“… That’s Where The Money Is!”

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          When notorious bank robber Willy Sutton was asked why he robbed banks, this month’s headline was his reply.  When people ask me why I switched from being a long-term holder of houses to going into the fixer/flipper business, my answer is that, today, “where the money is” is in the business of buying, fixing, and flipping houses and mobile homes.  Dollar for dollar, nothing in real estate rewards entrepreneurial effort as much and as fast.  Even though just about anybody can go into the fixer/flipper business, to be able to make a profit consistently, there’s a lot to learn.  Finding, negotiating a purchase, and financing a suitable fixer/flipper is only half the battle.  It requires skill to be able to rehab it at a cost that that will leave you a large profit margin.  That’s the bad news.  The good news is that there are very few fields of study that will pay you back as fast in as short a time.  In this month’s letter, I’ll try to give you a few tips that can make the fixer/flipper business more profitable. 

 

          To summarize, this business boils down to three fixer/flipper steps that almost anybody can perform.  Here they are:  

 

(1)  Buy or lease/Option a house or mobile home that can’t be financed because of its condition.  Pay a rock-bottom price in “as is “ conditionThis might seem like a daunting task for a desirable house in a desirable location, but your target will be an undesirable house in a desirable location.  In the case of a mobile home, an undesirable location can be overcome simply by moving the home to a more desirable location.  A few months ago, a vacant lot zoned for mobile homes was bought at a foreclosure sale as a part of a larger parcel for little more than the cost of the utilities.  A late model mobile home in excellent condition was bought for about 30% of its appraised value from a lender who was trying to close his books for the year.  All that had to be done to capture a huge profit both on the home and the lot was to move the home to the lot and set it up on an approved foundation.

 

(2)  Once you’ve bought a property, your next step is to improve and/or enlarge its living area.  You’ll be “manufacturing” equity by putting it into condition so that it appeals to a broad segment of the sale market.  A good bet is to buy foreclosed houses that repel others.  Ideally, they’ll smell bad, look bad, and have an obsolete floor plan that you can improve.  These are precisely the things that would drive competing bidders away.  When these houses come up at foreclosure, you can often buy them for just a few dollars over the minimum bid.  At this point, you need to sharpen your pencil to calculate your costs to turn the property for fast resale. 

 

         It’s amazing how much difference cleaning out all the trash, painting, carpeting, putting up some fencing, and bringing back the lawns can make.  Up-dating  kitchens, and remodeling baths costs a lot, but they are the key to getting a fast sale at a top price.  Be cautious when replacing or repairing heating and cooling systems, foundations, and roofs.  These can be very expensive.  Because they don’t create excitement in the buyer or appraiser, it’s more difficult to recover their costs when you sell.  Knowing the true costs of fix-up, interest, and marketing often spells the difference between profit and loss, so estimate this accurately.   

 

(3)  Last, but not least, because turn-around time is so important, a marketing plan must be put into operation so that as little cash is tied up for as short a period as possible.  Your final step is to aggressively market the fixed-up house or mobile home at a price and on terms that generate a worthwhile net cash profit.  This way, your money can be re-cycled within a few months so that you can repeat the process.  Each day that a completed house remains unsold, you lose interest and opportunity; so it’s not a bad idea to start marketing the house as soon as the exterior work has been done.  The prospective buyer can be arranging financing while the house is being finished. 

 

THE 4-F FORMULA: FIND ‘EM, FINANCE ‘EM, FIX ‘EM AND FLIP EM’

 

          It’s easy to look at another’s success and think how “lucky” they must have been to be so well off.  On my office wall I’ve got a picture of an iceberg to remind me of how success is achieved in any endeavor; only about one sixth of an iceberg is visible above water; 5/6ths remain out of sight.  In the fixer and flipper business, the part that isn’t readily perceived by those who aren’t in it is the amount of expertise and effort required to do everything that must be done.  Not only must a target property with a motivated seller be identified, but its purchase, rehabilitation, and sale to an investor or consumer must all be financed.  Being able to do this distances successful entrepreneurs from those who think it’s easy to find, finance, fix, and flip houses to make a living and build cash reserves.

 

          The foundation of the fixer business is equity that is created when an old, ugly, obsolete, unlivable, un-salable house is turned into a home that someone would be eager to pay a high retail cash price for.  Ideally, owners of these houses can’t live in them, nor are they under the illusion that they can sell them without incurring a huge expense.  They rarely advertise them for sale in the newspaper.  Brokers shy away from them because of the potential liability of undisclosed defects and the fact that their low price creates low commissions.  So, owners are motivated to make creative deals.  They‘re easy targets for skilled negotiators.   

