Unfortunately, now is NOT the time to start flipping homes.  The market is very fickle right now.  One week the market is hot, the next it is cold.  As I write this, it is very cold.  All of my flip customers have houses that are sitting and most of these customers are experienced rehabbers.

You don’t want to be holding a property for months waiting for a buyer, all the while the interest is eating up your profit.  Wait until the market firms up, then call me and we will take a shot at teaching you how to rehab and sell homes.

One speed bump in the sale of these newly rehabbed houses to the end buyer has always been that if the buyer is using FHA financing, (with certain exceptions) FHA currently prohibits insuring a mortgage on a home owned by the seller for less than 90 days.  With many of these rehabs taking 60 days or less, this can mean that you must lose an additional 30 days of interest while you wait with the property empty until the 90 day mark.  The loan process can not even begin (and the purchase agreement can not be dated) until day 91.

Many of the rehabbers were unwilling to wait the 90 days to resell to anyone with FHA financing. HUD realized that this restriction was shutting FHA buyers out from newly renovated homes, many of which were priced for first time home buyers. This week HUD announced a temporary waiver that removes this restriction.  The policy change will permit buyers to use FHA-insured financing to purchase HUD-owned properties, bank-owned properties, or properties resold through private sales. This will allow homes to resell as quickly as possible, helping to stabilize real estate prices and to revitalize neighborhoods and communities.

The waiver will take effect on February 1, 2010 and is effective for 1 year, unless otherwise extended or withdrawn.  This is good news for everyone.

It has been a while since I wrote about Flipping houses. Unlike many Realtor blogs, you will never see posts about “my new listing”. This blog is for you: The new or seasoned real estate investor. I thought it would be interesting to show you one of these North Minneapolis rehab projects.

Background

Just like other areas of the country, Minneapolis has been hit hard by foreclosures. In my opinion, North Minneapolis has been hit worse than other areas with some streets having 5-10 REO (bank-owned) properties on them. These large numbers of REOs are driving down the REO house prices in these areas dramatically. Houses that sold for $150-$175k a couple years ago are now vacant and selling for $30-$50k. Most of them have had their copper stolen and all need some work (but that work varies from simple paint and carpet to something short of a tear-down).

This situation has created a unique opportunity for real estate investors to profit from this glut of bank-owned properties. Most investors are buying low, fixing up the property and unlike a traditional flip: renting it out, and expecting to wait 3-5 years to cash out.

Search Process/Criteria

You would think that with the sheer volume of REO properties on the market in Minneapolis, it would be easy to find a property to buy, but we are searching for just the right combination. Here is what we are looking for (in order of priority):

1. Total cost of project including: acquisition, holding, rehab, and overhead costs < $95k
2. ARV (after repaired value) = $125k or greater
3. Decent floor plan/layout
4. Close to properties of our other real estate investor friends.

That’s it. Note that I did not say anything about size, bedrooms, bathrooms, garage, basement, etc. Number 4 is simply to have someone to ask “what’s the neighborhood like”? Ultimately, if we hit #1 & #2, everything else does not matter. In fact, even a 1 bedroom house finished at $95k with $850 per month rent will cash flow!

North Minneapolis Rehab Example

Mr & Mrs Customer G purchased a 1.5 story single family house on 33xx Girard Ave N for $35k. This was a very typical North Minneapolis rehab. It needed new windows, new bathroom, new flooring, all new plumbing, plus new paint throughout (and other miscellaneous items). Fortunately, the kitchen only needed new counters and appliances, saving about $3000 in cabinets. The total renovation costs were $41k bringing the total project including closing and holding costs to about $80k. Best of all, the property was filled by the general contractor/property management group with a tenant that signed a 2 year lease and will cash flow about $400 per month. The property had a final appraisal of $159k, giving the buyer less than a 50% LTV ratio.

 

See some of the before & after pictures here:

What an outstanding deal! The buyer has a completely renovated property, fully rented for 2 years with decent cash flow and a mortgage for only 50% of the value. Keep in mind that this was a turn-key rehab. The buyers bought the house and 6 weeks later the contractor had renovated and rented the property. The buyers only took their down payment and closing costs out of their pocket (in fact-talk to me about how you can get your down payment back).

There are many similar opportunities out there right now. Contact me for more information.

