All Forum Posts by: Harvard Hill

Ben - good question.  I would definitely try to negotiate more favorable commissions because it is a huge cost for flipping projects (second only to the renovation costs).  Just be careful how you structure it so you don't take too much incentive away from the agents.  Typical commissions in my area are 6%, split evenly between the buyer's agent and seller's agent.  I tell agents that scout for properties for me that I'm quite happy for them to retain the full 3% commission on the buy side and that I will list the property with them once I'm done with the rehab at a commission of 5% (3% to the buyer's agent and 2% for my agent).  This translates to a savings of around $7k for me on a typical deal.  I wouldn't push them too hard on a discount on the buy side because the agents will just take deals to someone else.  I also don't want to discount the commission for buyer's agents on the sale side because agents won't be as inclined to bring their clients to see my property.  I'm certainly interested to see what others out there are doing.

As the title of the post implies, I need some help determining the best structure for my real estate business.  I've flipped four houses over the last year and a half with my business partner and we're working on our fifth, so it's time to take it to the next level.  The key points of how we're setup today are outlined below and we are really trying to position ourselves so that we can go to the banks and try to establish a commercial line of credit.  We're also trying to think through the other implications around taxes, insurance, etc.

Key Points:

• I have an informal business partner
• We both have LLCs
  • He is a General Contractor that performs the work under his company name
  • My LLC is in place but all of the properties are purchased under my name because I must personally guarantee the loans
• I handle all of the finances, accounting, permitting, deal analysis and all of the other desk jockey work
• He handles day-to-day project management, hiring of the subs, material procurement and other GC activities
• Profits are split 50/50 with some adjustments made based on individual capital investments
• I essentially receive all proceeds from the sale of the homes and write a check to his GC company for the reno costs and his profit share
• I have a full-time job with an income/credit sufficient to allow me to purchase homes to renovate
• He formed his GC company ~1 year ago and does not have sufficient proof of income to secure loans

I think those are the basics for what we are doing.  Now time for the questions:

• Should we maintain a similar structure with the homes being purchased under my LLC and have his LLC perform the GC work?
• Should we form a new LLC that purchases the homes and retains all of the profits while only reimbursing his GC company for actual costs incurred?
• Should the work be completed by the new LLC or his GC LLC?
• My LLC and the potential new LLC won't have insurance so is it best to leave the work under his GC LLC that is insured?
• Any potential tax implications?  Hint:  I know the answer is yes here.
• How should I approach a bank for a commercial loan? Better with a single LLC or should I try to set it up with mine while indicating the work is completed by his experienced GC company?

I know this is a long and complicated post, but I would really appreciate any help that can be provided.  As a real estate investor I've come to be a firm believer in Karma so, in return for your help, I will share some of my experiences over the first year and a half of house flipping under separate posts to help build this community.

I’ve been dreaming of flipping a house for the last five years or so and trolling the BP forums for the last six months. BP was a big factor in getting me comfortable enough to pull the trigger and buy my first investment property, so I wanted to share my results in order to help others get over the ‘paralysis of analysis’ and just go for it.

Background

About two years ago I started talking to a good friend of mine, who happens to be a licensed contractor, about real estate investing. He shares a passion for real estate and construction and we decided to pursue a flip. We looked on and off for about six months with no luck, so we decided that we would start looking at new construction opportunities. We pursued this for another six months with a third investor, but were never able to get everyone lined up on a project. At that point we had increased the amount of capital that we had available to invest, so we went back to looking at flips. We made four or five offers, but were outbid (or too slow) in all cases. Then my partner went to look at a new listing (without me because I have a full-time job and was unable to get away) and he called me later to let me know that this one had a lot of potential. I reviewed the few pictures that he sent over, pulled the comps, ran the economics, discussed it with my agent and decided to take a leap of faith and make an offer. After one counter ($2000 reduction in seller subsidy) we had a fully ratified contract.

Yes, that’s right; I made an offer for my first flip sight unseen. That’s probably not a recommended practice, but I have a lot of faith in my partner and my agent. That is when, of course, the panic set in. I just purchased a house for $362k that needed ~$35k worth of work. No turning back now, so that’s when the renovation began.

