Residential rehab

While there are fewer distressed homes in the Greater Madison market, house flipping (aka rehabbing) remains a vital part of residential real estate.

From the pages of In Business magazine.

Unlike the scary days of the Great Recession, when so many residential properties were distressed or under water, there aren’t as many homes to flip in the now red-hot Madison residential real estate market, but that doesn’t mean opportunity no longer comes knocking at the door.

Local home rehabbers — the terms practitioners prefer over “house flippers” — are still finding enough “flippable” homes to buy, fix up, and put back on the market at a higher price. Even with the lowest housing inventories in memory and the real estate recession no longer even visible in the rearview mirror, there are situations in which homes have been vacant for an extended period of time, and they exist in a variety of neighborhoods — low-income, middle class, and up.

That’s somewhat of a surprise to Ron Restaino, founder and owner of Restaino & Associates in Madison, who notes there are no longer a large number of distress sales. Five years ago, people who wanted to acquire and flip houses had any number of options, including foreclosures and distress sales of one kind or another, and homes were selling at bargain-basement prices. Today, with the number of active listings falling below the 1,000 mark countywide and prices rising dramatically, it is the very definition of a seller’s market.

“The market is so hot that homeowners don’t have to worry,” Restaino says. “There will be multiple bids. We’re getting 10 to 12 offers on properties in a 24-hour period, most of which are over the asking price.”

The concept of house flipping is just as its name implies. In the wholesale context, somebody buys a property and immediately transfers it to someone else. In most situations, however, a bank or a private investor will provide the capital to buy and rehabilitate the home before it’s placed back on the market, where the hope is that its sale can generate a profit large enough to make the process worthwhile.

Chris Hake, president and founder of the Madison Real Estate Investors Association (REIA), and a partner in Madison House Buyers, says the average residential investor — probably 90% of them — is not buying many deals because they are trying to buy from the same place, the local Multiple Listing Service. As Hake explains, with inventories at a low point, “that pond is pretty dry.” Between 2007 and 2010, Hake almost exclusively used the MLS to buy all of his properties, but it has been about three years since he purchased a property listed there.

Instead, Hake and partner Matt Rockett spend their time and resources looking for off-market properties via direct mail, postcards, flyers, the internet, Craigslist, networking, and simply knocking on doors. That’s why they buy more properties than most. “Far too many investors are using the MLS as their primary source for finding properties, and in this market that is a very difficult place to find deals when it only takes one of those investors fighting on the MLS to overpay for a property,” Hake notes. “There are too many investors fishing in the same pond for the exact same fish.

“The few investors in the market today that do not rely on the MLS and spend the majority of their time, energy, and resources marketing to find the off-market properties are the ones finding the deals and therefore doing deals more consistently.”

John Schneider, president of Property Revival, a real estate company that remodels homes, notes there is situational value in homes, and this is what creates the opportunity for investment. “Sometimes, somebody just needs to get out of the house in a 30-day period, and they need the cash and they need it now,” he explains. “They are going to take 10% less or 15% less than it’s actually worth because I have a buyer right here, right now who is willing to pay cash and sometimes that’s the thing that creates the opportunity for investment.”

In the past two years, Property Revival has found most of its properties that way, including where there’s an estate sale but the owner doesn’t want to put the home on the market because it’s in bad shape. “It needs to be a trash out, as we call it in the business, where there is still half of the previous homeowner’s stuff in the home and they don’t want it anymore. It’s either going to be given to Goodwill or to the [Habitat for Humanity] ReStore or thrown in the garbage.”

Despite the occasional unscrupulous flipper, the house-flipping process usually is a win-win scenario for all the stakeholders — seller, rehabber, realtor, buyer, and municipality. If done right, desperate sellers get something for their property, rehabbers make a tidy profit, realtors make a commission, buyers can move right in without facing a gauntlet of improvements, municipalities see improvements to their housing stock, and all local taxing jurisdictions benefit from a higher property tax base.

No flippant calculation

The key to profitable flipping is to find a property where the economics make sense. According to Schneider, it’s about analyzing profit margin. “Margin is actually the biggest defining factor in any investment, and in real estate it’s no different and it’s certainly a big factor in terms of how well you’re able to remodel and turn a house, based on how much margin is there when you purchase it,” he explains. “You typically make money on any real estate investment on the purchase.”

What goes into that calculation? It starts with an actual acquisition cost and then the future value, or what realtors call the after-repaired value (ARV) of a property, and then defining how much it’s going to take — the cost of the remodel — to get to that ARV. “That will leave you with what the remaining margin is, and you have to factor in how much time it’s going to take with holding costs, and then your sales cost, and all those factors,” Schneider notes.

