I am calling this the Wholesaler House because I bought it using a wholesaler.
In late 2007 I had been studying the subject of real estate investing for 16 years. I read books, worked out formulas, found properties, did everything except make an offer and buy a house. I was in analysis paralysis and could not make the move from investing student to investor. I guess I was scared of what might happen.
Then I met a co-worker that had several houses and ‘helped’ others buy investment real estate. His pitch was simple: he would find the house, manage the renovations, find the tenant, and collect the rent, all I had to do was sign the papers and put ‘cash in my pocket’ at closing. The cash in my pocket would come from borrowing in excess of what was needed. Over time I would learn the business and be able to branch out on my own.
I was still scared of what would happen. Although I had a lot of theoretical knowledge about real estate investing I lacked the confidence I needed to move forward. As a result, I decided to partner with a friend who was also interested in the subject. My thinking was that this would reduce the risk to both of us.
We spent a few weeks looking for houses. The wholesaler had a real-estate agent and an appraiser working with him to help us with the deals. At first I thought we were looking at house he owned but I soon realized that he had only made offers on the houses and was trying to line up buyers.
We finally settled on a 4 bedroom 1 bath house in a bad neighborhood. We were told that it should rent for $700 per month. The purchase price was $15,000 and needed about $22,000 in repairs. We would end up spending about $40,000 after closing cost. His appraiser told us the house would be worth $80,000 after we made the repairs.
We were not convinced that the appraiser was being honest so we hired our own appraiser. The appraiser we hired was from one of the most respected appraisal firms in town. He valued the house at $30,000 after repairs. With such a wide difference we decided to hire another appraisers – just so we would know if our co-worker was cheating us. The third appraiser gave an after-repair value of $65,000. How could 3 appraisers give such differing estimates?
We decided to go with the middle appraisal and move forward. After all, the rent would more than cover the loan payment as well as taxes and insurance. We signed the contract and began working on getting the loan. He had a lender lined up, at a reputable bank that would loan 80% of appraised value- $52,000. However, we were looking to maximize cash flow and did not want to take cash out. We ended up borrowing $42,000 for this house.
A few days before closing we found out that this house was listed in the MLS for $11,000 (and we were paying $5k). We knew the wholesaler was making money, but he stressed that he was an expert negotiator who could get excellent deals. He would then sell to us a bit higher, but lowere than we could get own our own. Now we found out that we could save $4000 by cutting him out. However, we had an agreement and he was going to teach us the business. We ended up closing with the deal as we had agreed. At the closing we found out that he was buying the house for the $11,000 list price (great negotiator?).
We closed on this house in early November of 2007. Immediately after leaving the closing the wholesaler wanted an advance to buy materials. I refused to give the advance – I wanted to make payment after work had been performed. In addition, we were getting draws from the banks and no draw was allowed until some work was done. Eventually he relented and his crew began working on the house.
This house needed a lot of work! His crew turned out to be inexperienced, untrustworthy, and unreliable. We had one person build a closet through bedroom wall in such a way that the water heater could not be installed. We found people raking and cleaning the yard BEFORE renovation debris were thrown out of the house into the area just cleaned. We demanded an itemized list of materials from the wholesaler and found that he claimed to be buying used materials for more than new materials cost. I remember him paying $450 for a used and rusted water heater.
Soon Thanksgiving came and his workers took off for over a week. They only returned to the house after we repeatedly complained. They worked another week and then took off almost all of December. The wholesaler claimed it was the Holiday season and I should understand that the people wanted to be with their families. However, we soon found that they were working another house.
As 2008 began the renovation was several weeks behind schedule. Progress was intermittent as we had problems with the work crew showing up. Then the wholesaler informed us that we over budget and he would need another $3000 to continue. This took us over the loan amount so we would have to pay out of our pocket (this is why he wanted us to borrow a lot more than needed). We initially paid $1,000 so his people would get back to work. Then we failed an electrical inspection and I had had enough. We told the wholesaler to stop work immediately and we would finish this house.
During this time, we had purchased another house (which I will discuss in a future post) without using the wholesaler. We attempted to use some of his more competent workers on the newhouse and to finish up the house we bought from him. This infuriated him and he claimed that we should pay him if we use people that we met through him. We dropped the idea, found our own contractors in finished the house.
In the end, we spent a total of $45,000 on this house. Our loan was for $42,000 but we used money from a loan another house to finish this one up. This house was complete, but a lot of the work was awful. The carpet was ugly commercial carpet, the paint was splotchy, and the kitchen was oddly small.
We began to show the house and although we thought it was a dump the perspective tenants really like the house. We had several people show interest but we did not approve any of the tenants. They mainly had income that we thought was too low for the rent and several had poor rental history. I have now learned this is the norm in the bad neighborhoods and I am not as picky.
Eventually, the real estate agent who worked with the wholesaler found us a tenant. Her fee was the first month’s rent and then rent was set at $600 (with a $600 deposit). This tenant paid regularly for about 10 months and then we had to evict them. This was our first eviction but it went smoothly. We used a web-based service court filing service (nCourt) to file the eviction. The tenants left voluntarily after being severed by the court (most o fmy evictions have ended this way).
Our next tenant was a section 8 tenant and stayed almost a year. Their story is strange and one day I will detail it in another post. We are now on our third tenant who has been in the house almost 2 years. We have a good long-term tenant who likes the house. Their only complaint is high heating bills in the winter ($600+) and we are looking into options to reduce this.
This house has shown me that I should not have a partner if there is any way to avoid. It is very difficult to find a partner with your goals and priorities. In this case, during the renovation my partner was very interested in craftsmanship and I was interest in budget. We really put the wholesaler in a tough position because of these differences. I did two more houses with this partner and then ventured out on my own. I will discuss these houses in a later posts.
- NEVER pay for work before it is completed.
- Do not have a partner if there is any way to avoid.
- Manage your own renovation (Don’t do them, but Manage them).
- Find your own properties – unless the deal is very compelling.
- Appraisals are subjective and I only need one if a bank requires it. I should know the property value.
|Current Loan Amount:||$41,640.52|
|Payment (escrow included):||$454.15|
|Loan type:||30 year fixed|
|Monthly Cash flow:||$145.85|
|Comments:||We paid too much for this house and I wish I did not have it. This cash flow is tiny and I have a partner. It is probably worth about $40,000 and we could not sell it for the loan balance. Its cash flow is usually eaten up by minor repairs but we have never had to put money into it.|