Renovation

The plan was to gut and rebuild the kitchen and bathrooms, replace/refinish all of the flooring, replace all of the lighting, repaint, complete extensive landscaping and other odds and ends. We found that, as the rest of the property started to improve, the windows and the roof looked even worse, so we ended up adding these items to the scope of work, which as you know, put a significant hurting on our budget. We felt that the rising market justified the improvements, so we plowed ahead.

After beginning the renovation we discovered every investor’s worst fear, a FOUNDATION ISSUE. After the initial horror faded away we decided to pull the floor up and underpin the foundation, which resolved the issue. We lost several days, and several dollars, while this work was completed, but we felt that we had to handle this for the future owners.

About three quarters of the way through the renovation our primary subcontractor started asking for a significant amount of money in change orders, which we rejected and then he just stopped showing up all together. We, of course, fired him at that point and brought in a second contractor to finish the work. Unfortunately, we paid the first contractor a little too much too early, so we ended spending a little extra to bring someone in to finish the job.

After four weeks (and weekends) the project was compete and we had a home that we could be proud of. We listed the house and waited, and waited, and waited some more. A month went by and we had a lot of showings. Everybody loved the house but no offers were forthcoming. We tried to rationalize what the issue was, but at the end of the day it was the price. Isn’t it always? We dropped the price and had two offers within the week. We closed a month later.

Results

Purchase price: $362k

Closing costs (purchase): $9k

Renovations: $63k and four weeks

Holding costs: $4k (three months)

Closing costs (sale): $33k

Sales price: $550k

Profit: $79k

Lessons Learned

• If you think a buyer, or an inspector, might see it as a problem – Fix it

  • One of the things that will stress you out more than anything else is worrying if an issue will be identified that will derail the deal, so just fix everything for your own peace of mind and because it’s the right thing to do.

• Always have a signed scope of work

  • Don’t negotiate with a subcontractor verbally and assume that they will remember the discussion the same way you will. Subcontractors will conveniently recall that what you asked them to do wasn’t part of the original agreement. The moral of the story is, always document the work to be completed and the price in an SOW.

• Just because you ‘can’ do it doesn’t mean you ‘should’ do it

  • I’ve developed some skills over the years and I applied many of them during this project, but it took its toll on me after a while. If you’re not careful you can exhaust yourself physically and mentally, so while you can save some money by doing things yourself, it’s probably better to have your contractor handle most things (if not everything).

• Pay karma first

  • The house had been on the market for a month and we just went through our first price reduction. The stress was mounting and we needed to find a buyer quickly to free up our cash. I was lying in bed one night trying to figure out why the house wasn’t selling when it came to me. I hadn’t paid karma yet. While investing most certainly is about making money we can’t forget that as we succeed we have an obligation to the rest of society. That night I decided that I would take the first $1000 of profit and donate it to charity and the next day I had two near full price offers come in. I told my partner this and he chose to do the same thing. Now this has become one of our guiding principles ‘Always give back’.

• Price it right

  • We ambitiously listed the house for sale on the high side of the comps and watched it sit for a month before we reduced the price by $25k. In retrospect, it would have been better to start lower and get a quick sale in order to move on to the next project.

• Have faith in those around you

  • I’m a bit of a control freak and I feel like I need to be involved in almost every decision. One of my growth opportunities is to learn when to let things go and let someone else handle it. I have resolved to let my partner (aka contractor) take more control over the renovations and to empower my real estate agent more as well.

• When budgeting for your project if you think you might need to replace something, put it in the budget.

  • Don’t talk yourself into a project by assuming (hoping) that you won’t have to replace something. It’s better to put together a conservative budget and if the numbers still work your budget, and profits, can only improve. We found ourselves adding to the project in order to take advantage of an improving market and our reno budget increased from $35k to $63k. Just assume that you will do everything from the beginning and you won’t get as much heartburn as you move through the project.

Principles

We learned a lot through this process and we’re looking forward to our next project (set to close in a week). As our business grows we thought that it was important to set some guiding principles. Those principles are presented below for your consideration and as our reminder.

1. Do the right things the right way

2. Only do projects to be proud of

3. Always give back

With that – I would like to wish you all the best of luck with your endeavors and just remember that you can’t win if you don’t play the game.

-Harvard Hill