The Haywood Houses: Fixer-Uppers part 2

Haywood houses were a textbook example of the kind of proper­ty that can make poor investors a whole lot richer in a reasonably
short time. As investors often say, “This property had all the right things
wrong with it.”

Classified Ads Can Sometimes Lead to the Gold Mine

I found Haywood in the classified ads one Saturday morning. The ad read as though it were written especially for me. The described property sounded almost perfect. I responded quicker than flies to a picnic.
By the way, let me pause to emphasize an important point here— speed pays off. When you hear about a deal that sounds really good, check it out quickly, especially if other people will know about it—like in the classifieds.
Here’s how the Haywood ad was worded:
Income property for sale—2 duplexes plus 7 older cottages on 2 acres in city limits. Growth area—future commercial zoning. Property needs work—low down payment. Owner will finance for 10% interest. Price $189,000. Capital Real Estate Co. 413-4567.

The first thing I did was call the real estate office. The agent was off that day, so I called him at home. Somewhat reluctantly—after I prom­ised that, if I liked what I saw, I would immediately call him back—he finally gave me the property address. He wanted to represent me if I decided to write an offer; he was the listing agent and had high hopes of representing me, too. That way he would get a 100% sales commission.
After looking at the property and deciding it was definitely what I was looking for, I called him back to set up an appointment. I was ready to make an offer. But first, allow me to flash-back to what I saw at Haywood.
The location was excellent. It was in the east area of town where all new growth was headed. Although nothing exciting was going on at the time, I could sense future commercial zoning. Naturally, I’m always happy to have commercial potential when I buy properties; however, I won’t pay extra for “pie in the sky”—and neither should you. That’s called speculating. What I’m doing is investing.

Find What You’re Looking For and Act Quickly

The one word that best described the Haywood houses would be “neg­lect.” And, as you will soon learn, neglect is worth big bucks for us do-it-yourself fix-up investors. As you might guess, it’s easy to procrastinate or fiddle around too long with an offer on ugly properties like this. Don’t— because you’ll lose them.

I was pleasantly surprised to discover that the “duplexes” in the ad were really four individual, two-bedroom houses. Detached houses have more appeal to tenants because they offer more privacy and individual liv­ing. Also, the older cottages were not actually cottages. Rather, they were older houses of various shapes and sizes. Some even had garages. On the issue of “property needs work,” no one would have questioned that. The tall weeds and brush growing among and around the houses was so high it nearly hid them. Several junk cars were scattered about, fortunately hidden by the weeds.

1. Besides the high weeds at Haywood, there were a host of other things that made the property ugly. Let me list them, so you’ll know what to look for next time you visit a potential money-making opportunity.
2. Unsightly yards, dead grass, unkept trees, high weeds.
3. No painting done for many years, bare wood, peeling paint, or repul­sive colors on buildings.
4. Broken-down fences, porches, sheds, carports.
5. Ugly roofs that distract from looks of houses or buildings.
6. Broken and bent, nonworking garage doors—or lack of doors.
7. Exposed “pier-type” foundations with accumulated junk shoved underneath the houses.
8. Falling-down fencing and ugly entrance porches that looked like ten­ant “add-ons.”
9. Inoperative vehicles or, even worse, vehicles sitting on blocks with no wheels.
10. Piles of junk strewn about property, including stolen shopping carts.
11. External fixtures falling off houses—like gutters, fascia boards, gates, window trim, shutters, screen doors, porch lights, ugly amateur-built add-ons, and broken windows covered with cardboard.
12. Unsightly pens built with chicken or hog wire and scavenger mate­rials.
13. Unsupervised dogs and stray cats running around everywhere.
14. “Spider-web” wires, overhead electrical and telephone lines running in all directions. Very unsightly.

Fixing People Problems Is Worth Big Bucks

Besides the physical things wrong with the Haywood property, there were also people problems. Fixing people problems pays big bucks—the same as fixing house problems. In many cases, owners become so fed up or intimidated by their tenants that they are willing to sell out for much less than the potential value. Here are the most common types of people prob­lems I’ve encountered.

1.Scary-looking people with tattoos who hang around property drink­ing beer and working on junk cars.
2.The motorcycle crowd—where one or two legal tenants move in, then all their biker friends become permanent guests.
3.Loudmouth renters who constantly yell, fight, and scream, causing good tenants to move out.
4.Deadbeat tenants who pay only when you chase them down or catch them with cash. Most are always behind with rents.
5.Renters who attract a constant stream of visitors, especially nights and weekends. (Dopers do this.)
6.Uncontrollable tenants who routinely violate the owner’s rules. Examples: allowing unauthorized live-ins to occupy premises, haul­ing junk cars onto property, and doing substandard alterations to liv­ing units (houses or apartments) without the owner’s permission.

