You Did What with New Construction???

In my last post, I talked about the purchase of my first house ever.   It was a townhouse near Washington, D.C., and I paid $280k for it.

I thought I paid way too much and was sure I’d just made the worst decision of my life!!!

About a year later, similar townhouses were selling for $400k+.

HELL YEAH!!!!!!!

I’m Rich! (on Money) 

I tried to buy a second home, and repeat my success with the first.

Just couldn’t find a good enough deal!

The market was so hot, everything was snatched up for absurdly high prices (this is around 2005, the peak of the housing bubble)

I heard others were getting rich with a easy method that didn’t tie up too much money and was sureproof in this rising market!

Eventually, I decided flipping new construction was the way to go.

Keep in mind, at this point in my life, I had never flipped a house, let alone new construction.

       So how do you flip new construction, Rich??

Easy.

You go to a sales trailer on an empty plot of land that is destined to have several hundred new homes in a year or so.

sales trailer

You buy a house, or townhouse in our case, before it’s built for an agreed price and small down payment, and then need to come up with the rest of the money when the house is completed a year or so later (this can be done with a mortgage).

Keep in mind, it’s not just your house that isn’t built yet, sometimes no construction on any houses has started when you buy.

The idea is, between the time you lock in the price at contract signing, and the time the house is finished a year or so later, the house has skyrocketed in value!

SCORE!!

Then you sell it to some poor shmuck for it’s new, much higher price. You can still sell it as a brand new house because NO ONE HAS EVER LIVED THERE!!!!

You never even step foot in the house yourself.

HELL YEAH!!!

One of the best parts was my wife got to pick what options she wanted in the house. We knew we weren’t going to live there, but it was still fun to pretend. We had one of the first end units in the tract of homes, and while we didn’t go crazy with options, it was fun to make decisions about how the house would look.

We thought about totally pimping it out, but decide to pull back, in case things didn’t work out and it became a rental. (This was prophetic)

Things rarely goes as planned. Always plan for the worst-case scenario.

Rich on Money

I had the eighth house in a tract of several hundred to be built.

As the first seven neared completion, I found something that surprised and greatly concerned me.

Apparently, I wasn’t the only person in the world who knew you could become rich by flipping new construction. Seven of the seven houses before me all had for sale signs and so did those after mine.

No one who bought the new construction was actually planning on living there!!!  Everyone was flipping like me!

       Wow, everybody is as smart as I am!

        Maybe we’ll all be rich together!!!

To put icing on the cake, no one was buying, and prices were coming down to break-even numbers.

WTF???

This is 2005. Houses have been skyrocketing since 2001. There were probably some very lucky people who decided to flip new construction back in 2001.

In 2002, they may have pocketed $50-$75k in profit when the houses were ready.

They probably said:

       Wow! That was easy!!! I’m going to do this again and keep making money.

They would have been very successful in 2002, 2003, and 2004.

But 2005?!??!?!

       Whoever did it in 2005 or 2006 was a total dumbass!!!!!!!

       Ok, maybe not a dumbass, but a shitty investor!!!!!!

or

It was luck, stupid.

And yours ran out.

No one can time the market, but someone will charge you to believe they can.

RoM

       Hey, my realtor said the market will keep going up!?!!?!?

       He said the market is so hot, he can’t sell houses fast enough!!

I got nervous that I wouldn’t sell the house for break even, so decided I better try to sell it AND rent it at the same time, and see which one happened first.

This was a common practice as the real estate bubble crashed.

I didn’t get any takers for renting it out, until one day I got an offer for way over my asking rent.

HELL YEAH!!!

They explained that they were Section 8, and had 8 kids (weird coincidence?) and there would be a government-guaranteed rent check every month.

HELL YEAH AGAIN!!!

Thanks Uncle Sam!

Section 8 is a government program for private landlords to rent to qualified low-income tenants.

Eight kids? It was a 4-bedroom, might be a little tight.

I wasn’t totally comfortable with this. Seems too good to be true.

I had her come over to the house and chatted with her.

She spent a long time trying to convince me she would take great care of the house. I had a bad feeling about it. I decided to go with my gut.

Ultimately, this family was not for me.

Some real estate investors do very well with Section 8 and focus on it exclusively.  Not me.

RoM

       So renting’s not working out. I better sell this damn house!

Realtor-Mateus-Realty

For selling, I used the same real estate agent that helped me find my townhouse in DC (The retired Army Colonel). He had this great idea to let this new guy he was training handle my case, and he could supervise.

I fired him.

From my perspective, he got lazy and tried to pawn off some inexperienced kid on me. Three percent of the purchase price is too high of a price to pay for letting some pimple-faced newbie get some experience.

$500,000 * 3% = $15,000 commission to my real estate agent just for being around for closing and answering a few questions. Nice for almost no work. Sign me up!

Paying the commission did not add to the sales price of the house. It was paid out of a separate pot of money the new construction company had.

Top of the market, and I’m stuck with new construction in a development with every house going up for sale as soon as finished.

Time to harness the power of a good real estate agent:

  •        A skilled real estate agent was probably going to save my ass.
  •        A crappy one would cost me thousands, if not tens of thousands.

Demand high experience, a track record of success, and great service from your real estate agent. They are making a fortune off of you. Make them earn it. When they are good, they are worth their weight in gold.

