Flipping Houses Part 2: Renovation Realities

Posted by on Jul 12, 2013 in Blog, Featured, Real Estate | 0 comments

Please see Part 1 of this series.

Once our bid was accepted by the auctioneers we would sign over our cashier’e check and immediately spring into action. We first would call our insurance agent and insure the property. Next, we would call a locksmith to open the house and change the locks. I was fortunate to only deal with empty houses. However, my partner once purchased a home and found it occupied. To make things worse the spouse who answered the door did not even know it was being auctioned off and was caught totally off guard. It was sad, but in that situation you offer them some money to both protect the property and move out as soon as possible.

We reviewed each home and tried to spend money where it is most visible. We did not want to spend money on roofs, energy efficient windows or garage doors.  Those items do not excite the buyers as much as bathrooms and kitchens. We then have our construction team come in to bid the renovations. The bulk of our budget was spend on drywall, paint, bathrooms, kitchens, lighting and carpet. Curb appeal is important, so the final touch was a front yard landscape overhaul.

There are several things about flipping that many people may not know about.  First time flippers need to consider hidden costs like utility reconnection fees and homeowners association dues in the rears. Additionally, local CC&R’s in certain neighborhoods need to give approval for exterior paint colors and front yard enhancements.  This can take valuable time.

We would try to be back on the market in 30 to 60 days. The houses looked great after the makeover and were well received in the market place. We often had multiple offers and had to weigh the positives and negatives of each offer–more money for a slower, riskier close or an all-cash offer to get your money out quick.

We were fortunate not to run into any major surprises. We supervised all the work and did some work our selves. we would profit about $30,000 per home after all expenses, but we felt we earned every penny. The whole process would take about 120 days from courthouse to cash in hand.

Keys To Success

  • Flipping houses is not a recipe to become an instant millionaire
  • Do your homework first and don’t jump in too fast
  • The business takes a lot of capital, banks don’t want to finance these deals anymore
  • It’s harder than it looks, but it is still possible
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Flipping Houses Part 1: Circus on the Courthouse Steps

Posted by on Jun 28, 2013 in Blog, Featured, Real Estate | 0 comments

“Dominate your real estate market”

“No Money Down”

“No Experience”

“Flip your way to wealth and security”

Business #12 was an experiment in following the news and the hype.  The collapse of the housing market made waves across the world.  Several TV shows popped up showing people scooping up cheap real estate for next to nothing.  With foreclosures all around, the business of buying, fixing, and selling homes for a big profit seemed possible. We thought it was a good fit because many of my companies did residential work like electrical, HVAC and gutters.  I could give these businesses more volume and save money on hiring outside subcontractors.  We also thought our wives could help us with the interior decor like fixtures, paint, kitchens and carpets.  So, we tried it.

We started by creating an LLC and funding it with enough money to buy our first house.  Then we pursued our real estate licenses in order to save the commissions when we sold the homes.  It is not hard to get your real estate license, you just need to buckle down and study for the test.  There was some useful information, but it was mainly a “cram and exam” process.  We signed up under a broker in southern California that would allow us the freedom to do our deals the way we wanted.  The broker charged a fixed fee (very reasonable) per transaction for assisting with the paper work and providing errors and omissions insurance.  It was a great deal and his office was very helpful.

We started by tracking foreclosures in neighborhoods we knew well.  We tried to purchase foreclosures from the banks, but found most of them were very hard to work with and they did not price their homes properly.  We then went to the court house steps and find out what buying homes at auction was like.  For those that don’t know, the courthouse steps is where daily auctions are held to quickly sell foreclosed properties.  There did not seem to be a rhyme or reason why some houses found there way to the court house steps.  It seemed like the banks had foreclosure reduction quotas and if they could not sell enough houses the traditional way, they would auction off some of their inventory.

Everyday we would do drive-by reviews of the houses coming to auction.  The rule of law is you should not trespass or cause damage to the home as you inspect it.  We mostly looked for cosmetic fixes: carpets, paint and some drywall issues.  We did not want major structural problems or serious plumbing or electrical work.  Sometimes we would come across other bidders doing inspections in a very aggressive way.  If the house was empty they would break in to get a close look.