I’m sure I could think of several more; however, the six I’ve listed here should be enough to acquaint you with the basic people problems. They are the main sources of fuel for what I call “the fed-up factor.” Many own­ers become sellers because they get fed up. They simply get sick and tired of nonconforming, deadbeat tenants robbing them of the earnings they anticipated. Their dreams are shattered.
The Haywood owner had a mild case of “people problems” when I arrived—and it helped me a great deal in negotiating an excellent price and terms. Sellers will make big concessions when they lose interest in their property. In this particular case, the seller had moved to another town and asked me if I would mind overseeing the property while we waited for escrow to close. He had no interest in even visiting his proper­ty again. Whatever his real estate sales rep and I decided to do was per­fectly all right with him.
Smart investors in this situation can fix short-term people prob­lems in exchange for receiving valuable long-term benefits. For exam­ple, I could remove and replace every tenant within six months—maybe less. That’s a short-term problem easily corrected by a knowledgeable landlord.
In exchange for knowing how to solve tenant problems, I will expect to purchase the property for anywhere from 20% to 40% under the nor­mal market price, with a small down payment (5% to 10%). I am also expecting long-term owner financing (10 to 20 years). These are excellent benefits for a buyer—plus, they are long-lasting. They’re exactly the right ingredients for making a bundle of money with a fixer property.

Flexible Sellers Provide High-Profit Opportunities

The seller wanted $30,000 cash down, which I didn’t have. I offered $195,000, with $15,000 down and two additional principal payments of $5,000 each, the first due one year after close of escrow and the second due two years after close. You’ll notice that my offer is $6,000 more than the asking price in the newspaper ad. I was hoping that, if I paid a high­er price, the seller would accept a lower down payment and give me good terms on the seller financing.

The owner counteroffered, asking $20,000 cash down. He wanted three $5,000 lump payments instead of two. He also agreed to carry back a note for $175,000, for 15 years, at 9.5% interest. One big concession I asked for and got was that my payments for the first three years would only be $1,200 per month. After three years, I would increase the payments to $1,500 per month, which was the amount the seller wanted initially. I explained that $1,200 was all I could afford based on present rents; later, after I upgraded the property and increased the rents, $1,500 per month payments would be acceptable to me. The seller agreed and we signed the deal.

Flexible Financing Made Haywood Work

My Haywood houses were a perfect example of seller flexibility. He origi­nally wanted a $30,000 cash down payment, which I didn’t have. I was lucky to scrape together $20,000 cash. To come up with even that amount, I had to borrow on my overloaded Visa card. You’ll notice that the seller allowed me to make a smaller down payment if I agreed to make three future principal payments. I agreed to pay $5,000 payments at the end of the first, second, and third years following the close of escrow.

The seller originally wanted 10% interest on his carryback note—I offered 9.0% and we compromised at 9.5%. That seemed fair enough at the time. However, even at 9.5%, the interest payments alone on a $175,000 promissory note were more than I could afford starting out. Here again, the seller was very flexible. He allowed me to make reduced payments of only $1,200 per month for the first 36 months. I agreed to increase the payments to $1,500 or more per month starting at 37 months after close of escrow.
Obviously, during the first three years, the monthly payments were less than the 9.5% interest stated on the note. There were no accumu­lated payments or add-on interest to this deal: we simply agreed to reduce the monthly payments to $1,200 for the first 36 months. Until then, the seller would not start receiving his full 9.5% interest rate on the note. This concession alone saved me over $6,600 in interest. Now you can understand the reason why I agreed to the extra $5,000 princi­pal payment.
If you will recall, my original offer specified only two $5,000 princi­pal payments. As it worked out, the interest rate I paid during the first three years was slightly over 8.0% and not the 9.5% interest stated on the note. The lower mortgage payment ($1,200 per month) was extremely beneficial to me, because my rental income was quite low to begin with. I knew that after I cleaned up and fixed the property, it wouldn’t take long to increase the rents to market level. I felt that the current rents were about half of what they would be after two years of my ownership.

Good Financing Sets the Stage for Big Profits

The good seller financing I was able to obtain was the key that would allow me to unlock big profits later on. I did not try to beat the seller down on his asking price. In fact, I paid him more than he was asking, but the terms he gave me were well worth the extra money.