About 5 days ago, I was out with a customer looking at bank-owned properties in Minneapolis. We looked at about 15 houses and found 3 properties that looked like good candidates to “flip and hold” (rehab and rent). Our contractor was with us reviewing the houses and preparing estimates. Most of these investment properties required $30-40k worth of work, including bathrooms, kitchens, plumbing, windows, and general repairs. The three finalist REO properties were priced under $50k.

Both my customer and I were excited about Investment Property #1. It was a large 4 bedroom house (in Minneapolis) with beautiful hardwood floors throughout, large pictures windows on each side of the house, original dark woodwork, and the leaded glass windows were intact. After discussing the type of flip we wanted to do on each property, I was crushed when our contractor told us Investment Property #1 was the worst rehab deal of the three.

As we went through his estimate, I agreed with all his numbers and rehab suggestions. Despite being almost move-in ready cosmetically, the house needed 20 windows @ $400 each, all new plumbing @ $8000, the heating system reconnected @ $2500, new kitchen @ $4000, etc.

I forgot all my school of hard knocks training, my years of experience with flips and rehabs, and all my preaching to my customers to analyze the property’s financial numbers. I tried to argue with him about the value of the neighborhood, the number of bedrooms, the size of the backyard, the fact that it was a 1/2 block from the school, etc. Despite my best efforts, he whipped me back into reality like a freshman on the school yard with the following comment: “I don’t get emotional about properties, its all about the numbers”. Ouch! I was hearing my own words coming back to haunt me.

So here I sit licking my [ego] wounds. He is right, though. You must stay unemotional when analyzing investment properties. You can get excited about them when the numbers check out and you put in the offer. Analyze the numbers, use conservative estimates, get good quality bids from trusted contractors, and if necessary, bounce the deal off a trusted advisor. When you fall in love with a house, it make it difficult to stop thinking about it (even when it is wrong for you)! Staying emotionally detached will allow you to walk away from a property or deal when it doesn’t make sense.

There are properties available in decent neighborhoods that have simply been neglected for years and with the stigma of North Minneapolis, have been on the market for a long time.  Most of these are 2-3 bedroom, 1 bath houses with 2 car garages.  Some have hardwood floors and they were built in the 1930s-1950s.

Assuming you will need to do full kitchen and bath remodels and some other significant repair such as a roof, windows, or furnace, let’s run the numbers on how a $30,000 house may flip:

Purchase Price:	$30,000
Closing Costs:	$1,000
Repair Costs:	$30,000
Total Cost:	$61,000

Many of these house are then appraising for $90k-110k.  Truthfully, they are difficult to sell [today] because of the glut of properties in North Minneapolis and the apprehension of many to buy in North.  We do expect a turn around in a several years.

These are perfect properties to buy, fix up and put in your portfolio (“flip and hold”).  Most investors will take out 90% loans on the properties, potentially pulling out $10-20k (more than they put in for a down payment!).  With a 90% LTV loan on $90k ($81k loan value at 7.5%, 30 year conventional), your monthly loan payment (before PMI) is going to be:  $563.  Add in PMI, water/sewer/garbage, taxes, insurance and you have a monthly cost of approximately $675.

Prospective tenants are very excited to lease these newly remodelled single family houses.  This allows you, as a landlord, to be very picky on who you rent to.  Most of these tenants are paying $1000 for a 2 bedroom and $1200+ for a 3 bedroom.  Your cash flow is $300-500 per month!  And because the property was just completely renovated, your annual repair bills are very low.

These deals can be arranged in many ways with you participating by doing the flip or letting our seasoned investors do it for you.  We even have a very successful property management company that can take the day to day part of being a landlord off your plate.  If you may be interested in an opportunity like this, I encourage you to contact me so we can discuss it further.

