This article is a summary of the 5/4/22 EIC Club Conversations event of the same title. At this event, Jennifer tells the stories of two different types of investor mishaps and how you can avoid them.

Meet the “Flipper”

“The first investor had completed multiple flips during a time when the market was good for buying, renovating, and re-selling properties. This investor felt he could make a lot of money quickly through this strategy. People who are wealthy from investing don’t get rich overnight—or in one deal. It takes time, patience and a really good strategy to grow wealth.

“For the flippers who have the mantra of, ‘I’m gonna get rich and it’s gonna happen real quick’ you are in for a surprise. That type of thinking is a far-fetched goal and not easily attainable unless you really have a great team and have extensive experience.

“This investor was flipping properties using hard money loans. Many flippers are cash poor and unable to put down 20-30% to a get a loan. Hard money is not necessarily a bad thing when you can get leverage on acquisition and rehab costs. They are interest only loans over a short term, and the total is either recouped via a sale or mortgage. Hard money is really expensive—for example, if we’re getting rates at 3.5 – 4.5%, the rates for hard money are approximately 12 – 14% which is many times higher. When you use hard money, you need to have a clear exit strategy to execute within 6 – 12 months.

“This investor wanted the numbers to work so badly, he forced the renovation budget into the price he negotiated for the property. We had a hard time getting contractors that would give us quotes that would fit the budget window, and when he did get the quotes, it was always about the dollar and not about the quality. We ended up having to go with the cheapest vendor, and in the end, you get what you pay for.

“My guess was that the vendor was going to have a hard time delivering on what he promised in the time frame he promised. Time frames are critical during a hard money loan as the profit goes out the window when the time frame is not considered into the overall equation. And that’s not accounting for the mishaps and problems that show up as you go through the renovation process.

“He went with a contractor we had no relationship with and it didn’t take long for that contractor to fail. The contractor’s workers were not showing up for work and they were missing deadlines, thus they didn’t complete the job on time.

“We got halfway through the job and the contractor was far behind schedule, so we put pressure on the contractor. The investor started contacting the contractor directly and the contractor got spooked and walked off the job. By the time he found another contractor, we were paying again for the same work and were way behind the deadline for the hard money loan.

“This story’s lesson is: when you’re investing in real estate, you have to pay attention to the fine details and make educated decisions. You must plan and budget appropriately. You can’t flip a property when the contractor doesn’t finish the job and the contractor does not care what your profit is, they care that they get paid for the work. When you cut the budget, the contractor cuts corners and that will not help you when flipping a property.

“If you’re going to do any type of flip, you must have all pieces of the puzzle ironed out including a reputable contractor. That’s the first place you’ll make the bad mistakes. Have a tight time frame with buffers built in as well as a backup plan. Be fully prepared for any scenario.”

Meet the “Reserves Regretful” investor

“This story is about an out-of-state investor who was buying value-add properties. When they were talking about their spend, I’d ask, ‘How much do you have in reserves?’ When considering the J-curve, it goes down before it goes up, so you have to put more money in, hence the reserves. The building will not cash flow during renovations. Tenants can stop paying rent. You could have a leak or other issues to deal with. Cash reserves pay for the ‘what ifs’ and you should have a certain percent in reserves for those situations.

“The investors were not taking guidance and spreading themselves too thin. They wanted a large portfolio and although they bought good properties, their resistance to maintaining the properties when things came up caused more problems than they expected.

“For example, they had a heating problem and had to replace the boiler on one property for $8K. For a two-unit property, you may not make $8K in an entire year. It took them forever to face the truth—they were forcing tenants to live in an environment with space heaters running off electric, which the tenants were paying for, so the tenants stopped paying rent. In another unit, someone passed away. The insurance company wouldn’t cover the biohazard cleanup of the property. They had to cough up another couple thousand dollars.

“They bought a three-unit, and the tenants stopped paying rent. Each tenant had to be evicted. Now, there is no way anyone could see that coming but, you have to make sure you are preparing for worst-case scenarios. Consider that tenants may stop paying rent. You may have to put in capital investments you hadn’t budgeted for. Consider the cost of turning over units. Consider pest control or termite damage mitigation. You can also have issues with sewer lines. There are so many things that can come into play that will tap your cash reserves, so make sure you actually have cash reserves set aside for these moments.

“The lesson here with this story is that when you are buying heavily discounted, value-add properties, make sure you have sufficient cash reserves. You can decrease the J-curve time when you do renovations up front. Buying value-add properties is the right move. You will never buy somebody’s best investment—so you must account for the ‘J-curve.’ There are so many things that a spreadsheet can’t show you, so have the reserves in place to cover the unexpected.”