Owners may be easy, but there’s more to it than that:  A “fixer” must find the money to buy and rehab a fixer house; then be able to buy a target house at a price and with terms that will enable him to make a reasonable profit when it has been fixed up and sold. 

 

         Finding such a house is probably the hardest part of the process.  You have to do much more than simply ride around with a Broker looking at houses.  Broker’s don’t usually list el cheapo fixer houses.  The newspapers are full of houses for sale by owners who are still living in them, but, if they‘re still living in a house, the owners may not be motivated to make a buyer a good deal.  Once in a blue moon, a vacant house will be offered for sale by an out of town owner.  If the right things are wrong with it, this might be an opportunity; but it’s hard to make a living solely from out of town owners with vacant houses.  The following sequence is one that successful entrepreneurs have followed to be able to buy houses:

 

(1) First, line up financing to enable you to buy and fix a house when you find it. 

 

(2) Get mailing lists of out-of-town owners, single title holders, and delinquent property taxpayers and mail 500 letters per month to them. 

 

(3) Run several continuing advertisements in weekly newspapers and flyers offering quick cash for property in any condition, empty or full.

 

(4) Print up flyers offering to buy, trade, lease, or finance houses in any condition with cash up-front.  Leave them on cars in parking lots and on houses.

 

(5) Cultivate “bird dogs” — people such as news paper deliverers, Avon ladies, Lawn Care companies, postmen, UPS and FEDEX drivers, debit insurance salespeople, Brokers, etc. — who are in neighborhoods every day.  Offer to pay them $1000 per lead that you make a deal on.

 

(6) Walk decent neighborhoods.  Look for bad roofs, peeling paint, dying lawns and landscaping, etc. that hint at financial problems and potential opportunity for you.        

 

(7) Follow up on houses that are withdrawn from foreclosure to see if the owners are finally motivated to solve their financial problems by making you a good deal.

 

(8) Many times, Brokers might earn more money listing a house, but can’t wait for it to sell in the conventional real estate market; especially a house in need of repair.  Let Brokers know that you pay quick cash finders fees for deals before they’re listed or after they’ve gone off the market unsold. 

WHEN YOU PAY AND HOW YOU PAY DETERMINE PROFITS . . .

 

          There’s no point in building an apparatus to find houses to buy unless you can find the money with which to buy.  You’ve also got to be able to sell them to someone else who can find the money with which to buy them.  There seems to be very little creative financing involved in today’s fixer-scene because lenders are lining up to provide financing.  Until easy financing dries up, the fixer/flipper business boils down to being able to buy low and sell high; but trouble could be coming. 

 

          For those who have only been buying and selling houses for the past ten years or so, it may seem far-fetched that mortgage money could become very expensive and/or be unavailable to those who need loans in order to buy a house; but it has happened, and will again sooner or later.  But, if the time comes when lenders clamp down and there are no institutional loans available — or that “seasoning” requirements have become so stringent that is impossible to sell a house — it could create a cash bind that might drive a lot of people out of business.  

 

           If you start now to learn how to buy and sell creatively without the need for conventional loans, you could be the only game in town during hard times.  Let’s look at five basic ways to buy, fix, and sell without the need for a bank loan:

 

1.  Lease a “fixer” “where is, as is” for up to five years with an Option to buy at today’s value.  Have the lease specify that you will not occupy the premises until it meets minimum housing standards, but include a provision that allows you to do as much rehabilitation as you are willing to pay for.  Once you get the property fixed up, sell it and use your buyer’s money to exercise the Option.  Alternatively, create a monthly income by “Sandwich Leasing” it to a sub-lessee who will pay more rent for your fixed up house than you have to pay to the owner on your own lease.           

 

2.  Do all of the above, but move into the house as your principal residence soon as you can while you keep on fixing it up.  After two years, sell it and take out all profit tax free.  If your lease requires you to pay taxes, insurance, and mortgage payments, you have a de facto installment purchase contract which qualifies for the residence exemption under IRC Section 121.

 

3.  Buy a mortgaged property using a Single Payment Note secured by a Wrap-Around Mortgage or All Inclusive Deed of Trust.  This way you can make the underlying P.I.T.I. loan payments in lieu of paying the owner anything.  Payment relief is a strong argument for the seller extending you credit until the house can be fixed up and sold.  In the meantime, as you improve the house using your own money, the seller’s security is increased commensurately.  From your standpoint, not having to use up your cash to buy the house will enable you to work on more than one house at a time, and could result in far greater profit over a year’s time.