• Prospecting-The following tools will generate leads on potential houses to flip.  Once you generate the lead, use the county’s on-line property tax system to find the owner.  Call them or send them a letter asking if they are interested in selling and that you can close quickly.
  • Use the MLS or a realtor to find properties that are below the average price range for your target neighborhood.  Although it is not a perfect statistic, use a price per square foot as a rough way to find leads on properties.  Also, look for keywords in the listings that say:  needs TLC, fixer-upper, As-Is.  Additionally, review properties that have been on the market for an extended period of time.
  • Drive or walk around your target neighborhood.  Look for houses that have uncut grass or are vacant and/or boarded up.  Properties that also appears to need exterior work may be leads.
  • Sometimes desperate sellers will attempt to sell the property themselves first, before using a Realtor.  Check the classifieds in the local paper and Craig’s List for your area.
  • Check the foreclosures listings in the newspaper.  I do not recommend buying the property at the sheriff sale, but  contact the sellers to see if you can help them out of a bad situation.  Otherwise, simply make a note of what properties are going into foreclosure and watch for them to become available (probably on the MLS).
• Advertising can be an effective technique to generate qualified leads as people are calling you to discuss their property/situation.  Small “bandit” signs at intersections and boulevards is a highly effective technique that many national firms use.  You can also create letters or post cards and mail them to your target neighborhoods calling the recipient to call you if they need to get out of their house quickly.
• Networking involves connecting with as many people that you can find that many have knowledge of a lead on a house that needs to be rehab’ed.  These may include Realtors, contractors, neighborhood residents, and other investors.  One great source is to connect yourself with attorneys that handle estates.  Often the family members are not interested in going through the process of selling or fixing up their relative’s home and just want it taken off their hands.  Many times these will be homes that have been neglected for years by an aging owner.

Even once you start your first flip, do not turn off your lead generation process.  If you intend on continuing to do house flips, you will want to always have leads in your pipeline.  The above techniques will not only generate property leads, they should also help you understand your target neighborhood better.

Here are some examples:

• 30xx 3rd Ave South, Minneapolis, $324,000.  4-plex building, each unit has 3 bedrooms, 1 bath.  It has updated kitchens, hardwood floors and bathrooms.  All utilities are separated with newer furnaces and water heaters.  This building should cash flow over $1500/month for a well qualified borrower!
• 27xx Blaisdell Ave South, Minneapolis, $499,000.  7-unit building.  Most units have 1 bedroom, 1 bath.  It has been exceptionally well maintained building by a caretaker that has lived there for 14 years!  Even with owner-paid heat, this property cash flows almost $1000 per month.
• 36xx Elliot Ave South, Minneapolis, $300,000.  4 unit building that is currently bank-owned and vacant.  It needs light renovation, but could be a gem as it has 2 bedroom units and all utilities are paid by tenants (4 boilers).  Once repaired and rented, it could generate over $1100 per month.

These are just a couple of the outstanding opportunities in the investment property market right now.  Don’t wait, call me now and discuss how you can get started.

1. Hard money lender-These are individuals in the market that finance investors/rehabbers for short periods of time (less than 1 year and typically for 6 months) for higher than bank’s interest rates or a large percentage of the flipping profit. They will generally take a creditor position against the property to protect their investment. Your closing costs will be lower as their is no bank involved to charge fees. If you chose to hold the property, you will replace the hard money lender with a traditional mortgage.  They can also make a great advisor for your first house flip.
2. Construction loan-This is generally the best was to finance your flip to secure as you should be able to borrow not only the initial purchase amount, but much of the rehab costs also. Often you will need to contribute 5-10% of your own money and can then borrow 80-90% of the repaired value of the property. This method is typically easy to convert to traditional financing if you chose to hold the property. The initial construction loan also traditionally has lower closing costs.
3. Traditional loan with flipper infusing cash-Many first-time flippers will make the mistake of using a traditional financing product to purchase the property. They will then spend their own money to fix up the house, waiting till it sells to recoup their cash investment. This method requires the flipper to have all the necessary funds available up front to not only rehab the property but to also hold it during the sales process. Then, if you decide to hold the property, you will no choice but to refinance to pull your cash out to continue doing other flips.

There are many other complex and interesting ways to finance your flip which are beyond a short blog post, such as: self-directed IRAs, credit cards (yes, many people do it!), limited partnerships, and borrowing against the cash value of your life insurance.

Researching your different options for financing your flip in advance will make this process much smoother and should help you put more money in your pocket.

