November 3, 2013
New real estate investors often make mistakes on their first rehab. Here are a few common errors to avoid.
Poor Due Diligence
Before being committed to making the purchase of a property you have under contract, you will have a due diligence period. The due diligence period is stated in the purchase contract. This is the period of time you have to do your homework. Some of the things you want to determine include the following:
Sales Comps – You should have had a very clear picture of what the resale value of your property before you put it under contract. Now that you have the property under contract, double check the sales comps. A new sales comp may further confirm the accuracy of your previous comps, but it may also reveal that you made a mistake running your numbers. This is your opportunity to renegotiate the purchase price or terminate the transaction if needed.
Rehab Costs – You will need to develop a scope of work (see below) for your renovation project and get written bids from qualified contractors and workers. Your rehab costs should include an extra line item budget for cost over-runs.
Closing Costs – You will have to pay some attorney or title company fees, finance charges if you borrow money, and other costs associated with the purchase. You don’t want to go to closing with a surprise that you need to bring more cash than you calculated. Ask your title company to provide an estimate of the closing costs. In most cases, you will be able to get a preliminary HUD-1 statement soon after you send the ratified contract to the attorney or title company.
Holding Costs – If you are borrowing money, you need to calculate how much your interest charges are and add them to other holding costs such as taxes and insurance. In some cases, you may have housing association costs.
Zoning and Permits – You may be required to pull permits in order to complete your home renovation project. If you are adding square footage to the structure, you should also check with the planning and zoning department to make sure your plans don’t violate the zoning code.
Investors who fail to make use of the due diligence period to do their homework prior to closing on an investment property may be in for a shock. Do your homework!
Lack of Scope of Work
It’s imperative to develop a scope of work for your home renovation project. During the due diligence period, you should develop a detailed scope of work with a line by line list of expenses for each item.
New investors who fail to develop a scope of work will muddle their way through the rehab. Guessing what you might do before you get started and then bouncing around between repairs in a haphazard way is a recipe for failure and significant cost over-runs.
Poor Quality Workmanship
Some new investors try to cut costs by not hiring qualified workman and licensed contractors.
Some unscrupulous investors try to cut corners and hide repairs by covering them up cosmetically. Don’t do this!
When you developed a scope of work, you determined the repairs and improvements that should be made in order to get the resale price target. Do the work well.
Make all the repairs and improvements with excellence. Then when the buyer’s home inspector visits the property, you can be confident about the report. There usually will be a few very minor things that may need to be addressed, but a rehab done right with quality workmanship will make the buyer happy and motivated to get to the closing table quickly. This helps you to meet your resale target date and avoid extra holding costs (i.e. you make more profit).
Refusing to Provide a Property Disclosure Statement
Many owner occupant buyers will expect you to provide a property disclosure statement (also known as the seller’s disclosure statement).
Since you learned about the property during the due diligence period and did a great quality rehab, you should proud to disclose the property condition and renovation performed.
The rehabber who refuses to fill out and provide a property disclosure statement will cause concerns in the minds of potential buyers. Refusing to fill out the property disclosure statement sounds like you have something to hide.
Buyers will withdraw their offer if they suspect that they are dealing with an shady investor who is deliberately concealing known problems with the property.
Ignorance of the Home Mortgage Process
If you are reselling your rehabbed property to fetch maximum resale price, you are most likely selling to the typical owner occupant retail buyer. Such buyers will rely on a traditional home mortgage.
Home mortgages can be conventional, FHA, VA or variations of these. You will want the buyer to provide a letter from a qualified lender or mortgage broker stating that the buyer is pre-qualified for a home mortgage. This is often the best you can expect with most buyers. If it’s a hot seller’s market and expect multiple offers within a few days of putting your rehab up for sale, you will have the luxury of some buyers who will provided proof of funds or a stronger lender letter.
In the real world, many buyers who are pre-qualified actually begin the loan application process with their lender when they have a fully executed purchase contract. Many lenders will not begin the processing the application until the buyers has a property under contract.
Some new investors expect to find a buyer who is better than average. Good luck.
In most cases you will have to wait through the home mortgage process as the buyer works with their lender jumping through all the hoops to satisfy the underwriters. This process should take about 30 days and should be factored into your estimated holding time for the project.
Assuming There Will Be No Glitches
Every real estate rehab project has glitches. Things may not go smoothly getting to the closing table at purchase. The closing may be delayed for one reason or the other.
You may discover new information during the due diligence period that will require you to change your scope of work or renegotiate the purchase price.
You may run into problems during the renovation project.
The contractor you lined up for the project might get delayed because of a family emergency.
The buyer may suddenly get disqualified for a home mortgage because the underwriters discover that the buyer made a last minute purchase of a high ticket item which puts their debt to income ratio out of balance.
The market may suddenly change and you may have to reduce the price to sell quickly so that you don’t lose money on the project.
Avoiding Rehabbing Mistakes
Real estate investors who plan their rehabs, do a quality renovation, and who manage the project from beginning to end are the ones who consistently make a profit with each property resale. Avoiding mistakes that are easily avoidable will help put you on the path to being a profitable real estate investor.