How to go $85k over budget and take 15 months to complete

[Spencer Carpenter]

This is going to be a long post, but I felt it was worth taking the time to make because even after listening to nearly 150 episodes of BiggerPockets, there were still so many things that we missed, didn’t think of, or we (my partner Bob and I) simply didn’t know going into our first project.

Our first purchase was a 5-unit in Harrisburg, PA in June of 2018. Many of the multi family in the area were once large single family homes that have been converted into multi-family, so it consisted of (2) studio apartments and (3) 1 bd/1ba units. The property was brought to us by a property manager (PM) who knew Bob and was the PM for Bob's employer, who also invested in the area. The PM knew a contractor (GC) that walked through the property with us and provided a scope of work. Asking price for the property was $130k, but we knew it needed a lot of work so offered $100k and settled on $110k. The property was purchased with $20k from a private lender and a $90k from a hard money lender (HML) with a rehab budget of $45k. Between our real estate agent, PM, HML and GC, we felt we had assembled a great team that all agreed this property was a good opportunity.

A month after settlement, we did another walk through with our PM and GC to discuss the project more, time line, etc. To our modest disappointment, it sounded like the level of finish we wanted to accomplish was a little bit out of our budget and we will have to make some concessions, but roughly 85%-90% of what we had talked about originally was still in play, so we thought nothing of it and started the process of evicting the current tenets. Bob created a very thorough document with the products we liked, complete with pictures, pricing, serial number, manufacturer, dimensions and presented to the GC. After roughly 2 months of going through the eviction process, it was mid-September. We scheduled a final walk through to go over the document before getting started a week later. Before the final walk through could happen though, things soured between Bob and his employer, which we worried could create a conflict of interest between us and our PM representing our best interests. We did the walk through and the tone from the PM and GC had dissipated further, now saying only about 60-65% of what we wanted could be accomplished based on our budget. This seemed to confirm our suspicions of a conflict of interest with out PM, so we began looking for a new PM and GC to work with.

After a quick search on BiggerPockets, I found a property management company I wanted to meet with. The company was only a few years old, but the had grown tremendously and provided in-house GCs, plumbers, and bas electrician services at near-cost to keep pricing and response time minimal, making a great service for this customers. After meeting the owner, we were told they also had a team that could handle full rehabs and that our budget and turn around time wouldn’t be an issue. We were sold and signed with the company that day. The day after our meeting, we were assigned a project manager by the company, and we met for our first walk through the following day. Already having a scope of work from the previous contractor, our list of products in hand, and tenants removed, the new company could hit the ground running. Hitting the ground running is exactly what they did, but this is where our first major issue comes in.

Besides changing up our original team early on, dealing with bed bugs first week, and one of our tenants dying the second week, we hadn’t had too bumpy of a road. The PM company started doing work almost immediately. The GM said he would get permits filed, but was friends with all of the inspectors and guys over at codes, so they wouldn’t care if we got going a few days early (central PA is a pretty relaxed area). Now to some of you, this might be unheard of and a red flag, but to us, we didn’t think twice about it, because we didn’t know how unorthodox that was. It wasn’t until the end of November that we even learned that a permit needed to be displayed in the window of our property, and work began at the beginning of October. We learned this when a flooring company came to give a quote and their salesmen pulled us aside and told us we shouldn’t be doing work in there yet because it didn’t appear we had permits. As far as we knew a permit was in a filing cabinet back at the PM’s office. We were relying on the GM, a representative of our PM, to teach us what we didn’t know and act in our best interest. Luckily, no inspector came knocking, but it was clear to us that our team was disorganized and were routinely not completing work in the time frame given to us.

When I originally approached our HMLs, they were skeptical of us. It was a mom and pop operation out of Philadelphia and they had never done a deal in Harrisburg. With us being new investors in a market they were unfamiliar with, it is easy to understand why. We scheduled a time to walk the property with them in May of 2018, however we weren’t able to get into most of the units. Instead, we walked them around the area, told them about on our vision, and sold them on us as new investors. Fast forward to the end of November, after learning of our change up in PM and contractor, never having seen all of the property, and being behind schedule, they wanted an update and a walk through before providing out next draw. We asked our GM to send the most up to date list of completed tasks and scope of work and forwarded it along to our HMLs. However when we walked the property with our HMLs, they immediately saw no permit in the window and were extremely alarmed, as that would NEVER happen in a market like Philadelphia. We continued the tour, however the list we were sent with completed work was far from accurate. Debris was everywhere, old appliances were on site, hazardous materials were in the basement, all items that were said to have been removed. There was water damage to a ceiling in one of the units they had not previously been able to see, which greatly concerned them, and there was no apparent logical work flow of what is being completed on the project. Many of the things they expected to see completed were all suppose to have been paid for with our first draw. Naturally, after this meeting, they were not confident in the project, accused us of not allocating funds correctly (which breached our contract), and over all felt as if they had been duped by the new investors they lent money to.

