflation, contractor games, days on market, and a buyer pool that has feelings about paint colors. Every variable works against you and the margin for error is razor thin.
On the commercial side the value is in the income. You control the income. You improve the asset, stabilize the tenancy, the value goes up on a multiplier. A $50,000 improvement that adds $1,500 a month in NOI doesn't add $50,000 in value. It adds $225,000 at a 6 cap.
The contractor problem doesn't go away in commercial. But the spread is wide enough that catching it early doesn't kill the deal. It just costs you a conversation instead of the whole margin.
That Pittsburgh deal has good bones by the way. Clean exit options. You've clearly done this enough to know what you're looking at.
You have no idea, I went through 8 contractors in 2.5 years. One of my clients is in a lawsuit as we speak and now that I've seen that process - it is a nightmare. You have to put up the money in question in escrow while the arbitration is going on - which takes 6 - 9 months. Nightmare. I've had contractors walk off and ghost, I've had them lie, steal, underproduce.
And let me tell you something else, taking a run down house and turning it into a comp worthy structure is not easy. Even if you know the order of operations, it's about execution.
Point of entry for the investor is so important. If you enter at the top with no built in margin, your room for error on the rehab and the exit is zero and let me tell you the actual error WILL NOT be 0.
I had one flawless deal with a client doing it the old way. In and out of the deal in 90 days and gross 45k. The rest had issues with the construction, issues with the exit, some wholesaled out for a loss mid construction. And holding costs will eat you alive. Pay 1500/month for a year. 18k. Then you sell for less than you expect on top. How are you supposed to make money?
I am from the school that great deals do not exist on MLS, people overpay way more than find a deal there. And wholesale houses may be a tic cheaper than MLS but I've never been in one that didn't have more problems than the budget outlined. Plus when you buy wholesale, you pay all closing costs. All realtor fees, all title fees, all transfer tax. I'm on the other side of it now sometimes and it is nice. I've gotten rid of a few properties through wholesale and I get my number. So if I sell for 75k, I get 75k. All closing costs are paid by the buyer. When I sell on MLS I have to pay my own closing costs, including that 5% realtor fee.
If some 60% project cost to ARV deal was on MLS, price would get bid up till the project cost was in the mid 70s like the rest. Really after closing costs people are north of 75% project cost to ARV lots of times. That's a red zone. One or two errors and you will lose.
Because I changed the way I enter the game, I lowered my project costs down into the low 60s, sometimes the 50s. That gives me wiggle room on construction and wiggle room on the exit. That is essential. Without it, you are trying to be one of the flying Wallendas walking the high wire but without a net.
I know people do fix n flip off the MLS, I hear the stories. You may have heard this before: YOUR RESULTS MAY VARY