By Cheron Williams
Venturing into unknown territory can be a little frightening in the beginning. Despite all the books, seminars, lectures, and talks with investors, going for my first rehab property was still challenging. I decided I wanted a multi-unit building and I found a 2-Unit on the Westside of Chicago. Before buying this property, I did as advised in every real estate book, seminar, and lecture; I worked the numbers. I began to put together my rehab team and decided to partner with some of my family members. They have over 25 years of construction experience and I thought we would make a great team. I have the real estate knowledge and they have the construction experience. In addition, they do really good work. So we got together and walked through the building notating what renovations needed to be done. At the end of the inspection, we had a detailed list of the necessary repairs and I divided the renovation work logically into 4 phases. I met with my team again to review and discuss the associated costs for each phase. At the conclusion of the meeting, we had agreed on $18,000 for supplies and 25% of the total profits to cover their labor expenses. Meaning, I would purchase the supplies upfront and the team would get paid a percentage of the profits after the sale of the building for their labor.
Getting Comfortable with the Numbers
I was comfortable with the $36,502 profit that I had calculated and decided there is no time like the present. So I submitted my offer and it was accepted. I put 5% down and my loan consisted of 80/15, 3-year Interest Only, Combo Loan. Meaning, I had a $12,000 down payment and financed the remaining $228,000 in 2 loans: 1) First mortgage = $192,000 (80% of the purchase price) and a 2) Second mortgage = $36,000 (15% of the purchase price). I decided on an interest only, adjustable rate mortgage (ARM) because it allowed for lower mortgage payments and my plan was to fix and sell immediately, within three months to be exact. I even had a contingency plan in place to rent the units in the event the property didn’t sell within the three-month timeframe. Therefore, at least the rents would cover the mortgage and I would not be losing money. I closed in early November and I was officially an Investor.
So I went to Home Depot and opened a commercial credit card account to cover the cost of the rehab supplies. I gave the card to my team and I believed all was well. They had unlimited access to the credit card and the list detailing the renovation work. It was divided into four phases to be completed within a three-month timeframe. The first of December arrived and I scheduled a meeting with my team to discuss their progress. Unbeknowest to me, the demolition work was the only thing they had completed. I was completely baffled, but I got over it and together we revised the original plan in order to meet the original completion date. I was ok with the results and they promised me that they would be on it. This time, however, I planned to go check their status on a weekly basis. At the end of the first week after our meeting, I went to the property and surprise, they had not been there. Therefore, the first week of the new plan was wasted. I called the team and was told that they would be at the property the following week. Although I was once again highly upset, I accepted it. After all they were not getting paid until the project was complete.
A Week Later
The following week, I arrived at the property and the work was in progress. Yet we still had a problem, they had replaced all of the drywall throughout the building. The plan called for the basement to be completely drywalled and for specific walls in Units 1 and 2 to be replaced but not all the walls throughout the building. Now my repair budget was off by $5000. In the process of re-drywalling, some of the oak woodwork was damaged and had to be replaced. Oakwood trim is not cheap, so that added another $1000 to my repair expense budget. We had just begun and I was already $6000 over budget. The next week, while replacing the electrical outlets, it was determined that some of the electrical wiring needed to be replaced. An electrician was called in at an additional cost of $1500. Then, because the vents and the furnaces were left exposed during the demolition and drywall installation, the furnace went out. I had to call a HVAC contractor to come out to clean and repair the vents/furnaces for both units at $500 cost. Alright, at this time I’m $8000 over budget and almost two months behind schedule.
Building Still Not Complete
February came and went, and my building was still incomplete. Not only had the work not been completed, but they had steered away from the defined phases. Everything was being done out of sequence with no order and I decided enough was enough. Most of the major work had been done in the 1st and 2nd floor units, so I got involved in the painting and refinishing of the woodwork. It took me about 3 weeks to finish both levels. The next week, I started working on sanding and finishing the hardwood floors. Once again, I met with the team to discuss the progress and to hammer out the final stages of the project and we came to an agreement of how to get the job done. The next four weeks, the guys spent about one full week working on my property. My bathrooms were incomplete, the basement and the garage hadn’t been touched, the carpet needed to be laid, light fixtures hung, and a couple of broken windows needed to replaced. These were things that I couldn’t physically do and therefore I needed them to complete them. So I scheduled another meeting and this time no one showed up. Can you imagine how I felt? Another two weeks went by and I finally got a return call from the team.
I Begged & Begged
I begged them to go ahead and begged them to go ahead and finish the property. Three weeks later the bathrooms were complete and the carpet was laid. Another two months and the garage and the basement were finally complete. Toward the middle of June, I was finally able to put the building on the market for sale. It was not 100% complete, but enough was finished for potential buyers to walk through and get a feel for how it would eventually look.
Here we are in July and my building still isn’t complete, therefore my contingency plan to rent it out is of no effect. I consider myself lucky that I’m not in the hole yet, but my profit margin has decreased considerably. I’ve spent $14,770 in mortgage payment, $25,000 on repairs, totaling $39,770. I had initially allocated $24,300 to cover the mortgage payments and repairs, leaving me with a $15,470 loss thus far.
Some people say that experience is the best teacher and I can honestly say that I learned some valuable lessons in this transaction that may help you:
1) Investing in real estate is an excellent way to change your financial status and create wealth.
2) Planning is vital to an investor’s success. However, the plan must be followed and adjusted as necessary.
3) Don’t underestimate the importance of good contractors. Contractors should be properly screened. Get references and inquire about their standard turnaround times. TIME IS MONEY!
4) Hire someone to visit your property on a daily basis to ensure the contractors are adhering to the plan.
5) Don’t be afraid to get your hands dirty and take part in your project.
6) Use some precaution when working with family. Know what you are getting into.
INSIDE THE NUMBERS
Purchase Price: $240,000 ARV: $325,000 Repairs: $18,000
Closing Cost: $12,000 Mortgage: $2,110 Rental Income: $2,400
Profit: $48,670 Contractors: $12,168 My ROI: $36,502
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I’ve read this account before and I didn’t realize what bothered me about it till now – I’m almost certain that the decision to pay the contractors out of profits contributed to the delays in the completion of the job, because they didn’t have any upfront cash to work with. My experience is that contractors operate on very tight margins and thin balance sheets; the way your job was set up meant they were funding the labor out of their own pockets till the building was sold and they could receive their profit percentage, since most employees will rarely work on promises alone. They probably had difficulty doing this and because they were family members didn’t want to tell you what was really happening after having agreed to take on your project. A possibly better strategy might have been to pay them 25% of their fee up front, with graduated payments at stages 1, 2, 3, and 4, to give them the incentive of receiving cash at the completion of each stage. How do others feel about this? Does what I’m saying make sense?
Yes, Pierre, this makes a lot of sense!
I have spoken to Cheron and believe me, she agrees! The facts are you cannot hold people’s payment ransom and family will choose to be civil, at times, rather than be confrontational. I am sure she wished they would have been upfront with her about the money and the project could have been a lot faster.
Great response, we would love to hear from others on this situation and Pierre’s line of thinking.