“Top 10 Mistakes that Make Deals Go Bad” Series – Part 2

#8 Having a Greed Attack

Webster’s Dictionary defines greed as “A selfish and excessive desire for more of something (as money) than is needed.”  The two words that stand out seem to be more money.  It is interesting that money is the example Webster’s chose to use.  To a rehabber, more money sounds like a pricing decision for the finished product (the house) whether it is for sale or for rent.  That decision could come as early as the acquisition stage when you are trying to determine a comparable price for the finished product.  Eventually, if greed bears its ugly head, it will come to roost when you list the finished house for sale or for rent.

What’s wrong with more money?  A very popular credit card company has made that very principal the topic of a massive advertising campaign involving one of America’s funniest comics and an adorable infant girl.  But that’s all about rewards points for credit cards users; we are focusing on the affect on rehab investors.

Greed can be seen as a good thing in a world in which time stands still; otherwise, greed should be seen as time’s evil nemesis.  If you are holding out for a price above reasonable, you stand to wait more time to get it.  Basic supply and demand economics are in play here.  However, economics also teaches that there are many costs to time; two of which should be illustrated to show why greed, or certainly too much of one thing, can actually work against for profit endeavors like rehabbing and investing.

Time has carrying costs – ask yourself how much does it cost to prolong the continued activity?  Is your rehab project financed?  Then you are paying interest to your lender, property taxes to the government, and insurance premiums to your agent, all of which costs money.  Completed projects which remain vacant also cost money to maintain including the costs of utilities for basic services.  Hopefully there are not too many other fixed expenses (as salaries!) resulting from carrying an inventory of unsold houses or vacant rentals.

Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative that is not chosen. In other words, it is the sacrifice related to the second best choice available.  Opportunity costs deals with concepts about scarcity and the most productive use of resources.  Are your contractors at this job when they could be at another?  What is the listing agent or property manager doing? And if you answer “That’s me” to any of the above, what else could you be doing with your time?  If your time is not being spent on the highly priced project you have got, it could be finding that next great deal.  You can’t be in two places at once.

# 7 Repairing Fire Damage without Permits

Fire damage is a specialty. Good money can be made in fire damaged homes, but NOT being trained can and will lead to unexpected surprises, delays and losses.

The first thing to be aware of when considering a fire damaged home as an investment is that the local fire, police, code enforcement, and zoning are all aware of the fire.  Fires draw attention. Because the authorities are aware of the condition of the home, past zoning issues will need to be repaired as well as the recent fire damage.  This can and will add thousands, or worse, to a project if old issues are required to be fixed before getting permission for occupancy. Permits will be required and inspections are a must, adding cost and time to the project.

Fire can cause damage not visible to the eye.  Fire can get between walls and damage the framing with minimal evidence from either side of the wall.  Without looking behind the drywall or plaster, there is no way to know.

Fire is hot. Water is cold. When the two meet regularly, the pipes will burst from the pressure of the steam build up and leak, driving up the water bill.  If this occurs outside the foundation, there is no easy way to be sure short of a very large water bill, a very wet spot or a professional plumber.

Remember that there may be more to the repairs than may meet the eye when considering a fire damaged property. Zoning and code attention will apply so know what you are getting into and how to get out of it when entering into a fire damage real estate investment transaction.

“Top 10 Mistakes that Make Deals Go Bad” Series – Part 1

#10 Relying Solely on Seller’s Research

What a way to kick off our Top Ten Ways to Make a Deal Go Bad (for you, the rehabber, that is)! 

In any arms-length, investment real estate transaction, it should be assumed the buyer and seller of the real property are at complete and opposite odds with one another. 

  • Price is the just the beginning of the illustration.  The buyer wants the lowest possible price; the seller hopes to maximize profits (or cut their losses).  The seller should, it stands to reason, market the property in the best possible light and point out all the best features in an attempt to maximize selling price.  The buyer should be making the best possible, lowest cost deal for themselves in order to lower their cost basis and maximize future profits.

Buyers and seller opinion of condition is also at diametrically opposing views.  The seller will have the house in best possible condition, possibly covering up defects and hiding blemishes.  The rehab investor will want to peel back all layers to expose any flaws with the property and completely understand the scope of the work that needs to be done.

  • Seller information, such as comparable sales, tenants, neighbors, school information, etc., is not reliable and should be taken with a grain of salt.  In the current foreclosure environment, most properties are non-warranted, sold as is where is, and this point may not be relevant to the buyer.  However, anything offered up should be seen as an attempt by the seller to maximize selling price and should be vigorously vetted and verified before proceeding.