Randy King, business development partner with Madison REIA, says the organization obeys the 70% of ARV rule. Say a property is worth $100,000 after renovations are made. “My math right off the bat would be I’m going to take 70% of that ARV, of that $100,000, so now that takes me down to $70,000, so that’s my starting point for my negotiation to purchase,” King explains.

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Using a repair estimate worksheet that lists all the possible repairs, the next step is to figure out how much it’s going to cost to fix that property so that he can sell it for $100,000 ARV. If that number is $20,000, he subtracts that from the $70,000 figure, and now his not-to-exceed purchase price is $50,000. On the flip side of that 70% ARV is 30% represented by the fixed costs that will be incurred in transitioning a property from the seller to the eventual retail buyer. Fixed costs include holding costs, utilities, taxes, and realtors’ commissions, and they vary depending on how long it takes to sell.

The gutted-out rooms of a home being rehabbed on Madison’s west side by Chris Hake (left) and Matt Rockett. Both men say that eight years after the recession, there are still plenty of homes to acquire, rehabilitate, and place back on the market.

A small percentage — 3% to 5% at most — of the market rehabbers cater to are people with houses in distress because of death, divorce, a pending move, or money problems. Even for sellers who sell below market value or the value of their mortgage, the benefit extends beyond getting whatever money they can for the property. The value is sometimes getting rid of a property that for whatever reason they just can’t deal with anymore. “That has a huge value,” King says, “and I would say it’s sometimes a much larger value than the money piece. I cannot tell you how many times we sat in closings with the sellers and they have just given our guys a big hug because it’s like, ‘Oh my God, you’ve taken this burden off the plate for me.’”

That’s not to suggest that every property is flip-worthy. Hake, who has been a realtor for 20 years, sometimes has to bluntly tell people who want more money for their home that he can’t work with them, and he will refer them to realtors.
“If I pay you what you need for the property, I’m taking on your current situation and that’s bad for my business,” he explains to them. “This is what I do 100% of the time, so from a business standpoint I run my business around formulas. If the formula works, then here are my numbers. If people need more money to pay off other debts or something, we walk away from those deals all the time because people need more then we can offer.”

Rehabbers can use an appraiser or rely on real estate agents, and Schneider views the latter as a good way to determine a property’s value at a lower cost. “Truthfully, investors who are looking to find value in real estate need to do their own homework and figure out what that neighborhood has been selling for average, good, and great properties, as far as the condition and the finishes, to know if there is upward mobility,” Schneider says. “What we use is a dollar-per-square-foot average sales price. Let’s say the low price in that neighborhood is $125 per square foot, and the high price in that neighborhood is $200 per square foot. Well, if you’re buying a house for $110 per square foot, and there isn’t that much remodeling to do, and you know you can get it done for $15 per square foot or $20 per square foot, you know there is margin to be made.

“It is more of a numbers game than people perceive,” he adds. “We really need to crunch the data to find that investment, and make sure it’s a valid one that we can earn a return on.”

What is considered an appropriate range for the profit margin? King says a project will earn anywhere between $5,000 at the very low end for a wholesale in which investors or purchasers do nothing but marketing and negotiating, all the way up to $30,000 for a really good, high-end remodel. “That will be our take away from it if we’re lucky,” King states. “Between this point and that point, there is a huge amount of risk that we undertake. Some of the factors include market conditions because in real estate, that can shift on a dime. We could have another crash like we did in 2008 and everything will go away.”

Schneider plays the percentages. “Ideally, what you want to have is at least 12% on your investment, and actually that’s fairly low. Most investors are looking at closer to 20%, and I think between 12% and 20% is reasonable. There are unforeseen expenses that come up and you want to have a contingency budget, but even that contingency budget can be exceeded and that 12% can turn into 6% really fast.”

Luke Bruckner, a realtor for Bunbury & Associates in Madison, has flipped houses himself, and he wants to make at least $30,000 on each transaction. “That makes it worthwhile to me,” he states. “The time it takes to make a flip, at least with me doing my own real estate, my wife helping me with picking out everything, being the general contractor and organizing the plumbing and electrical work, it can be anywhere from a four- to six-month process. So I look at that and say, ‘Well, if it’s $15,000, it’s really not worth it.’ I’m not spending that amount of time for $15,000.”

Finer points of financing

With rare exceptions, Madison REIA’s primary financing source is private lenders, and most of its private lenders are regular people with low performing 401(k)s, individual retirement accounts, and other investment vehicles. “We have them invest into our properties and the returns go right back into their 401(k) and IRA tax-deferred or tax-free, depending on the structure of their instrument,” King explains. “What we find is that we don’t need very many private lenders because as soon as one of them does a deal with us, he’s harassing us for the next one because the returns are so good, and it’s safe, it’s secure, and it’s wholly insured. It’s far safer than investments in securities.”

