This is part 2 of our interview, if you have not seen part 1, please CLICK HERE
Have you ever considering flipping homes, do you think it would be an easy way to make money. If you are a baby Boomer and would like to know more information about flipping homes. We have an industry expert who specializes in flipping homes.
Video Transcript Follows:
Interview, Part 2 – House Flipping: An Insider’s Interview with Joseph Smith
To view Part 1, Click here.
Dan F.: Can you take us through the course, the outline of a typical fix-and-flip transaction? You’ve got some houses, just pick one that you’ve have worked with.
Joseph S.: Yeah, I wrote down an example here. I had a property in Riverside not too long ago that I purchased it for $260,000. It was easy to estimate the value because it was in a recent track development. The property wasn’t too old. It was built in 1990s so a lot of them were identical. I mean you could see 10 to 12 of the exact same houses just around the corner within the same area. That’s always important to determining value.
Not only could you have value change within city, obviously, but you could have a change of value from across the street. So it is really difficult to make sure that you are right on your numbers. If you were wrong on your numbers and you wrote an offer, you would be locked in that offer, pretty much. So you can lose money on a transaction if you don’t have the right training in the MLS system, in home repair, and all the other costs. Because there is one more cost and I will go over that then just the purchase price and the rehab cost. Again, I had a property I put under contract for $260,000, and the value I had was about $375,000, which turned out pretty close.
This particular franchisee wanted to actually fix and flip the house, which means he actually had to close on the property. There was an initial closing cost for $9,000, the cost of repair was $25,000, and as I learned, the rehab cost. You always want to be a little heavy on your rehab costs because you go into a property and not fully estimate them pretty carefully. You can pull back the carpet and find there are stains on the hard woods that you have replaced. You can find a lot of heavy repairs that you didn’t necessary see right away. This particular closing cost was for $25,000 and those were pretty minor. Three 3 months later, the house sold for $350,000. So I was a little high on $375,000, but I think the franchisee wanted to get it out quicker. I think you if you hold the property longer you can get the higher number, but that relates in the more holding cost. The holding cost totaled about $2,000 worth of HOA fees, water, insurance, and things like that. The second closing cost, including a relator fee, was much higher at about $16,000. I was paid $5,000.
DAN F.: – The second closing cost for the person who actually sold the house to the eventual buyer who is going to live in the house. So in your case, you have closing cost when you buy it and you also have closing cost when you are selling anything?
JOSEPH S.: Right. And then this franchise that I worked for they required a fee on the transaction and their portion of that was $7,500. So for $260,000 purchase, it actually cost about $335,000. So they only netted about $20,000.
DAN F.: How long was the project from the time that you actually put it on a contract to the time that you resold it?
JOSEPH S.: It was 3 months. Oh actually there was time before when I put it on a contract before the initial owner moved out. So it took about 5 months from when I put in on a contract till he closed the final last round.
DAN F.: That’s a pretty low return on investment for that kind of risk, don’t you think?
JOSEPH S.: I do, but there are other ways the franchise can limit its risk in this.
One is wholesaling a property. So in $250,000 purchase there are lots of investors out there who will pick that property up for about 75 percent of its value. So if the franchise was new, they can pretty quickly assign that contract without even closing it to about $275,000. So they can make a quick $10,000 or $15,000. That’s not including the franchise fee because they still charge a franchise on wholesaling and they still have to pay me. So they can take a lot less money quicker on their first transaction if they like to or they can gamble for the bigger money by doing the rehab themselves and double closing.
DAN F.: Ok let’s review it a little bit. This wholesaling assignment — what capital is involved to do that? You’ve got the same property, you are making exact same offer, you are putting up a certain amount of capital. At that point is that is that the total amount of capital that is involved in the transaction for the franchisee?
JOSEPH S.: Well no. When you open an escrow on the initial transaction, so when I put a home on a contract that we know the franchise is going to assign, they have to put up an earnest money deposit. So that when we open the escrow, which is the very next day, that franchisee has to put up $2,000 or $5,000 to open an escrow. And that money is held till the escrow closes. When the new investor comes in and basically meets them and buys the contract for whatever they’d agree to which sometimes is up to 75 percent and sometimes high as 80 percent of the value of the home, depending on how much that new investor wants that property.
DAN F.: Ok, but the earnest money deposited is really part of their actual deposit to put the house under the contract. I think what am getting at is that it sounds to me like there is a huge difference between the risk involved with just simply going out finding a property, putting it into contract and then immediately assigning it to a wholesaler. Or on the other hand, actually closing it, having to come up with the money to actually close or repair it, coming up with the money to actually hold onto it during the time that you are doing that, and then placing it back on the market. Am I describing that properly?
JOSEPH S.: Right. That’s not the only capital required because in addition to that in the background you are still funding your next marketing campaigns. You are still going in a lot of times that’s not the only property you have under contract. So even if you are taking the less risky way of assignment and you are only putting up $2,000 to $5,000 per deal, you probably have 2 or 3 deals in progress, in addition to continuing your business. I hope I answered that correctly?
