House #30: First Contract

March 7, 2012 · 7 comments

We listed The Easy House as a wholesale deal last week, and as expected, we got a ton of interest. Unfortunately, very few of the interested buyers had all cash to buy it outright, and given that we were on the fence about selling it (as opposed to rehabbing it ourselves and waiting three months), we weren’t going to mess around with non-cash buyers…

But, ultimately, we found a cash buyer who is planning to hold it as a rental, and we got it under contract over the weekend…

We are having the utilities turned-on this week, and will test the basic electrical, plumbing and HVAC systems to make sure there are no major issues for the buyer; assuming everything checks out, we are scheduled to close this one at the end of the week.

7 responses to “House #30: First Contract”

  1. Kristine-CA says:

    J: congrats on a getting a cash buyer and getting it under contract quickly! I’ll be curious to hear your thoughts after this one is all said and done. If you net 10K, give or take, on this one, with no rehab and a short holding period, won’t you be tempted to do more of those? 🙂

    Compared to your other houses, did this one have less retail potential? Less profit margin or less desirable to your first time home buyers? The holding costs of the 90 holding period shouldn’t be a deal breaker and it’s obvious that you buy right. So, wondering why wholesale?

  2. J Scott says:

    Hi Kristine –

    This one had as much retail potential as others, and the holding costs associated with the 90 day waiting period certainly wasn’t an issue. The biggest reason for wholesaling this one was that by holding for 90 days, our ROI would go way down, and I thought that wholesaling it would be pretty easy. On any project that I have to hold for 90 days, I seriously consider wholesaling, but this is one of the few that I thought I’d be able to wholesale without any real trouble, just because it was in really good shape.

  3. Kristine-CA says:

    Hi J and thanks for explaining. I’m just not that good at ROI thinking, since it’s the rare deal I’ve used my own funds for. If I’m into a property with 100% lender funds (including rehab costs) then there is no ROI. There’s only calculating the cost of the funds and how much it eats into the profit margin. If the Easy House has the same retail and profit potential as your other deals, aren’t you leaving a lot of money on the table by buying it with any of your own funds? By using your own funds, don’t you become a slave to the ROI instead of the profit? 🙂

    Since you are buying right and have a track record, you must have access to funds that would allow you to do a property like this one without anything out of pocket. That being said, you do have a lot of rehabs going and props for sale, so doing a wholesale deal creates cash flow.

  4. J Scott says:

    Hi Kristine –

    There are a lot of things at play when you are considering an exit strategy on a property. Certainly ROI and profit are two of them, but there are a lot of ancillary factors that are integral to the analysis. For example, ROI is always important. Even if you never use a penny of your own money, you still devote time, and time can very much be translated directly into dollars if you think about it. As for profit, generally more profit is better than less profit, but on a specific deal, taking less profit can mean the opportunity to do another deal (or two or three) that will increase your profit long-term. So, without looking the whole picture, it’s tough to say that an exit strategy is better or worse just based on ROI or profit.

    That’s use my deal as an example, and let’s associate some specific numbers to it (these are real numbers). As a wholesale, I’ll likely make about $6000 after holding the property for 2 weeks. If I rehabbed and resold it retail, I’d likely make about $15,000 in 12 weeks. Assuming I invested my own cash, that wholesale profit of $6K is about 300% annualized ROI. Assuming I invested my own cash, that retail profit is about 100% annualized ROI. So, from a profit standpoint, wholesaling is 40% as profitable but 3 times as good an ROI.

    That ROI number is especially important if I have lots of deals in the works — imagine if I could wholesale and make $6K in two weeks and imagine if I could do that every two weeks — in the 12 week period where I would could rehab and make $15K, by wholesaling I could make $36,000 (wholesale six times in 12 weeks for $6K each). If that were the case, wholesaling is definitely a better choice. Now, I don’t have enough deals to do that, but I do have enough deals that I believe getting my cash out quickly and moving on to the next deal *WILL* be more profitable long-term than holding for 90 days. So, that’s why I made the decision to try to wholesale.

