If there is a ticking clock in foreclosure investing, it’s the holding time – the period from purchase to disposition. Every day spent between those milestones is a day your investment is not delivering a return, yet, and each additional day that doesn’t add value lowers your return on investment.
Consider your holding period in terms of your annualized ROI. If you buy for $90K, put in $10K, and then sell for $110K, you make a 10 percent return on your investment. Do that in 90 days and it’s a 40 percent annualized return. Take 180 days to do the same thing and it’s a 20 percent annualized return.
Some repairs increase value more than others, but they may also take a lot longer than others. A new kitchen, a new addition, or anything that requires a permit will push out your holding period. You may increase your return with that renovation, getting say $115K instead of $110K and pushing your ROI to 15 percent, but because it took you 180 days, your annualized return shrinks to 30 percent instead of 40 percent.
So, when looking at repairs, you want to look at how long they take, not just the cost of the repairs and the increased value.
At the fix stage of a fix-and-flip strategy, it’s about controlling costs and avoiding delays. This is where the team of professionals you’ve assembled can make or break you. A good contractor can put you ahead of the game. A bad one can put you behind the eight ball.
During the evaluation stage you made estimates as to the cost of repairs After purchase, you’ll get more solid estimates or quotes from licensed contractors.
Establishing a reputable pool of contractors
As a foreclosure investor, it’s a good idea to build a team of professionals you can call on at each state in the process. This team would include real estate agents, inspectors, contractors, handymen, cleaning services, and others.
A contractor is in a unique position to affect the profitability of a deal. A good contractor can increase your profit by delivering solid, good quality installations and repairs at a fair cost. A poor contractor can eat up all of your profit margin and even cause you to lose money on a deal.
Because the contractor is so important in a fix-and-flip strategy, it pays to take the time and effort to identify the good ones and keep them happy. You should focus on contractors that are licensed, insured, experienced, and who provide references. If they use subcontractors, get information about their experience and verify that they are license and insured as well.
Once you have possession of the property, draw up a list of the repairs to be made, specifying scope of work and schedule, and get three or more bids for each project. Let your contractors know you are putting the job out for competitive bid, which means they are more likely to give you their best prices. Ask that the bids break out material and labor costs. By establishing a solid group of dependable contractors, managing repairs becomes the business that it is intended to be, rather than the headache it can often be.
Getting a contractor to do the work for you is not a set-and-forget activity. Schedule and costs are both greatly influenced by the amount of attention you pay to the project.
Timelines and payment schedules. The timeline for the repairs to be completed should be explicit and the contractor who wins the bid should understand the time-critical nature of the project. While contractors may have their own preferences for payment, it’s best to establish payment based on progress, not based on the calendar.
Incentives and penalties for contractors.One way to encourage timeliness is to write the contract to include a bonus for early completion and penalties for being late. The penalty can be based on daily lost income (for a rental property) or daily cost of a mortgage, whether you have one or not (for a property to be flipped).
Controlling costs. Select durable materials of an appropriate quality for their purpose. Lower quality materials might cost less initially, but will require replacement or repair much sooner. Exotic floorings, countertops and wall coverings may appeal to you, but potential buyers may have different tastes. Keep costs in check by taking a moderate route on repairs. Stay sensible and keep fixtures, colors and materials common and easy to obtain and repair. The new homeowner can always install exotic fixtures to their taste later.
Material selection depends on outcome. Your decisions about materials and appliances are influenced by whether you’re renting versus selling. When preparing a rental, the emphasis is on durability and ease of maintenance. If you’re selling the property, you may want to get a nicer grade carpet, custom paint colors, upgraded appliances and lighting fixtures.
Availability of materials. Time to revenue depends on minimizing downtime. Get to know the builder supplier in you area, whether local or chain, and what they stock. Also learn their return and builder/contractor bulk discount policies.
Waiting to Improve
There are some situations where haste is either inadvisable or impossible.
It’s best to wait for trustee’s deed to be recorded before investing in the property beyond replacing the locks, in the case that the trustee or lender decides to rescind the sale, or if a lis pendens is filed against the property. See Taking Deed in the Auction Investing section for information about fighting a rescission.
Rights of Redemption (IRS). The IRS has the option of exercising a right of redemption on a lien against a property for up to 120 days after the sale by matching the highest bid and taking possession of the property. Any repairs you have made have just become a gift to the taxpayers.
Estimating Return – Key fixes
Focus on repairs and upgrades that will make a property more attractive and desirable. Renters who want to live in a home are more likely to care for the property than renters who are just settling for the cheapest option.
When selling the property, focus on key fixes, updating aspects of the home that will improve the livability and functionality of the home.
One rule of thumb is to work with the bumps that you have. Additions are not cost effective. Renovations trump rebuilding in most cases.
Maximize curb appeal by repainting the front door. If the lawn is anemic, go the extra mile and roll in sod, drop in a tree and spread a few yards of bark where it will do the most good.
You can standardize your colors and materials for renovations to establish a brand. By taking advantage of the economies of scale you can establish a signature in your area. One investor who follows this tactic has agents calling to ask if he has anything available in a specific area where their clients are looking. If he doesn’t, it tells him where to invest next, as there are buyers for that area.
Bathrooms.A little renovation goes a long way in a bathroom. It doesn’t cost much to clean the walls, scrub an old shower door, install a pedestal sink in a small space replace the faucets, light fixtures, towel hangers, toilet seat, and shower curtain, or to caulk and clean the grout. But those simple changes can completely transform a bathroom and dramatically increase the perceived quality of the house.
Kitchens. You don’t have to replace appliances to improve the kitchen, although there are times when you should. Surveys show that new appliances bring high returns. Like the bathroom, some simple repairs and renovations can add significant value. Refinish the cabinets and drawers. Upgrade the knobs and handles. Replace the sink and faucet. For a little more, you can polish a granite or marble countertop with scratches or replace a laminate counter.
Flooring. Replace worn or damaged flooring with quality ceramic tile, laminates, or stain resistant low-pile carpets. Exotic floorings may appeal to you, but potential buyers may have different tastes.
Paint and walls. A quality paint job can make a room pop. You don’t save anything by getting budget paint and then having the extra expense and time of doing multiple coats. Pick a pleasant but neutral color scheme that will allow buyers or renters to visualize their furniture in the space.
Siding and windows. Installing siding can be lest costly and more durable than painting. Quality windows can increase curb appeal and increase energy efficiency, but for the typical house it takes 10 to 20 years to make back the cost of the windows in energy savings and upgrading windows has a lower ROI than other renovations, such as bathroom and kitchen upgrades.
Tales from the Trenches: Leveraging Seredipity
I know of an investor who once saw an accident on the freeway. A Keller Williams semi truck crashed. He stopped, talked to the trucker, and eventually bought $15 a gallon paint for $1 a gallon and put it in the warehouse. If your painting cost is 1/15 of your competitions, you have an advantage.