DAN F.: I understand what you saying. So let’s assume that someone is interested in getting into this business and they want to start out with as little risk as possible. So that means they just want to go find and put houses under contract to be assigned to a wholesaler. What do you believe would be the minimum amount of capital that someone would need to actually successfully get into this business and get to a point where they are actually making money before they run out of money? Because they don’t have enough to actually go buy the next house or they don’t have the money to support their marketing campaign?
JOSEPH S.: You reminded me of something as well. In addition to the assignment fee that you’d give to an investor, you also have to figure out that $6,000 to $15,000 custom acquisition is still included in that. So I put $15,000 again after you pay me and you pay the franchise fee and you still got the custom acquisition. But to answer your question, I have seen hundreds of franchisees in this business and a lot of them are undercapitalized because for one they think they are going to buy a house right away and is quite impossible that you don’t buy one for a whole year. So you have to be able to capitalize your business for a year and you have to be able to live with no income on the private side for up to a year. And not to mention, in funding if you are going to rehab your property or if you are going to have several houses on a contract all those take more capital. So, I wouldn’t do it for less than $100,000 or $150,000 in liquid cash available.
DAN F.: So you think that at least $100,000 to $150,000 in capital is necessary to pretty much assure that you are not going to run out of money before you actually start to create transactions that are going to start returning your investment?
JOSEPH S.: Yeah, if you do it right they will start returning investment
DAN F.: So, we’ve talked about basically a lead format where you are generating these, what about the ideas of going to the auctions, you know, the bank auctions, foreclosures, things like that. Is that real or is that just that hype that we hear?
JOSEPH S.: It is real, but you are competing with everybody else out there. All those investors that you have been assigned to or you end up selling to on assignment or even on a rehab, those are all the guys that are standing at the court house steps willing to pay 90 percent for that house. So this business model can’t survive on a 90 percent purchase. It never will with both transaction costs and everything else. We have to buy at 65 percent to 70 percent, 75 percent at the top end.
DAN F.: Less repairs?
JOSEPH S.: Right. And that’s not going to happen on a foreclosure. No bank will agree to that. And doesn’t happen on probate sales and everywhere else that people are trying to get leads from.
DAN F.: So these advertisements of companies that are telling you to buy a list of foreclosures and it will make you rich, that’s a pump and dump; that’s a hype scheme?
JOSEPH S.: Well the list of foreclosures is not a secret. Anybody can buy the list. So you are competing with everybody else who has mailed that person or phoned that person. And you are probably not the highest offer, especially in our case. A lot of times if I was competing against another company or individual investor who didn’t have the same overhead that my franchise had, I would lose every time because that franchisee have to account for me, their franchise fees, and everything else included.
DAN F.: I kind of zero in on this because I think this is really one of the most important aspects of the hype that surrounds this business. Everybody thinks they can go get a foreclosure or they can just talk to a local bank and the bank is going to sell to them at a discount. They think they can drive up and down the street and see some house that is in need of repair and just knock on the door and the person says, “Gee, I’m so glad you came by today because I was waiting for someone to come take my house at a discount from me. Essentially that’s not realistic; it is really a lot of hard work and there is a lot of money that goes along with that hard work to actually locate those individuals who might be prospects. And in order to do that, you’re taking a pretty big risk. It’s not like a sandwich shop where you put up a sign, you buy some inventory, you start making sandwiches and people start coming in the door and giving you money. In this case, it could be months and months, maybe even a year before you get any kind of return. Is that right?
JOSEPH S.: That’s right, and all the while you are capitalizing the next month of leads that will be coming that are vital to your business.
DAN F.: Okay! Good, that’s depressing news. I think in this case this is exactly what am looking for. I am looking for the answers that tell people the reality behind each one of these types of opportunities. And if someone really has the ability and the temperament to actually go out and find these properties and talk with the people and deal with the people and has the money to kind of back them up as they are doing it, this could be a pretty good opportunity. But if they don’t have all of those things in place, it’s probably not the right opportunity for them. Would you agree with that?
JOSEPH S.: – If they have the right temperament, the money and the skill, they probably already doing it. So, it can be done if you have the time and the patience and skill of selling. And you have the financial means to sit back for a while and learn and buy enough leads to do it. But it takes the right amount of money and temperament, I suppose.
DAN F.: – So one last question before we wrap this up, tell me what you feel are the pros of this industry or this business model and what are the cons?
JOSEPH S.: I got a lot of windshield time, I wasn’t stuck in the office, the franchise seemed a little different. Well the pros is I have talked to a lot of franchise who like seeing a project done together and they like helping people. So for example I worked for a franchisee here that he bought a house from a woman who was in a pretty bad situation in her marriage needed to leave the house and we were able to get her the money that she needed quickly and get her out of that particular situation. We were able to to fix up the property and make a little bit of money. But the cons are, it’s a long process. You have to find the right deals and not to just sit out there waiting for you and it takes a lot of money to find those deals. And it takes some patience. It takes a skill or at least the relationships in multiple fields of construction, of escrow, of lead generation, of selling. You know you need to have that type of broad network in other to make it successful.
DAN F.: Yeah, I got it. Joe I really appreciate your time and I wish you lot of luck out there. I think we will probably get in touch with you in a few months to see how things are going. So thanks again, and we will talk to you soon.
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