    Now, as for your other question about financing vs using my own cash, there are a lot of things to consider there as well. First, if I have cash sitting around in a savings account, it’s fairly obvious that it’s better to use it than to borrow money and just let my cash sit in a savings account. Again, let’s use real numbers from this deal. If a typical lender would fund 100% of the costs, and require me to pay 3 points and 12% annual interest (this is somewhere between a private lender’s rates and hard money rates), it would cost me about $1900 to borrow the money for the wholesale option and about $3600 to borrow the money to do the 90 day rehab and resale.

    If the cash is just sitting in my bank account, I’d be paying between $1900 and $3600 in fees and only earning a tiny fraction of that from interest on the bank account. That doesn’t make any sense. Using your points above, wouldn’t I rather make more money than less money (by not having to pay loan costs)? So, generally speaking, I’ll use my own funds vs getting loans any time I just have money sitting around. Here’s another way to think about it — if I invest $0 and make $1, my ROI is infinite and I’ve made $1. If I invest $1 and earn $3 back, my ROI is 300% and I make $2; in the second case, my ROI is MUCH lower, but I make twice as much profit. Which sounds better to you? I prefer the more profit even at a lower ROI, especially if I didn’t have anything else to do with that $1 I was investing.

    Now, when I run out of my own cash, I certainly am willing to borrow. In this example, if I didn’t have cash, I would much rather earn $6000 – $1900 (wholesaling) or $15,000 – $3600 (rehabbing) than earning $0. But also remember, there are other things involved besides money. It takes time and effort to do a project, and even if I could borrow enough money to do 100 projects at a time, the overhead involved (hiring employees, book-keeping, etc) would likely eat up a significant portion of the profit, and the amount of profit I earned might not be worth the 100 hours per week I would need to put in to manage it all. I haven’t done the math to determine if that’s true or not, but you get the idea.

    So, I guess my basic point is, there are LOTS of things at play when analyzing deals, exit strategy and financing, and you have to really know your personal situation and your goals very well in order to ensure that your getting the most out of the deal — and by “most” I mean “exactly what you most want.”

    Does that make sense?

  5. Kristine-CA says:

    Hi J. All of what you say makes sense. It’s also a way more detailed and interesting explanation than I deserve. If there’s any chance your wife and children aren’t getting the time or attention they want and need from you, please don’t answer my comments!

    You are right in that ROI should be calculated by considering more than just cash investment, to be sure. We can always make or find more money but not more time. But my point was about ROI versus profit in our little world of buying and reselling RE. ROI isn’t what makes house payments or buys our cars or buys groceries. Profit does that. For example, MH investors LOVE to talk about ROI. Love, love, love to tell you the ROI on 1K or 3K or heaven forbid 7K invested in an MH. Don’t get me wrong, any and all positive ROI is precious, so I don’t want to knock ROI, but the actual profit number is what’s important to me. If I make 10K or 20K or 50K profit on a deal, I can compare the money to how much time I spent and how much energy and other resources I used. Then I can decide if what I’m doing can be repeated or should be repeated.

    Let’s assume that you are super human and/or could be cloned to personally supervise any number of rehabs. So, let’s look at the Easy House a different way. Your projections, using your own funds, are 6K wholesale profit versus 15K retail profit. That’s 9K on the table. 9K buys a lot of groceries. If you were to use 100% hard lender funds at the cost you describe above, that’s $3100 profit wholesale versus $11,400 profit retail….still more than 8K on the table. Again, 8K+ plus buys a lot of groceries.

