This post will describe my first house flip.
First a review of my background.
I’m Rich on Money.
- I paid off $32,000 in student loans in a year.
- Paid off our $280k mortgage in 6 years.
- Flipped several houses in Washington D.C. to help me build income for real estate investing.
- Have purchased several rental properties without using debt.
Back to my flip.
I was scared to death about it!!
But it made me some money.
How did you get so flippin’ Rich, Rich???
(Ok, I’m not Rich. It’s a play on words!!)
Let’s review a little what I’ve done so far.
I’m in the military. From 2003-2005, I lived near Washington, D.C.
While I was working there, we were able to purchase our first home. It was nerve-wracking for us. This is the subject of my fourth blog post:
The purchase of that house worked out well for us. It shot in value from $280k in 2003 when I bought it, to $400k in 2005.
Some would say I am a smart investor who bought at the perfect time! Yay for me!!
Maybe I should start a blog! (But I need a clever name)
I would say 2003 just happened to be when I bought my first house. It’s the first chance I had to buy. Chance being the key word.
If I would have bought a few years earlier, I would have made much, much more.
I wanted to, but I was stuck in Guam (small island in the middle of the Pacific).
If I would have bought three or four years later, I would have been screwed!!!!
The only way to know the perfect time to buy real estate is to wait until that time has passed. Also true of stocks.
Rich on Money
So I felt smart because of all the money I made on my first home.
I’m so cool!!
My second adventure into real estate was flipping new construction, the subject of my previous post.
Long story short.
About 80% of the people that bought that new construction when I did got foreclosed on.
The rest struggled with high payments on a property that nose-dived in value.
I lucked out and flipped the new construction with about $10k to show for it. I was just happy to get rid of the house. It could have easily been a negative flip.
That was flippin’ close!!!
I owe that success to having a good real estate agent.
Another reason we got out with a small profit was I had one of the first new townhouses in a project with several hundred. The market wasn’t flooded with inventory yet when mine went up for sale.
A couple of months later, everybody and their dog was trying to sell new construction in this neighborhood. Almost all of the buyers like me were flipping. Hardly any were planning on actually living there.
Prices plummeted, and life was not good for the rest of the sellers.
Coming off that close call, I continued looking for real estate deals. I almost bought in California, but couldn’t come up with a down payment on $900,000 (thank god!)
That would have ruined me, as that was THE PEAK of the housing bubble.
Now I was living in Japan, and eager to continue making money in real estate.
I came back to D.C. often for business. I would always have Mike, a real estate agent who was a neighbor in D.C., show me around and help me look for a rental property to buy
He decided to make me an offer I couldn’t refuse.
He explained that, due to the housing bubble burst, there were houses in our neighborhood that were in bad shape, and people were trying to sell.
If they sold for distressed prices, this would hurt housing value in our neighborhood. The people that bought these houses at distressed prices aren’t always the ideal people you want in your neighborhood.
They might not take good care of the houses and yards, and drag down the look of the neighborhood (and the property values).
If we bought the house as a team, pimped it out, and sold it, we would raise property values in our own neighborhood, and make money on the flip (ideally).
I had known Mike for several years, and liked him. He seemed knowledgeable and trustworthy.
BUT MAN WAS I NERVOUS ABOUT THIS!!!!!
I needed time to think about this. I was living half-a-world away, and had no experience in renovating houses for a flip.
Time to think about this carefully. Can we do this? How would we divide the risk and work?
Here is what I knew about Mike:
- He had been a successful real estate agent in our neighborhood for several years
- Well-respected in our neighborhood for giving advice on housing issues, included buying and selling
- Usually had a few real estate projects going on at any given time that involved some type of flip
- This means he had a lot of experience in remodeling houses
- And working with as well as supervising contractors and handymen
- Previously worked with Habitat for Humanity, where he built from scratch or remodeled houses that were ultimately given to the poor
- Extensive experience dealing with all aspects of construction and remodeling
I felt I had observed and known Mike and his family long enough to feel I could trust him.
But what did I bring to this deal?
Mike had several irons in the fire and was highly leveraged. He had a mortgage on his own property, and on several others. No banks were going to allow him to buy anything else. He also didn’t have much liquid cash.
- I paid off my primary residence two years prior, so I had increased my savings rate by quite a bit and had some money socked away
- I had enough money between cash and S&P500 index funds to make a 20% down payment on a house in our neighborhood
So Mike has the experience, know-how, and the connections, and I had the credit and the cash.
Now that’s a good team.
Maybe we can make his work.
What I could bring to the deal was the ability to buy the house in my name. I was able to tell the bank I had no debt (including primary residence) and perfect credit, so it was easy.
But there were other things to things to consider.
THE WORSE CASE SCENARIOS!!!
Some very strange things crossed my mind. I kept thinking there might be some way where I bought the house in my name, and when we sold, all the proceeds would go to him and he would disappear.
I was nervous. I wasn’t even in the same country, so I could not see any of the renovations that were happening.
Maybe Mike would tell me he remodeled the entire kitchen for $10,000, and all he did was paint the cabinets!!
I had no way to confirm any of the work he claimed he was doing.
If my trust in him turns out to be misplaced, it could be the most expensive mistake of my life!!!