The experience on the courthouse steps was a trip.  When we showed up there was a whole cast of characters.  There was the gangster, baggy pants, cap turned on 45 degrees, Bruce Lee, Danny boy (doing an Irish gig), Lindsey Lohan and Charlie Sheen look-alikes complete with his tiger blood.  Here is the deal: all of them were packing a million dollars in cashier’s checks.  All of them had a neighborhood they were after and they were very protective against outsiders.  When newcomers arrived they would often start telling horror stories to deter would-be buyers.  They would say things like “Do you remember when that guy won the bid on a house only to find out it burned down the day before?” Or, “I just saw someone that bid over $100,000 on a 3rd mortgage thinking it was for the first mortgage!” Admittedly, it was a little intimidating.  The dishonesty of the bidders carried to the auctions.  We saw obvious bid-fixing, secret deals and signal calling from the McDonald’s across the street.  Over time, the authorities began catch on to these illegal activities and people across the country began to be charged with fraud.

We stayed focused and did buy some homes, but it was no slam dunk.  In the next article we will cover the fix and flip side of the story.

Keys To Success

The everyday players have deep pockets

They regulars are educated on values, liens, judgments, and loans

Know your costs to purchase, fix, and flip.

Come ready to play and when your houses come up,  jump on them

Operate with a strategy, i.e. resales, rentals, lease to own

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Business #11 – Art of the Appraisal

Posted by on May 31, 2013 in Blog, Featured, Finance | 0 comments

Business #11 came to us in a roundabout way.  We were advertising for drafting employees to meet the needs of our cell tower engineering customers.  A young lady came in to apply for the position.  We asked her why she was leaving her existing job and she said her employer was retiring.  We took that information and called the owner to find out about his business.  Sure enough, he was selling his business.    He was old, tired and ready to move on.

I contacted the business broker and we started in on the negotiations.  The first thing I received was a copy of the appraisal, which the owner paid a lot of money for.  Historic income statements showed declining sales:  2001, $1,119,655; 2002, $716,131; 2003, $439,599.

The appraiser then developed a risk factor model:

Build-Up Model, Risk Factors:

Risk-Free Rate                                     3.97%

Market Equity Risk Premium           6.92%

Small Business Risk Premium         20.00%

Total Discount Rate                       30.89%

The appraiser then capitalized the earnings with a weighted average:

Capitalization of Earnings            Normalized      Weighting        Weighted

                                                            Earnings           Factor                Earnings

Fiscal 2001                                             401,135                  1.0                  401,135

Fiscal 2002                                             239,774                  2.0                  479,548

Fiscal 2003                                             80,132                    3.0                 240,396

Sum of Weighted Earnings                                                                          1,121,079

Divide this by Sum of Weighting Factors                                                              6.0

Weighted Average Earnings                                                                        186,847

Divided by Historic Capitalization Rate                                                              30.89%

Total Equity Value                                                                                           604,877

It is important to note that business appraisals are part art and part science.  There are a lot of assumptions to be made and the combination of those assumptions can change the value wildly.  In this case, the appraiser weighted the last 3 years of earnings, giving more recent years a higher weight.  This is a common method, but past performance does not predict the future.  If you follow the trend line, the sales will hit zero in a matter of a couple years.  Stating that the company will generate free cash flow of $186,847 in perpetuity is wishful thinking at best.  The new owner needs to pull the business out of a nose dive, which could cost even more capital.  For this reason, its important to appraise a business in at least a few different ways to get a good idea of what’s at stake.  We plan to cover some of these ways in future articles.

With an appraisal in hand, the owner opened negotiations with a sales price of $600,000.  We told the broker we were not interested at all at that price.  His expensive appraisal was only looking at past results and did not forecast the most likely scenario going forward, which was a continuation of 2003 results.  We just stayed in touch while the broker tried to find other buyers.  The seller and broker came to the realization if they wanted to sell his business he needed to lower the price to a reasonable number.  We entered serious negotiations and the business sold for 25% of the appraised value.  I negotiated my usual 50% down, 50% financed over 5 years.

We were able to stream-line the operation and this became a very profitable branch office, even at historically low volumes.

Keys To Success

  • Business appraisals are just assumptions, if yours are different, don’t buy
  • Do not be put off by the initial asking price
  • Be observant and look for opportunities everywhere

 

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Business # 10 – On The Lookout

Posted by on May 16, 2013 in Blog, Featured | 0 comments

Business #10 was flat out a business of opportunity.  My mentor had seamless gutters put on his home and during the process he asked the installers about the business.  The foreman explained that they pull a trailer from job to job that extrudes rolls of flat aluminum into gutters of custom lengths.  These gutters are then installed on the spot.  One crew can do two jobs a day and bill out up to $2000 a day.  This seamed to be a low overhead, easy-to-operate business.  After that discussion with my mentor, I was on the lookout for a gutter business.

