Case Study #1

Why multiple exit strategies?

Investor A was looking for homes to flip. Now, this is not a practice I recommend in Houston. It is much more successful in Seattle or Atlanta (at least for the moment). Houston's reasonably priced housing market makes it a much better place to employ a buy and hold strategy; more on that later. Investor A was adamant and we began our search for deeply discounted property.

We located a property in Missouri City that was deeply distressed cosmetically but had already been fairly well prepared on the inside; the master bath had been completely gutted, the flooring was already removed, some slate tile had been mostly installed in the 2nd bath and entry way. We put in an offer and eventually got a purchase price of $80,000 for a 3 bedroom, 2 bath, 2000 square foot, 2 car attached garage patio home built in the 80's. It was estimated repairs would be around $16,000. This included new carpet, new paint inside & out, tile for the wet area, new appliances, some yard work and a new A/C condenser (the old one had been stolen). According to the market data the property could sell for between $124,000 and $130,000 quite easily with rents in the area going for between $1,050 and $1,100 for the 3 bedroom homes in the subdivision. A nice $40,000 equity proposition!

Restoration work began immediately or at least they tried. There was no electricity to the property in the quiet subdivision and Investor A came to find out that there was a special inspection and permit required by the city to have electricity turned on in Missouri City's jurisdiction. The inspection revealed there had been tampering with the electrical box and meter and it would need to be repaired or replaced by a qualified electrician. Such an electrician was hired and after some significant costs the investor was ready to have another inspection from the city and request the power be activated.

The power company reported the power was on to the house but the contractor was reporting no power in the house itself. Another electrician was called out and it was discovered there was a problem with the underground wiring from the utility pole to the house. This issue required retrenching and replacing of all the exterior wiring as well as a new meter casing. The final price tag $2,400.

This was just the beginning; when time came to begin work on various parts of the interior it was discovered that all the copper piping and much of the copper electrical wiring had been stolen along with the A/C condenser. The plumbing was completely replaced for an additional $1,900 and the new wiring was an additional $1,000. Finally it was time to replace the A/C unit. The HVAC contractor said the duct work was too old and inadequate for the new model condensers. An additional $3,800 for the required duct work yielded a non-working A/C in addition to breaking the newly installed plumbing. The hard working handy-man was able to restore the plumbing and the HVAC contractor did return and get the A/C working again.

After that the rest of the remodel went great. The cabinets in the kitchen were in great shape and were restored instead of removed and the money saved was used to replace the outmoded sink in the 2nd bath. The porch was screened in and the upstairs hardwoods were in near mint condition. The exterior siding was in good shape and only a few areas needed full replacement. The money saved there was put into two new garage door openers and upgraded carpet and pad (made from recycled plastic bottles with a 10 year warranty and embedded stain resistance).

Only 12 weeks off schedule the home was finally ready to stage and put on the market to sell. This was a blessing and a curse; the conditions of the financing stated the home could not be resold for a profit of more than 20% within 90 days of the purchase without significant penalties. The delays in the rehab worked out perfectly. On the down side the market in the area was beginning to flatten (July 2007) and though prices were holding steady traffic had fallen off sharply and several other homes had come on the market both foreclosure and resale.

The investor was adamant about their price of $125,000 due to the nearly doubling of the rehab costs (still very reasonable at about $24,000 especially considering the all new A/C, electrical, plumbing and master bath) and wanted to be able to still make a profit in the flip while absorbing the cost of the sale (about 8%) as well as the rehab. This would leave only $15,000 profit from what was supposed to be $23,000.

Unfortunately the market continued to slow and Investor A was burning money on utilities and mortgage costs. They had put aside 120 days worth of these carrying costs but 120 was fast approaching and something had to be done to avoid a loss. This is where the multiple exit strategies come in to play.

The Investor decided to market the property for rent and after filling it with a tenant either refinance to get the capitol out or sell it as a turn-key cash-flowing investment. Finding the tenant was no problem; theirs had become the most well improved property in the subdivision and they were easily able to get $50 above asking price and rent the property for $1,200 (the next door house was asking $1,150 and had to settle for $1,100 due to property condition).

It was not as though no one was interested in buying the property. Even with the small amount of traffic Investor A had several offers tendered at or near the asking price but none of the buyers were qualified and were not able to find loans to finance the purchase.

That's actually where the property stands now. It has a positive cash flow of about $200 a month and, according to the lender working on the refi, is worth $129,000. That's not liquid equity but Investor A is willing to wait 12 months, have an extra $2,400 in cash as well as the equity in the property. By choosing a location for the flip that not only had flip potential but a strong rental market the sudden downturn in the market and the added costs of the repairs were easily assimilated and another strategy put in place. Flexibility is a key element in successful investing.