Using private lenders expands the number of people who can be investors. “We don’t solicit it,” Hake says. “It’s friends, family, and associates who know that we’ve been in the industry and we have a track record that makes it easier to do this. We’re not soliciting in magazines and on the radio. That’s a whole herd of trouble. We’re not securities brokers.”

Schneider does some private financing, but he prefers banks. Typically, banks lend at about 75% of the after-repaired value, although some will go to 80% of ARV.For homeowners who buy and remodel a home and then live in it, meaning the investment is for themselves, banks will lend up to 90% of the after-repaired value. “The difference between banks and different lending institutions — all kind of offer their own niche as far as where they are willing to lend — is that some of them are more aggressive on the investment side and will go to that 80%, and some are less aggressive depending on their particular appetite for that investment,” Schneider says.

Since time is money, prolonged property hold times are the bane of a rehabber’s existence, but that’s less of a problem in today’s residential real estate market because there is so little inventory. For King, six months would be the high end of a “hold,” with three months of that taken up by the rehabilitation process.

“If you rewind the clock eight years, you had to know what you were doing because you had to buy right, and you had to make the necessary repairs because the people coming in to buy had a lot of choices,” King explained. “To get their attention, you had to be the best-priced and best-looking property or you were going to have those long hold times. We’re just on the other side right now.”

Once a property is remodeled, rehabilitation companies generally hand it over to a listing agent and they sell it just like a conventional property. Residential realty executives believe house flipping makes selling homes easier, with one caveat. “The short answer is that it’s easier — if it’s done well,” states David Stark, president of Stark Company Realtors.

Stark offers a word of caution to would-be house flippers. He notes that a lot of people think that buying and trying to turn a quick profit on real estate is the right way to go, but generally speaking that’s not how real estate works. “In the big picture, I always say real estate is a get-rich-slow rather than the get-rich-quick investment,” he states. “The only way you get rich quick is if you’re able to spot an unusual value.”

Flipping over labels

Home rehabilitation professionals cringe a bit at the label “house flipper” because it has a negative connotation associated with making a quick buck. “We’ve flipped close to 200 houses over the past 10 years, and we really don’t even call it flipping anymore,” Schneider notes. “We are full rehab specialists. We’re not really buying many houses where you’re just putting paint and flooring in and putting it back on the market.

“Most of our projects are large-scale remodels.”

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“Rockett Man” flips career script

Matt Rockett was one of Chris Hake’s first pupils in the Madison Real Estate Investors Association’s real estate coaching program, and now he is Hake’s partner in Madison House Buyers, a business that buys, rehabilitates, and sells houses.

Hake, who also taught the subject at Madison College, estimates that Madison REIA has educated about 270 people about the real estate investment process, including home flipping, since its inception in 2012. Real estate investment is a team sport, and not only was Matt, aka the “Rockett Man,” the very first student, he was the first person to graduate from the coaching program Hake helped develop through REIA.

Matt Rockett in front of the home being remodeled on Madison’s west side.

Interviewed at the site of a home being rehabbed on Glacier Drive in the Parkwood Hills neighborhood on Madison’s west side, Rockett recalls enrolling in the real estate coaching program in early 2013 and advancing through it in about 18 months. Rockett and Hake have been partners for more than two years, and in that time have rehabilitated more than 30 homes, mostly in Dane County.

Prior to that, Rockett served in the Marines and worked in the trades — heating and air conditioning — in his late teens and early 20s. “I remember doing a lot of heating and air-conditioning systems in houses that were being flipped, and I was wondering why I wasn’t on that side of it,” Rockett recounts. “That’s kind of what sparked the interest. Six or seven years later, I finally got into it.”

Rockett has one characteristic that complements Hake’s real estate experience and connections — a zeal for the marketing aspects of home rehab. “He was my best student, and that’s why we’re together,” Hake says. “He’s got a gift, too, for diligence and his tenacity with the marketing.”

Rockett handles what he calls “front-side marketing,” which involves working with prospective sellers and occasional frank talk about the purchase price, and getting the properties under contract for closing. “Chris pretty much takes over after that,” he notes. “When we close on a property, he follows through with the contractor and the other important pieces — insurance, title companies, private-money lenders — all the way through to the end-product.”

The split-level dwelling on Glacier Drive will be completely overhauled for a cost of between $150,000 and $160,000 by late June, and sold for between $400,000 and $500,000. “Obviously, the housing market in Madison is doing very well right now,” Rockett notes. “Our plan is to finish this house with some pretty high-end stuff because of the nice neighborhood.”