Not long after this, I was given a tip that someone was interested in selling his gutter business.  I was not told the identity of the potential seller so I had to cold-call some businesses in the area using information from the contractor’s licensing board.  I eventually identified the owner that was thinking about selling his business. His response was, “Maybe, but not yet.” He wanted out of the industry to pursue something else, but his new venture was not up and running yet. I stayed in touch with him for many months, calling occasionally to see how his new venture was developing.  I even had him replace gutters on my house and I was impressed with the crew and the quality of the work.

After 8 or 9 months, the owner called and said he was ready to sell his business.  Given that our relationship was now quite strong, the negotiations went smoothly. We did the typical 50% down, 50% over 5 years at 6%.  The matrix was 65/0/15/20.

At the time of the acquisition we did installations directly for home owners and also teamed up with roofers to sell new gutters with the new roof.  I hired my new son-in-law to manage the business and he landed Home Depot as a customer, which increased sales by 30%.  We added another gutter machine and a second crew to keep up with demand.

Things were going well until the housing market crashed.  With falling home prices, people were less motivated to make improvements to their homes.  Home Depot started to put the squeeze on their wholesale contractors, which left us with little or no margins.  Things looked pretty grim for a while, but the market is recovering and things look much brighter for East Bay Gutters.

Interestingly, after my son-in-law moved on to go to law school, the old owner came back to work as a manager.  His venture did not turn out as he planned and he was looking for a job.  He worked for me for a few more years before finding another job.

The business has had its ups and downs, but it really turned out to be a neat little businesses that can be expanded.  We are looking to reinvigorating the business even more with a new marketing campaign.

Keys To Success

  • If you can, take the business for a test drive
  • Patience will save you money
  • Quality relationships always prove to be valuable
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Business #9 – Putting the Pieces Together

Posted by on May 9, 2013 in Blog, Featured | 0 comments

My mentor always kept an inventory of the skill sets and interests of people he knew so he would have certain pieces in mind to put together his next deal.  This networking tool came into play for me on business #9.

I found business #9 on BizBen.com.  In many ways it was a perfect fit.  It was 10 miles from my home, highly profitable and a great niche.  The seller was running the business at 52/0/10/38 and, like so many other of my deals, he was burned out and motivated to sell.  The only problem was that the company was a civil engineering firm, a discipline outside of my expertise.  The owner was the only licensed engineer, so the new buyer (ideally) also needed to be a professional engineer. Upon learning this, I realized how I could use this fact to my advantage.

The business was priced very high, but finding a buyer with the capital, skills and engineering license would be difficult for the seller.  My brother-in-law proved to be the first piece of the puzzle.  He is a licensed engineer and was looking for a new opportunity after being in city government for 20 years.  He was immediately onboard.  I also added an additional investor to spread out the financial risk.  The seller was tough, but he liked our team.  Knowing his business was a hard sell, he started to move on price. However, the terms turned out to be another obstacle because the seller was not willing to follow my usual 50% down 50% seller-financed model.

The second puzzle piece was financing. We went back and forth many times, struggling to find middle ground.  In the end, we got our price and he got his terms, 70% down, 30% seller-financed for 54 months at 6% with a personal guarantee from my brother-in-law.  I had avoided personal guarantees up to this point, convincing the owners that the business is the seller’s security.  For my brother-in-law’s experience and personal guarantee he was named president in charge of daily operations and issued 1/3 of the outstanding shares of stock.

The final piece of the puzzle was a collection of things I try incorporate into all the businesses I buy, strong accounting practices, efficient operating systems and sufficient working capital.  Luckily, business #9 was the cleanest, neatest business I had ever owned.  The engineering business has minimal inventory; we sell designs and drawings.  It is a great business provided you have work.   We took over the business in the middle of the cellular tower construction boom and we did millions of dollars of cell tower designs.  Fortunately, the seller’s niche paid the business off quickly.  Since then, the company has had to adjust to changing market conditions.  The cellular business became super competitive and dried up with the 2008 crash.  We were blessed to segway into solar and wind energy projects, but that market is developing slowly . The business will need to reinvent itself to continue to thrive.

cell_tower

Cell Tower

Shiloh_wind_farm

Shiloh Wind Farm, Solano County, CA

 Keys To Success

  • Business deals are like a puzzle, the pieces need to fit.
  • Look for great businesses, regardless of your skills.
  • Focus on running the business and leave the rest to the right talent
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