WHEN YOUR REHAB GOES SOUTH
What You Can Do When Your Rehab Takes a Wrong Turn
How can real estate investors turn it around when rehab projects don’t go as hoped?
Fix and flip projects don’t always go as expected. That’s a given. It’s what you do when things get off track that makes all the difference in the end. Taking the rhinoceros approach and just charging ahead, oblivious to the financial minefield, is not a strategy. The property investor with an eagle eye for spotting issues early, who has the bigger-picture view, will have the edge in turning potential pitfalls into bigger rewards.
Why Rehabs Go Wrong
Real estate rehabs, like any renovation or building project, can go off in the ditch really fast for a variety of reasons. Sometimes it is simply the result of poor planning and more specifically:
•Forgoing property inspections and thorough due diligence
•Not conducting further testing for mold, meth labs, and Chinese drywall
•Over (or under) rehabbing for current market conditions
•Failing to obtain accurate contractor quotes in advance
•Failing to get good contractors on the job
•Under budgeting (money and time)
•Not budgeting for overages
•Failing to stick to the budget and scope of work
•Taking the DIY approach on items that need a professional
Other rehab issues that can impact newer real estate investors include:
•Falling in love with the wrong property and trying to force it to work
•Paying contractors before they finish their work
•Failing to secure the property during and after rehab
•Ignoring final inspection requirements
•Changes in local property values
•Damage from natural disasters
•Bad contractors who don’t alert you to issues or watch your budget
Coping with Over Budget Issues
The impact of all of these issues generally hits you directly in the budget. If your budget gets blown too far out, you may be lucky to get out without heavy losses. Many novice investors have bankrupted themselves by rushing in without education and with no financial reserves to back them up. In these circumstances:
Step 1: Reevaluate the deal and the numbers (where you are, what you can afford).
Step 2: Reestablish priorities.
Step 3: Ensure that you have access to the money you need to complete the deal.
Step 4: Get going fast, and objectively.
Step 5: Document the issues and remedies, and create better systems and rules for next time.
What’s most important is getting the property into a livable and salable condition. If you can’t do that, things are likely to only get worse. A habitable, salable property still offers you multiple exit and financial options.
Where to Save
Real estate investors who get stuck can find ways to save and still finish the job.
You can save money on:
•Appliances
•Where you shop for materials
•The quality level of materials
•Eliminating low ROI items
•Patching and repairing versus replacing
•Negotiating to pay contractors after you cash out
Where Not to Skimp
Do not skimp on your marketing budget!
Your marketing budget is what is going to get the opportunity turned into profit and get cash coming back in. Every day, holding costs are eating into your bottom line to cash out—or, for the buy and hold investor, it means loss of cash flow.
Focus on getting the property into a livable and marketable state while still accounting for all of your expenses and desired profit.
When Investors Need More Money
What if you absolutely need to come up with more cash to finish the project?
Watch these two golden rules:
1.Raise more money as early as you can.
2.Protect your credit so that you don’t get cut off from capital.
One of the worst mistakes that new real estate investors make is immediately turning to their savings and personal credit cards to try to finish the project. All too often this results in completely running out of cash and destroying credit ratings to the point of not being able to borrow. Once you are in that place and the property still isn’t livable, you may not even be able to afford to file for bankruptcy. Pull in partners—money is attracted to opportunity. If there’s an opportunity to make money, partners and funding will follow.
Working with Your Lender When You Need More Money
There is a chance your current lender will provide more cash, but you have to ask. And the earlier, the better. This is especially true of alternative lenders, asset-based lenders, and commercial real estate and specialist rehab lenders. They may be able to “open up” your loan and provide more funds. If you have lender money in escrow to reimburse you for repairs made, you might be able to get that money early, too. Lenders usually don’t want to risk losing their capital and will want to work with you, if you can show them some better numbers. Go in with a game plan.
Other Capital Sources
Your existing lender may not be able to help and may be very wary about throwing good money after bad. You should be cautious here, too. It may be better to eat the loss, for a clear exit, rather than gambling more money on the unknown.
Before you tap your children’s college tuition or the retirement funds or destroy your credit rating:
•Ask other mortgage lenders about a refinance.
•Apply for a different type of loan if the property is in livable condition and value is up.
•Look into home equity loans and lines of credit.
•Check out business loan lenders and business lines of credit.
•Don’t overlook friends and family for cash or partnership possibilities.
Four Strategies for Turning Your Rehab Nightmare into Cash
1.Complete your rehab using lower-end finishes and rent it instead of selling it (if your funding is secured for a longer term).
2.Sell it as-is and cash out versus renting it out.
3.Offer the property “designer ready” or have the buyer pay for custom finishes.
4.Try “pre-habbing” or “whole-tailing,” a hybrid that’s a step up from simple wholesaling but not quite rehabbing for retail sale.
TAKEAWAYS
Suppose you have a rehab under way. You take stock of the project and discover that you are $5,000 over budget and at least two weeks behind schedule. What can you do to get your project on track and/or minimize losses?