The house, first built in 1974, has been vacant for four years after the original owner was placed in an assisted living facility and, for a variety of reasons, the children could not maintain it. It came to the attention of Madison House Buyers through a family realtor friend who concluded it was not in a condition to list.

Hake notes that Madison House Buyers has done two properties in the neighborhood in the past year and a half, “and you will probably never drive through there and think, ‘Wow, those houses have been vacant for four years,’” he states. “There is more of that happening than people believe.”

In some cases, the city is coming after homeowners because they are no longer in compliance with city codes, and neighbors are calling the city because the property’s deteriorating condition is taking down their property values. There are any number of scenarios, and even with a strong residential real estate market, there are plenty of homes to rehab.

“We look at a lot of houses, but we don’t buy all of them,” Rockett says. “They definitely have to be the right fit. It’s typically stuff where the owner either inherited the property or in this case, it was vacant for four years. It’s more or less distressed houses, but not always. Sometimes, it’s the motivation of having to relocate to another house and time is the issue.”

Hard business

Hake calls the REIA program a “real world” version of the house flipping depicted on cable television programs, some of which suggest the process is much easier than it really is. Investors and rehabbers who buy into that are in for a rude awakening. “Then they get into the real world and they get into their first deal and they realize that everything is work,” Hake notes. “If it were that easy, everyone would be doing it. It takes work like anything else does, but with the education and having realistic expectations, you can do great things.”

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Giving rehabs their due diligence

Norah Fox and Ian Gort are pleased with their new, remodeled home on Madison’s north side, but they applied the same due diligence to a home that was given new life as they would if it were brand new construction.

The upgraded look of a rehabilitated home, now owned by Norah Fox and Ian Gort, on Marcy Road in Madison.

For $282,500, they recently purchased a rehabbed ranch-style home that had been in foreclosure for more than one year and vacant for quite a while.

The most important parts of it were redone — everything from sanding and staining hardwood floors and kitchen cabinets, to the installation of new tile and carpeting, repairs to part of the roof and various window soffits, and completing unfinished portions of the basement. As they waited to move in sometime in late May or early June, a new air conditioning system was being installed on their dime.

“When they restored things, they didn’t just knock down walls,” says Fox, referring to work arranged by Chela O’Connor, co-owner and founder of CJ Family Properties. “They restored it to be what it started out as, which was a modern home. It’s still has its original design character, and it’s still funky and fun, but updated.”

The improvements were documented along with various permit applications required by the city of Madison, and they had the added benefit of having the same inspector who examined the building as a foreclosure also inspect the home for prospective buyers. From his previous work, he knew which improvements had to be made.

The couple’s advice to others who are considering whether to buy a rehabilitated home is to approach it with the usual due diligence because less than reputable flippers are only interested in maximizing profits. “In terms of looking at what’s been redone, it’s important to have an eye for quality material,” Gort explains. “Inside the houses we had seen, everything looks brand-new, but upon closer inspection you had apartment-quality materials. In certain transitions, you could tell where some things ended and other things began because of the quality of materials and quality of craftsmanship.”

With the home they purchased, Fox cites what she calls the “unsexy updates” such as modernizing the mechanicals, including a new boiler and water softener. “Those things are not as flashy but they definitely give us a lot more confidence that these people were not just out to make a profit,” she states. “They actually paid attention to updating the home.”

Fox, a business analyst for Therma-Stor, and Gort, who works with the national register program of the Wisconsin Historical Society, have lived in Madison for 10 years. When it came time to make this big decision, they benefitted from the help of a realtor — Mary Duff of Stark Company Realtors. “I certainly have known people who were burned by flippers,” Fox notes, “but our realtor knew exactly what to look for and was our best advocate in every situation.”

“It’s important to have a working partnership with your realtor because some realtors would like to offload you as fast as they want to offload the house,” Gort states. “Having a realtor that’s going to look out for your best interests and who would be your best advocate is certainly important for buying any house, but especially so for a house that has recently been flipped.”

Market dynamics

According to Randy King, business development partner for the Madison Real Estate Investors Association, homeowners who want the best quality should be aware that in a strong residential housing market, house flippers might settle for more of a basic, rudimentary rehabilitation job because they can do that and still the sell a house in a reasonable period of time. For example, they might use good material such as high-resolution laminate countertops instead of high-end granite countertops.

“There is so little inventory and there are multiple offers on properties that are in poor condition, and all the ones that are in great condition, because they’re fighting over the low inventory,” King explains. “We now sometimes don’t have to go to the same extent.”

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