Naturally we were frustrated with our GM and explained the awkward walk through we just had with our HMLs. A week later we received an email from a lawyer that represents our HML's with a list of demands that were to be met or they were going to foreclose on the property. They wanted proof of the GM's license and insurance, hazardous materials removed, permits pulled, all accounting, etc, all while the industry is preparing to take a break for Christmas/New Years. We somehow managed to complete everything on the list in a short amount of time, however the HMLs wanted out of the position and were demanding we get them out before the end of the year, meaning we need to find a new lender during one of the longest industry shut downs of the year, while also paying for the fees associated with a new HML.

We brought all of these issues to the attention of the PM team and we were assured that our property was the number one priority of the office, but it wasn’t true. The following several months were exactly what you could expect based on the information I’ve already laid out about the team we hired. I’ll spare all of the details and specific issue, but work not getting done when said, mistakes on the job, numerous delays, stretches of days when work wasn’t done to our property at all, and over all most of the work was mediocre at best. The electrician we hired also took significantly longer than he was supposed to, but when we confronted him about it, his reasoning was because the PM wasn’t completing work on their end that needed to be done for him to do his work. Same thing with the flooring company. This continued until our GM ultimately quit the company all together citing he was over worked, understaffed, and just unwilling to trade the stress and the blame for money (ironically getting a job at Codes office of all places). Our new GM was now an admin person that handled scheduling of repairs at the company, not even someone with a construction background or much knowledge of what goes into a rehab. We considered firing the company at this point, however the end seemed so close, so rather than have yet another set back, we continued with the PM company.

We persevered, taking down issue after issue. We were fortunate enough to have a tenant approach us that wanted to rent all five units to house the recipients of her non-profit, children that were in the foster care system, but are now adults removed from the system and still need assistance. We worked on getting one unit done at a time to get people in ASAP, as these young adults were homeless in the meantime. It was not until the end of August 2019 that we finally let our PM team go, concluding what still needed to get done we could hire GC’s we knew and trusted to complete, however we are still (December 2020) paying for multiple issues that arose after the PM’s dismissal the was a result of their sub-par work, over $10k in water damage and plumbing issues from letting galvanized pipes sit for 6 months without water running through them and not correctly connecting drains to showers leading to water running down the walls of the building for months.

Beyond the terrible experience with the PM company, only one other speed bump caught us - the refinance process. The building was a 5 unit, which meant it required a commercial mortgage. We knew to expect this, but we did not know how exactly their criteria was set for a valuation. The arrangement we had with the current tenant was a 2 year lease, the tenant provided a resident assistant to take care of minor issues around the property (at their expense), and the tenant essentially was the property manager. So the way we saw it, we could knock 8% off the P/L for property management, cut out 8% vacancy costs, cut out turn over costs and cut out some of the repair/maintenance. Taking these expenses out gave us an ARV of nearly $300k on the P/L. When going into the project, our best case scenario was originally $245k. Naturally, we thought we were finally having a change in luck, however when the appraisal came in, it was for $230k. The reason being that just because our specific situation lent itself to fewer expenses, that is not the situation the bank would be in if it took ownership of the property, so they added those expenses back in. While this was a bummer, we could pay off out second HML, most of our vendors, but would need to come out of pocket for some of the expenses and the loan from the private money lender.

Ultimately, the project took two PM companies, three GCs, two HML companies, two lawyers, 15 months to complete (11 months longer than expected), and went roughly $85k over budget, but we did it. While this was a very difficult first project, there are a few key take aways I want to share with new investors:

• - Referrals are important. This isn’t news. Just about every BiggerPockets guest has talked about it, but we didn’t do our due diligence and check referrals before going into business with out PM company and that is 100% our fault. Not only was the work and service not good, but these were the people we relied upon to act in out best interest and somewhat guide us. Instead we had to tell them when they were doing poorly every step of the way.
  
• - You don’t need to have any background in construction, electric, plumbing, tiling, etc to get into real estate, though knowing some basic knowledge is extremely helpful. If you only know ONE single thing about rehab side of the business know this: If you don’t have a permit in your window, assume the permit hasn’t been pulled and work should be done.
• - Be sure to keep your HML's up to date with your situation. We didn't choose to not tell them what was happening with the project. I think with how quickly things were moving, we just forgot and really didn't consider that they actively cared to know. Had we told them, when we changed up our team, adding delays and holding costs and eating into our original draw, they might have been understanding. We also decided to buy some utilities preemptively, taking advantage of a holiday sales, thinking our project was going to be done in 3 months, they might have backed that idea. It had not occurred to us that the order of how the money was spent was of importance to them, as long as the project was moving forward and they got paid back. Considering they ask for a draw schedule from the contractor, maybe we should have taken that as a sign (though our second HML was much more lenient and didn't care how money was spent at all), we could have saved a lot of faith with them had we just kept them up informed of what was happening.
• - Lastly, try not to over complicate things an re-invent the wheel. Our issue with re-financing came because we tried to get TOO creative with things. We tried to get TOO creative with our vanities and sinks, choosing IKEA products that our laborers didn’t readily know how to put together, and getting replacement parts was a full day’s task. Getting creative was find when we knocked out a couple walls to make the apartments better, but just be aware of how much you’re deviating from the proven systems if you’re going to get creative - it could cost you more in the long run.