 

4.  Joint venture a fixer project by splitting the profits with someone who has enough money to buy the house and pay for the repairs.  Who might this be?  Almost anybody with money in a retirement plan.  The plan would lend you the money on a Note that would incorporate terms that give the lender the right to share in any profits when the house is sold.

 

5.  Do the above, but, continue to hold the property for income and appreciation.  The investor would swap his loan for i.e. half the equity in the house, and you would get the other half in return for the time and effort invested.  If you are going to do this, it’s much more tax-efficient for you to borrow half of the money needed to buy and fix the house, then invest this money along with the investor’s funds to buy the house so that each of you own one half of it from day one.  You might offer free management services in return for an interest free loan from the investor.  When you sell, your profit will be taxed as long term capital gain.  You might avoid all gains taxes by exchanging your profit into another house.

 

           In each of the foregoing techniques, you would be using your skills to leverage into a fixer house without the need for very much cash or credit.     

LEARN WHEN TO FIX, FLIP, OR FORECLOSE . . .

 

          A lot of people think that they can garden, cut hair, and fix-up houses.  Usually, they can’t.  Fixers have to know a lot about repairing, removing, and replacing major elements of a house quickly and at a low cost.  It’s easy to bite off more than you can chew once you start turning an ugly house into a home that a buyer would like to live in.  You have to know what to do, and what not to do.  You have to cultivate sources of labor and materials.  You have to know the requirements of various governmental offices that control zoning, land use, building permits, etc.  This is something you can learn, but it consumes a lot of time and effort

 

          With a bunch of pals, I started my on-the-job training as a “fixer” by working for free to help a friend build a house from the ground up; or more accurately from below the ground up.  By hand, under the critical surveillance of the new owner, I excavated not only the foundation, but also the well and septic tank.  I mixed cement, laid block, hand-cut rafters and joists, nailed on the roof, set doors and windows, hooked up wiring and plumbing and laid tile.  Miraculously, when we finally got the house finished after a couple of months, everything worked.   

 

          You might not want to go to as much trouble to learn how to do things, but it’s not a bad idea to start watching the “how to” shows on TV and reading books that deal with construction and home repair.  Home Depot and Lowes both offer home repair classes that will teach you how to do a lot of things.  Learning how to do things is only half the battle, you’ve also got to learn how to hire people to do things you don’t know how to do.  And,  you’ve got to find out how much materials and appliances cost, where to buy them at the best price, and how they can be financed.  Using a credit card to pay for things is a bad idea unless you will be able to pay off your balance within a month or so.  Even then, it’s a good idea to shop for a credit card that charges a low interest rate on the unpaid balance.  This way, by the time interest starts to accrue, you can pay it off and start over again.

 

          I found that fixing houses wasn’t as lucrative to me as buying and selling houses that didn’t need much fix-up.  I specialized in fixing up the financing rather than the property itself.  Many houses can be bought with very little cash from owners who have loaded them up with high interest rate debt, then find they can’t make their payments.  For some reason or other, many of those who are foreclosed could have easily sold their houses and paid off their mortgage with cash to spare, but they delayed doing anything because of their emotional attachment to their home and blind faith that someone would come to the rescue.  I’ve bought a lot of houses by buying the house with a zero-interest short-term Note, after which I brought payments current, and sold the house with only minor cosmetic refurbishment

 

          For many people, being able to remain in their home a little longer until the school year ends, or a new job can be found is a valuable bargaining chip for a buyer when negotiating a purchase.  With larger equities, I found it easier to make deals by dividing the equity with the homeowner and allowing families to stay in the house as long as possible while I readied it for sale.  In any event, my only investment boiled down to making up late payments and paying for renovation.  My profit was made by negotiation instead of by fixing up the house.    

 

          Buying a defaulted Note at discount, then being paid off at a foreclosure sale is a way to make money without fixing up a fixer property.  One frustrated out of town lender’s borrower had quit making payments and had left town.  The lender didn’t want to go to the trouble of foreclosing.  He sold his loan for the unpaid balance as of the last payment that he had received a dozen years earlier.  It cost $15,000 cash, totally disregarding years of accrued interestWhen interest was added back in, over $120,000 was owed.  The title holder couldn‘t be located.  Because the house needed extensive repair, in lieu of fixing the house up, it was foreclosed.  At sale, eager-beavers bid the price up to $95,000 which was given to the Note holder.  The buyer got a good deal, but the Note holder got a better one.     

 

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