I had to consider that the repairs he estimated for the flip could be too low due to some unforeseen problem. Maybe foundation issues, hidden water damage, or termite damage.
If the house was going to sell for a loss, I would have to make up the extra money myself when the sale closed. How could I be sure Mike would come up with his fair share. It was in my name, he could just walk away!!!
I brainstormed as many of the scenarios as I could, then had a long sit-down (actually Skype phone call) and talked through as much of it as I could.
After much negotiation, here is what we settled on:
- Buy the house in my name with a 20% down conventional mortgage
- Come up with the $60k+ down payment
- Oversee and pay for all renovations
- Make the monthly mortgage payments
- Act as the real estate agent for both the buy and sell (He gets the commissions)
- When (or if) the house sells, we both recover our own costs and then split profits 50/50
Mike had to spend a lot of time overseeing renovations, but was not putting as much money into it and was not risking his credit.
I spent less than 2 hours total filling out paperwork and signing documents, but spent more money and had my credit on the line.
Mike was able to provide me with detailed estimates that showed what he thought we would make depending on different scenarios of costs for renovations and sales price.
It all looked good and made sense to me, but to be quite honest, I really didn’t have the background to know if these numbers were even close. Also, I was in Japan and couldn’t even see the house we were buying or the progress being made on it.
He seemed to think we’d make a decent profit. He claimed it was possible to make $30k each on the deal.
I pulled the trigger. He already knew which house he was buying. It was someone he had known in the neighborhood for a long time.
Purchase Price: $295,000
My down payment (including closing costs): $63,746.97
Interest rate 30-year conventional loan 5.75%
Mortgage payment $1,739.41
But, hey Rich! What are the obstacles to making money on a flip?
There are several.
One thing I understood from reading enough books on flipping and thinking through the process is how hard it is to make money on a flip when you finance a house, and use an agent.
- You are going to make at least two mortgage payments, and in some cases six or more payments, before you sell the place (at $1,739 a month this time)
- Paying points at closing (explained further down)
- Commissions. 6% of your potential profit gets eaten up by this on both the buy and the sell ($16,000 on this deal, and that’s just the buy)
- Closing costs: Several thousand (my settlement charges were $4,500. Low due to negative points credit)
Sometime you have a buyer lined up, you wait a month to close, and they back out or don’t qualify at the last second.
Then, you start the process over of looking for a buyer. At this point, the house has been on the market longer, and the freshness is gone. This means a lower sales price. Also means a few more months of mortgage payments.
There was certainly a leap of faith involved.
So Rich, did you get a good interest rate?
I’m glad I asked that question.
I guess I did, but who cares!
When you are financing a flip, you don’t really care about the interest rate. In fact, it probably isn’t even that crucial to have 20% down, you could have less, or potentially no money down!
The interest rate affects your monthly mortgage payment. Since you only plan on making two or three of these payments, the rate matters very little. The difference might be a few hundred at most.
The best plan is to get the loan for the least out of pocket possible.
What does matter is points.
Points, also known as “discount points,” are fees paid directly to the lender at closing in exchange for a reduced interest rate.
Sometimes when you choose your loan, you will have the option of paying or not paying points. Paying for points at closing (purchase) could reduce your interest rate for the loan, but that doesn’t make any sense on a flip.
You want to spend as little money out of pocket as possible. A higher interest rate over two or three payments means almost nothing to your bottom line.
On this particular loan, I actually took a slightly higher interest rate for negative points. That meant, I got a $2,950 credit at closing for taking a higher rate. That’s $3k in profit before we even started!
That’s the way to go on a flip if you can!
If you can’t get negative points, just ask for no points.
Without this credit, my closing costs on this house would have been $7,500.
By the way, if the bank knew the purpose of your loan was to flip a house, they wouldn’t give it to you. They don’t make any money off you when you close the loan out in a few months.
They didn’t ask, so I didn’t say.
You better make sure there isn’t a pre-payment penalty on the loan, pre-paying is the whole point of a flip!!
Rich, This is a long post. Get to the point and shut the hell up!
We sold about three months after closing. It was a smooth flip. No major issues, found a buyer fairly quickly and…
GOT A SALES PRICE WE WERE HAPPY WITH!!!!!
Here it goes…
Sales Price: $405,000 with a $9,517 closing credit
Rich, what does that mean???
The seller allows a portion of the sales price to go to the buyer to offset his closing costs charges.
Essentially, the seller is getting that much less money for the house. Another way to think of it is that you are actually selling the house for the sales price minus the credit.
It’s a way of enticing a seller to purchase your house.
$405,000 – $9,517 = $395,483 we walk away with
The official “sales price” on record is still $405,000. Just some creative accounting.
Mike got his half of the leftover profits.
For two hours of work on my part.
So that means I made $8,454 per hour
Wow! That’s like CEO pay!!!
So Rich, what do you always do when you are successful on a real estate deal?
Try the same flippin’ thing again!!!!!
Is it going to keep working? Click here to find out.
If it does, we’ll be rollin’ in it!!!!!
Rich on Money
First time reading my blog? See my method for accumulating 20 rental properties debt free. Check out my Complete Guide to Real Estate Investing.