House #2: Due Diligence

August 12, 2008 · 2 comments

I’ve talked a little bit about The Bulge House, and now that I’ve gone through some of the due diligence — and am fairly convinced I’ll go through with this purchase — I’ll go into a bit more detail…

First, here are some pictures

From a numbers perspective, I’m picking this house up at around $61,000. It’s a bank-owned foreclosure that dropped from $125K down to $70K before I put in my lower offer. Rehab costs to rent are about $12,000 (see below), and rehab costs to resell are about $25,000. If I were to resell, I’m guessing that I could currently get about $115,000, though in this market, it may take a couple months. If I were to rent, I’d likely get between $800-850 per month.

Therefore, as a rehab and sell, after closing costs, financing costs, rehab costs, holding costs and selling commissions, we could expect to earn a profit of about $10-20K. While that’s not a horrible return on what is likely to be just a couple week project, I’m not confident that this house will be easy to sell, so there is certainly a risk of over-improving and then having to rent at some point anyway.

And as a rehab and rent, assuming a 10% down payment on a 30-year fixed interest loan, after closing costs, financing costs, and rehab costs, I could expect to spend about $21,000 out-of-pocket, and earn about $100-150 per month in profit (after paying all bills and maintenance costs). This a return of about 7% on that out-of-pocket investment, which isn’t great, but considering that the property will likely sell much more quickly and for a higher price in a couple years, it may be worth a lower return for the time being. Additionally, if I refinance the property at some point, I should be able to pull all my investment out, and still earn a couple dollars per month in profit. This is a more optimal situation, as it would allow me to pull out all my cash, but still hold onto the property until the market turns around.

Based on that analysis, I’m currently leaning towards renting this house for at least a year or two.

That said, the rehab costs (even to just rent) are higher than anticipated, based on the inspection I had yesterday. While the “bulge” in the wall that I was concerned about is almost certainly not a structural defect, the inspector uncovered a number of other issues that must be addressed, even if the house were only to be rented:

  • The roof has three layers of shingle, and the weight of the shingles has caused a roof rafter to crack. The entire roof needs to be redone, and the rafter must be replaced. The roof is about 8 squares (a unit of measurement for many contracting jobs), putting the total roof replacement cost at about $3000, plus some extra for the rafter repair/replacement;
  • Both the air conditioning compressor and the furnace need to be replaced. For an 1100 sq ft house such as this, that will likely cost about $4000;
  • The water heater needs to be replaced. This will be another $1000 or so;
  • There is some evidence of prior vermin infestation, so getting an exterminator will cost about $500 (assuming some follow-up work);
  • The kitchen needs a new refrigerator (and dishwasher, if I decide to replace the broken one). I expect another $500 for these;
  • There are some minor plumbing issues (clogs, leaking water filtration system, etc). I’m budgeting about $500 for plumbing issues.

Based on those estimates, these big-ticket items will likely run about $10K.

If I choose to rent, I’ll likely add an additional $2K or so to the rehab for things like carpet cleaning, house cleaning, new mini-blinds, and interior paint. If I choose to sell, I’ll probably add another $10-15K on top of that for things like all new appliances, landscaping, exterior paint, building a patio, leveling some floors, fixing the “bulge”, etc.

The next step is to get a good roofer, HVAC guy, and plumber out to give me quotes on the big-ticket items above; these quotes need to be completed this week. Once I have those, I’ll know for sure whether I want to move forward to close on the Bulge House.

2 responses to “House #2: Due Diligence”

  1. Steve says:

    As a first time flipper. How do you get to where you are not paying for home inspections only to find out the home will need more work than what my budget will allow. I know a GC should be able to help with determining what repairs are needed and the cost associated with that. I just don’t want to be spending money for inspections and wasting money.

    Thanks in advanced for any response.

  2. J Scott says:

    Hey Steve,

    When you’re first starting out, you’ll likely want to get inspections and/or have a GC walk the property with you to give you an idea of rehab scope and cost.

    I actually have two ebooks written (one on flipping and one on estimating rehab costs) that I plan to release in the next week or two. They should help a lot, so stay tuned!

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