    I guess my question is: was the decision to wholesale the Easy House really about ROI or is it about energy, cash flow or issues with the house/neighborhood? I finished an easy 2-week rehab in Feb for a 20K profit. Easy house, easy neighborhood, lots of buyers. I have a wholesale deal closing next week for a 7K profit and I didn’t even consider rehabbing it (tough neighborhood, tough house, tough buyer pool). The equity is there for a rehab and a 15-20K profit, but I’m not! Since I doubt you have any lack of cash or lender funds available to you, something about your Easy House had me wondering if something else was going on beside ROI. Just my thoughts, Kristine

  6. J Scott says:

    Hey Kristine –

    This is a good conversation…happy to keep discussing…

    First, there is nothing wrong with the house/neighborhood that would keep me from wanting to rehab/resell. In fact, to that point, we’ve already purchased/rehabbed one house in this neighborhood (House #25), we’ve rehabbed 2 others in this neighborhood for another investor who did well on them, just this week we acted as buyer’s agent for another investor who bought one in this neighborhood, and I currently have an offer on another in this neighborhood. So, clearly the neighborhood isn’t an issue. In terms of the house, for the wholesale, I agreed to ensure that the plumbing and HVAC were working without issue (we even replaced a couple plumbing valves, replaced a toilet and had the HVAC inspected for good measure), which was the extent of the things needed to be done to get the house in rental condition. So, that’s not an issue either.

    I think the point I haven’t done a good job of getting across is that ROI and profit are very much related, and it’s not a choice between one or the other. As an example, let’s say I had $100K of my personal cash in the business that I used to invest (it’s actually more than this, but that’s a nice round number to make things easy). While ROI might not seem like a big deal to you, it’s everything to me. If my ROI in a given year is 50%, I’ve earned $50K on my investment into the business, and that’s the money I can use to put “make house payments” or “put food on the table” as you would say. If my ROI is only 40%, I have less money to pay myself; and if my ROI is 60%, I have more money to pay myself. So, in actually, ROI is just another term for “profit” in my business. The higher my ROI, the more profit I make.

    This is the reason why I consider ROI for things like The Easy House. Sure, my profit is smaller ON THIS ONE DEAL. But, because my ROI is higher than if I rehabbed/resold the property, my profit is bigger LONG-TERM. And because this is my business, I’m in it for the long-term.

    In terms of your example about assuming I was super human and could be cloned to do any number of deals at once, I’m not sure that’s a good example. The truth is, there is a real cost to scaling up the number of deals we do, and if we were to do just 20-30% more deals than we currently do, we’d likely need to hire another person, which would dramatically cut our ROI until we started doing twice as many deals — unfortunately, scaling is a step-function in terms of profit (not linear), so 20% more deals doesn’t necessarily mean 20% more profit. Btw, your example would be like me saying, “What if you were super human and could clone yourself to work 100 full-time jobs — you could make $5M per year!” Obviously, that doesn’t work in real life.

    In the end, the biggest determining factor in wholesaling The Easy House is actually something I haven’t yet mentioned in our discussion — opportunity cost. I know how much money I could make if I held The Easy House for 3 months ($15,000, as I mentioned previously). So, the real question is, “By wholesaling The Easy House, will I be able to parlay the cash I pull out to make more or less than $15,000 in that same three month period. I’ve already made $6000 in the first two weeks of that period, so can I make more or less than $9000 in the next 10 weeks using that $53K investment?

    Given the math — the fact that we earn about $20K on an average deal in an average of about 100 days, that’s $200 per day, which is $1400 per week, which is $14,000 in 10 weeks — mathematically I should be able to make more money by pulling out the cash and starting on the next deal. If the math indicated otherwise, I’d happily do otherwise. And in this case, if we hadn’t wholesaled the deal, we would have happily rehabbed and resold it — that was our backup plan given that the math supported that as the second best option.

  7. Kristine-CA says:

    Thanks for your thoughts and for explaining the biggest determining factor in your Easy House wholesale vs. retail decision. “Opportunity Cost” is something I can and do relate to. Never thought of using that phrase, but that’s what it is. Could I make more by cashing out here and putting it to work there.

    I understand where you are coming from with ROI. Your example of $100K is good, because a fabulous and consistent return on 100K is something I can get excited about. I just don’t get too excited about great ROI on a 3K MH or fantastic cap rates on investment props renting for $350/mo.

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