To be successful at flipping houses, there is a considerable amount of prep work that you need to complete before you ever begin to make offers on houses.  You should be able to answer the following questions with confidence: 

1. Do you know what type of flip you are going to do?  Read my August 27 article:  “What type of Flip are you doing”.  The type of flip will determine how much prep work you need to get done.
2. How are you handling the financing for the initial purchase of the property as well as the renovation expenses?  Do you have an emergency reserve, in case the house needs an unexpected and/or expensive repair or it takes longer than anticipated to sell?  If you are planning to do a “Flip and Hold”, your financing should be slightly different to allow you to recoup your renovation costs and roll them into permanent (and possibly less expensive) financing.
3. Have you researched various neighborhoods and do you understand what price range is selling (and which is not) in your target neighborhood?  You know that you are ready on this point when you can walk up to a house for sale and name the price before looking at the Realtor flyer or on the MLS.  Your flip profit and your on market sale time are dependent upon you very accurately understanding the price range you are targeting with your completed flip.
4. Have you interviewed various contractors that you may need for the various phases of the project such as:  plumbers, electricians, carpenters, landscapers, etc?  Are they available to start when you need them?  Do they know they would be working on a flip (I have found some contractors that hate working on renovations).  Do you have back-up contractors in case your first choice is not available or does not show up?
5. If you are planning to do most of the work yourself, have you mapped out the project time-line and overlaid that with your availability?  If you are not working on the house, it is sitting idle, and the interest clock is running on your loans.  Do you have buy-in from your significant other that you can spend that amount of time working on the flip?!
6. Do you know how much new cabinets generally cost or what a new tile floor costs per square foot for the tile you want?  How about any of the other materials you will be installing?  Although each flip is different, if you  understand what price range you are targeting and what type of flip you are doing prior to finding the house, you should be able to do some early materials selection.  This will help you when you prepare your budget when putting your offer together on a prospective flip.  (It is also easier to be prepared with all those selections now instead of making them in a rush once you are in the middle of the flip.)
7. How are you planning to sell the completed property?  If you are using a Realtor, have you identified him/her?  If so, plan to include them in the property selection, the scope of the renovations, and material selection.  If s/he has to sell it, make sure the Realtor is confident in the price, materials, and property.  If you are selling it on your own, what are you doing to market the property once it is completed to generate interest?

The answers to most of these questions are not difficult.  You would need to have answers to all of them eventually, so why not take the time up front to do the research and make the best possible decisions you can?

As you begin to work on deals for your flips, you will find that every flip will fall into one of the three categories:

• Paint and clean
• Bath and kitchen rehab
• Major renovation

These are NOT concrete categories, as often a flip will involve some of all three categories, but generally it will fall into one of these categories overall.  Here are the definitions:

• Flip #1-Paint and clean-You are not looked at any differently if you admit you do this type of flip!  It is probably the lowest capital requirement and lowest risk, but also possibly the lowest amount of income potential.  This type of flip has a low degree of difficultly and is very good for new flippers that are going to do most of the work themselves (almost anyone can learn to paint in a short amount of time and hopefully you already know how to clean!).  Because of the lower income potential, the key to the success of this flip is to do the work as fast as possible.  These are also good candidates for “flip and holds” (as I like to call them) as you should be able to quickly begin to rent them out and generate cash flow (possibly even before you first mortgage payment is due).
• Flip #2-Bath and kitchen rehab-Often these flips are not totally confined to the bath and kitchen, but they generally do not include significant wall removal, installation, or any structural changes.  They will normally include a paint and clean of the entire property also.  These flips can produce high income, but require less risk and capital than a major renovation as you may not be moving walls and adding square footage.  The key to success with these flips is to minimize the lead times on cabinets and have a standard “package” of materials (cabinets, flooring, counters, etc) that you use repeatedly and become familiar with and know that they appeal to your buyers.  The level of difficulty is moderate with this type of flip and will require the use of professionals for plumbing and electrical at a minimum.
• Flip #3-Major renovation-These are renovations that add square footage, change the floor plan significantly, or repair/replace a major part of the property.  These include additions, finishing basements or attics, moving walls (including load bearing walls) to open a room or add more space from one room to another.  This type of flip has a high degree of complexity, risk, and capital requirement.  It should be undertaken by individuals that have experience (or access to someone with experience) in framing and general contracting.  The key to success is to have an accurate understanding of everything that must be done and when to coordinate this complex project.  Often new flippers will take on a project of this size in their spare time and weekends, only to find themselves overwhelmed, over budget, and over schedule.

When considering getting into flipping, it is important to be realistic in assessing your capabilities, the capital requirements of the project, the time commitments, and risk.  It is always better to start small or easier and graduate to larger and more complex projects.