RoM

Got a new real estate agent. He had a long track record of success, and he was grooming his son to take over the family business. He suggested I offer a $5000 selling bonus to the real estate agent that brought me a buyer. My townhouse sold first in the neighborhood, and I got out of the deal with about $10k in my pocket.

SCORE!

I’ll take it!

I was happy to come out of that deal with anything! I’m lucky I didn’t lose my ass!!!

I had long abandoned the dream of making $100k in a year like I did on my last house.

I was the only person to do better than break-even in that tract of homes. Eventually, that neighborhood was full of brand-new townhomes in foreclosure.

The house next door to me was bought for $550k. It went into foreclosure and sold for $285k.

One of the houses in our neighborhood sold in $2008 for $221k.

          So I’m a brilliant real estate investor again, right?

Wrong.

There was some luck involved.   I had one of the first houses in the development.  Being one of the first houses available made it easier to sell.  So did having an end unit.

What if I would have had one of the last houses available? OUCH.

But yes, I made a few good moves:

  • Having a good real estate agent
  • Offering the $5k bonus to the buyers agent
  • Not renting it out to Section 8 (I don’t think that would’ve worked out)
  • Not renting it out for a huge loss each month (which happens all the time in D.C.)

I was witnessing the actual bubble bursting, but it was impossible to realize at the time.

I got out just a few months before people realized the tide was changing. I will say that my real estate agent was crucial in surviving this.

He was worth his large commission. It’s up to you to make sure your real estate agent earns his/her commission. Don’t just give that money away to sub-standard service like many do!!

I made $100k quick on the purchase of my first property (on paper anyway), and I made a quick $10k on new construction, but the market was starting to feel a little squirrelly (again, we didn’t know it was top of the market, they weren’t running those news stories yet).

I need a moral of the story for this post:

You make money in real estate when you buy a house that will cash-flow well. When your investment strategy involves counting on massive appreciation, you are doomed to fail. There are only brief periods of history when this happens, and nobody knows when those periods are until they’ve past.

RoM

We moved to Monterey, CA for my next assignment (3 years as a graduate student with full salary!)

       Thanks Uncle Sam!

What a gorgeous place!!

pacific-grove

Just like a drug addict, I went and found a real estate agent in Cali. She had me convinced prices would just keep going up and up, and I’d be filthy rich.

       I’m glad she’s looking out for my best interests!

I found a small 2-bedroom near the ocean for $900k. All I needed was $180k for a down payment.

       It’d be worth a milly-and-a -half in no-time!!!!

I’m glad I couldn’t come up with the down payment.   I’m also glad I didn’t fall for no money down, 5/1 Arm, or interest-only loans. Those were all the rave back then.

A few years later, the house I almost bought would be worth $500k.

Looks like I live to fight another day. There were military members I knew who bought more reasonable houses in suburbs of Monterey at the peak of the market. Two years later, the houses were worth half.

That could’ve been me.

What about my townhouse in DC? I rented it out now that I lived on the other side of the country. It rented for $2000, and my mortgage was about $1600 and change. HOA was only about $300 a year, but taxes were about $3000 a year.

Nothing to write home about.

My rent would not climb much higher than this in future years (But property taxes sure did!). It doesn’t pay to rent that type of property in the DC area.  Not a good rental.

I only had about a 5% return on investment per year

And that was once the mortgage was paid off!

When I had the mortgage, I was losing money on the rental.

          And how many people can afford to pay mortgages off in D.C.?!?!?!?

I eventually realized I can do MUUUUCCCCCHHHHH better in a different part of the country buying rental properties.

But that’s a story for another day…

Rich on Money

How have things been for you flipping houses?  Leave a comment or send an email.

My next flipping houses post.

Want to understand what this blog is about?  Read my entire financial life so far on my first post.

My Wife Knows Money

 

 

 

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4 Comments

  1. REP

    Good blog, keep the posts coming!
    I appreciate your perspectives on real estate and mortgaged property; i hope you have more posts brewing on the topic.
    I don’t know that i completely agree with paying off a mortgage extremely early, but i realize everyone’s situation is unique and it’s worth re-investigating how i allocate my time and resources!

    • rich

      Rich!

      I’ve got a post on my first flip nearly done (not the new construction flip, but a normal flip), and also a post where I review Jim Collin’s new book.

      I’m somebody who despises debt, but loves real estate investing. I’ve found a way to make that work. I’ll spend more time in future posts talking about why I feel no debt real estate investing is the way to go. I love how safe it is, and how the rent from your house almost all goes to your pocket! No mortgage payments with interest and PMI cutting into profits. When I have large repairs to make or if I deal with bouts of vacancies, it’s far less painful with no mortgage to worry about. Highly leveraged investors can be wiped out by spouts of bad luck!

      • REP

        all of those reasons make sense for investment property. I don’t know that i agree with paying down a low interest mortgage early on a primary, occupied residence. I view it low on a list of priorities in allocating limited resources.

        • rich

          Fair enough. I’m a no-debt guy. No debt on primary residence, and no-debt on rental properties. I love it. I love the freedom of knowing and saying I have no debt of any kind. I don’t need to be leveraged to make good money. I seriously doubt I’ll ever buy a primary residence again. Renting is the way to go for where i live. And cash is the way to go for my investment properties. For me, there is no such thing as good debt.

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