Remember the buyers golden rule: us versus them.  Act professionally but be diligent in your buying process and assume the seller’s motivation is not your own.

#9 Commingle Personal and Business Money and Debt

When running a business the line between business and personal regularly gets fuzzy. Underwriters HATE fuzzy.  If there is any vagueness to the situation they will always assume the worst. This is most pronounced when it comes to debts.  Business debt, even if on your personal credit report, needs to be only business debt and only paid from a business checking account. If this is NOT done then the business debt will be held against the useable income for loan approval. The best plan of action is to have accounts 100% dedicated to the business, only using them for business reasons, and have other accounts that are 100% personal. Good record keeping and proof of what is personal and what is business will increase your income useable for mortgage qualification, lower your debt ratio and make your CPA happy at the end of the year.

Co-mingling personal and business assets needs to be avoided also. Keep business accounts and personal accounts separate. Deposit all business income into the business account and then pay yourself with a check drawn on the business account. This accounting method places the income where it was derived and eliminates any fuzziness in debts, assets and income when your loan file gets reviewed for approval.

Top 10 Mistakes that Make Deals Go Bad


Easy Money!

One of the mistakes that many rehab investors make is using consumer debt for business purposes because it is “Easy.”

On the surface, the lowest hanging fruit for a rehab investor is the credit card or Home Equity Line of Credit (“HELOC”). Often these consumer credit facilities are used for repairs and even purchases of real estate.  Why go through the hassle of gathering information and approaching lenders for a loan that they will charge points, fees and potentially higher interest on, when you already have or can easily obtain a credit card or HELOC? The short answer is that using consumer financing for business purposes does not work long term. In fact, it can be lethal for you as a business operator and a consumer.

ImageSpecifically, this “Easy” financing methodology can have a very negative impact on credit scores.  For entrepreneurs in the rehab investor market segment, where capital availability is a critical success factor, the credit score is your most valuable asset.  It must be protected.

A credit score is determined using five main methods of analysis, payment history, amount you owe, length of credit history, new credit, and type of credit.  Amount you owe or utilization is impacted the most by using consumer debt for business purposes.

Amount You Owe

The second largest impact on your credit score is the amount you owe in relation to the credit limit.  It is also known as the utilization rate.   If you have borrowed and are near or at your credit limit, this damages your score. In fact, any balance above 40% of the limit has a negative impact on the score.  This is important for rehabbers because financing rehab projects takes a great deal of capital, which will most likely exceed that ratio.  High unemployment and the decrease of home values have prompted many lenders and banks to cut credit limits in order to minimize risk, resulting in an immediate increase of utilization rates.

Why Does It Matter?

Utilization rate accounts for 30% of your credit score. According to FICO Score Simulator, maxing out your credit cards could drop your credit rating from 700 down to 590 or worse, assuming that you still pay your bills on time and all other factors remain positive. According to myFico, “Carrying extremely high balances on all of your revolving accounts (i.e. credit cards, equity, and personal lines of credit) makes you look ‘maxed out’ on your available credit. It is often considered a high-risk trait by lenders and the FICO score.” In short, lenders (and credit scorers) don’t like high balances.

Make sure you understand how a loan or line of credit is being reported to the credit agencies.  Many “Business” lines of credits and loans actually use the credit score of the business entity owner(s) and reports to the agencies.  This means it has the same impact as a consumer loan.

So how do credit-reporting agencies distinguish between a shopping spree and a rehab project?

Well, they don’t. It is hard to blame them, however. This is because they report on 190 million consumers. Extremely few of these 190 million people are rehabbers, so it is impossible for credit bureaus to track the difference between consuming and investing on credit cards. When you purchase and pay for improvements on a property with your credit card, the agency cannot distinguish between that luxurious vacations, extravagant jewelry, expensive clothes, and pricey dinners.

Why are these credit scores important? It can make the difference between being able to obtain a loan and getting denied. Also, even if your score only drops several points, it can result in higher interest rates.

Pennsylvania Real Estate – Title Insurance Price Change

Attention Pennsylvania Real Estate Investors, The Pennsylvania Department of Insurance has issued a change in the closing cost rates that will take effect on July 1, 2012. The department has agreed to a new price structure for title insurance that will allow for easier calculations for title insurance and will increase rates for title insurance. Note that if you are to close at the end of June but are delayed in to the month of July, you will be subjected to the higher rates.

For more information, read Jeff Geoghan’s “Watch out for changing title insurance rates” an article from Central Penn Business Journal