In Part I of my article “Making Money on Vacant Real Estate Properties”, I discussed how you could find vacant real estate properties, gather valuable information, and then negotiate a good price. In Part II of my article, I discuss how you can best close the sale on your vacant property, successfully refurbish it, and then either sell or rent it.
Buying a real estate property for income generation is not like buying the house in which you live. There are several issues to consider, namely, cost of ownership, profit potential, and taxes.
Consider that, unlike the home in which you live, your income-generator is going to stand vacant for some time until it is fixed up and ready to either rent or sell. Those months of vacancy are going to cost you money in terms of mortgage, utility, insurance, and tax payments. Therefore, you don’t want to get a house where the repairs are so extensive that it takes years for the house to become saleable. Likewise, you don’t want to buy a house if you cannot afford to spend a significant amount of time on its repair.
Another thing to consider is how you plan to pay for the property. Unless you have cash on hand, you will need to refinance your current home or obtain a bank loan. While interest rates are low at the moment, banks have become leery of lending to people with less than stellar credit. Consider your credit history and your current ability to pay interest on a loan that might span a year or more- will you still be able to make the payments in the event of possible sickness or unemployment?
Many new real estate investors get in a lot of trouble when it comes time to estimate the profit potential of the purchased property. Vacant properties have been kept in a state of abandonment and disrepair, and even a generous estimate of rehabilitation costs may not account for the surprise discovery of extensive required repairs. This is why you need a profit window of at least 40% (some say 65%) when calculating the ARV (after repair value) of the property minus its repair, purchase, closing, mortgage, and other costs. Any smaller of a profit window could mean that you will walk away from the sale of your property completely even (or in debt).
Finally, take into account the amount in taxes that you will be charged for the future sale of the house. Depending on the state or province in which you live and where the house is sold, you will be charged a certain amount of capital gains tax. If you decide to “flip” your property (buying and selling a property in less than a year), capital gains taxes may be even higher. Some real estate investors work around this issue by forming a limited liability company (LLC) and charging their costs and taxes to the company. This usually reduces their tax liability if profits remain below a certain threshold.
Vacant real estate properties will typically require up to $20,000 in repairs before becoming saleable. Costs of refurbishment may grow even higher if you hire out contractors and/or repair personnel. There are also permit costs, insurance costs, and inspection costs.
Should you do the repairs yourself or hire someone? There are pros and cons to either decision. If you can do your own repairs, you obviously save money on labor. However, if you don’t fix something according to code, you will ensure major problems down the road. Also, if you have a day job and can only perform repairs at night and on weekends, your refurbishment project will drag on for months (or even years).
Hiring outside repair personnel or contractors ensures a professional job that is performed within code specifications. Even though you pay for the labor and need to ensure that the people hired are doing a good job, the job itself is done in a lot less time than it would take you. This means that you can sell your property quicker and move on towards your next deal.
It is best if the people you hire have been personally recommended by another real estate investor and rehabilitator. If not, first give them a small job and see how they do. If they do well, you can assign them to bigger tasks. If they do not perform the job satisfactorily, show them the door.
If you can afford it, hire licensed plumbers, electricians, carpenters, etc. Licensed professionals have worked hard to obtain their licenses and are therefore less likely to do shoddy work. They are more likely to be honest in their estimates and purchases, saving you the worry of being ripped off. Also, licensed professionals are more likely to be up to date on what jobs require a permit, an inspection, or additional rehabilitation.
You will need to decide how to pay your repair and contract personnel. It is advised that you use the “milestone” method of payment rather than a weekly rate of X dollars. This means that your crew will get paid an agreed upon amount of money only when the bathroom is officially finished, then when the kitchen is officially finished, and so on. Weekly payment is not advised because crews will be expecting payment even if they get behind on their work.
It is imperative that when hiring repair or contract personnel you stop by on a daily basis to inspect the work. Don’t rely on their word or on a third party like a neighbor or friend. You are paying your people your hard-earned money; make sure they are also working hard to earn it.
Refurbishment of a property requires supplies as well as labor. You can pay your repair or contract personnel a bit extra so that they help you find the needed supplies or you can buy the supplies yourself. Depending on how much you trust your personnel, you may just give them gift cards to home improvements stores like Home Depot or Lowe’s, asking that they give you all the receipts.
Don’t try to sneak around the city and eschew obtaining work permits. This is especially important if you are planning on doing any kind of work on the property’s structure, roof, electrical system, plumbing, and in some areas, windows. Some of the work you may be able to do on your own on the weekends, thus avoiding the need for permits, but you will be playing a cat and mouse game with the city. Furthermore, how will you justify the property changes when the home inspector comes by to assess your property at the sale?
Obtaining work permits is also imperative so that you avoid lawsuits in the future. If one of your refurbished properties has a personal injury, fire, or some other calamity, you may become liable for damages. Also, a disgruntled buyer may decide to sue you on the claim of shoddy work because you did your refurbishing without obtaining any city permits. It is best that you protect yourself by all means necessary, and that includes obtaining permits for the work performed.
As news spreads of the real estate property being refurbished, you will start getting calls and visits from interested buyers. Don’t show the property to anyone until the work is at least 95% finished. Most home buyers do not have the imagination to make the leap from the ugly, gutted property standing in front of them to the newly finished home in which they would want to live. However, it doesn’t hurt to get the names and numbers of interested parties. By lining up potential buyers now, you will be able to sell your finished property that much faster once everything is finished.
Once you are ready to show your remodeled property, it is your call whether or not you want to work with a realtor. Most realtors charge 6% for selling a property. You can accept that percentage or you can negotiate for a lower percentage- say, 3%. If the realtor has a problem with the 3% commission, you can meet him/her halfway by paying a listing service to place the house on the MLS (multiple listing service). Most realtors will take the lower commission, though- after all, 3% of something is still better than 6% of nothing.
Don’t be afraid to set your own terms for the sale. State in your contract that a “qualified buyer” means a buyer who has had the underwriter already approve him/her for a loan. Give a specific window of time for the house closing, such as 30-45 days. If the buyer is using a mortgage broker, speak with that individual personally and tell him/her that if the buyer is not approved for a loan within a certain amount of time, you reserve the right to replace the buyer’s mortgage broker with your own. That will provide the mortgage broker with additional incentive to make sure the property sale occurs as quickly as possible.
Alternatively, you may want to rent out the property for a while. In such a case, it is a good idea to have a renter’s contract printed and signed before letting someone into your newly refurbished home. If you are just starting out with renting and renters, hire a lawyer to iron out details like the deposit amount, eviction conditions, and so on. Don’t forget to ask prospective renters for (preferably three) references; a renter with a good rental history should have no problem finding ex-landlords to vouch for him/her.
Vacant real estate properties can be a great source of profit. It pays to keep certain costs in mind, though, like taxes, permits, and mortgages. Be firm in your negotiations, conduct your affairs legally, and don’t forget to keep the bottom line in the picture. With sufficient time and practice, vacant property investment and rehabilitation may even become your main career focus.