The terms of the financing you get when you purchase a property will directly affect your profits when you sell. They will also determine whether or not you’ll get cash flow from the rental income. A 15-year mortgage term is about my average seller carryback. In my view, any­thing less than 10 years should be avoided, unless there are special cir­cumstances involved. Examples might be purchasing property for a very substantial discount—say 40% or perhaps zero-interest financing.
Several years ago, I started acquiring larger single-family houses with my extra rental income. My objective was to buy them for 10% cash down and get the sellers to carry back mortgages for their equity (owner financing). I prefer situations where I can assume loans, because I don’t like to refinance the property. My plan with these larger houses is to break even on the rents and expenses starting on the day I acquire them. These types of properties appreciate much faster than my small houses and make excellent long-term investments. They can also be sold to users (home­owners) as well as to investors. Users buy with their hearts rather than their heads and will often pay 10% to 15% more.
It’s much easier, with seller carryback mortgages, to customize the payments in order to balance out the income with the expenses. Owners are much more flexible than banks. My longer-range plan is to complete­ly pay off one house every year. Naturally, I always allow myself an extra year or so for miscalculations.

Clobbered Financing Won’t Work
A common mistake that far too many investors make is becoming overly concerned about how much they pay, rather than how much time they have to pay it. Here’s what happens: It’s very difficult to sell properties with “clobbered” financing (lousy terms). Buyers will shy away from lousy terms. Typically, buyers want to pay so much cash down and assume some “nice and easy” long-term financing. If you cannot offer that, it gen­erally makes your property less desirable to the buyers. It also means your profits will be less than they could be. When the financing is short-term, it’s likely the monthly payments will be so high that it’s impossible to ever achieve cash flow. Also, most buyers are very leery of big balloon pay­ments that are due three to five years after they purchase the property.
Looking for Loans in All the Wrong Places

Many deals I’ve witnessed will go like this. The investor buys an older property for $50,000. He’s able to buy it for $1,000 cash down, because it’s a real “dirtbag” property. However, the seller wants the $49,000 balance in five short years. Older properties are always tough candidates for acquiring conventional bank financing, even when the loans are variable-rate with extra high points and low loan-to-value (LTV) ratios. The seller in this case agrees to take $500 monthly payments, including principal and interest (mostly interest). Obviously, there will be a large balloon pay­ment of over $40,000 at the end of five years.

The buyer figures he can clean up the property and fix whatever needs fixing. After that, he intends to sell or refinance the deal to make his profit. The problem with this strategy is that few buyers will purchase an older property with a $40,000 loan due in just five years. That means refinancing is necessary and that can be very expensive.
If you sell to a homeowner, he or she will need to qualify personally for the loan, as well as the property. This can be a real hassle and it often takes a long time. Worse yet, there can be many added expenses before everything is done. Obviously this means less profit for you.
If you sell to an investor, you can almost forget a refinance with non-owner occupancy lending rules. Naturally, it’s tougher with older proper­ties. Even if you find a lender, chances are the only type of loan you’ll get is one where you are personally liable, in addition to securing the loan with the property. It will also be a short loan, which means 50% to 65% of the lender’s conservative appraisal.
Many lenders will not allow sellers to carry back a note for any part of the financing. This means the buyer must have a larger down payment. Investors don’t usually pay large down payments. Before you’re through, this seemingly simple straightforward transaction can turn into a real horror story. Worse yet, with $500 monthly loan payments, there’s a good chance you’ll never be able to rent this property high enough to have cash flow, should you keep it. My advice: Don’t do deals like this—they’re much too risky for such a limited profit potential.

Fixer Skills Turn Ugly Duckling into Beautiful Swan
Let’s get back to my Haywood houses. I want you to see how just one property can be enough to give your real estate career a tremendous financial boost. In terms of plain old profit making from start to finish, I earned a respectable $8,000 a month for my “hands-on” fix-up skills and management.
I want you to understand that the skills I’m talking about are skills easily learned by anyone. Mostly, my skills involve cleanup, hauling junk, and various other jobs that make a property look bright and shiny when I’m done. I call it “grunt work.” Equally important is my technique of rear­ranging the tenants, a management technique that I call “tenant cycling.”
When I buy a property in rundown, junky condition, I most always inherit tenants who are similar in condition to the property. You can’t fix one without the other, because they go together like a pair of shoes. They are different parts of the same problem.

Getting a Tan and Building Your Bank Account

I spent the better part of one full summer doing outdoor work on my Haywood property. Sometimes, I would hire a handyman to help me. Several houses were in desperate need of major cleanup from top to bot­tom. They all needed painting. I started my inside fix-up on the first vacant house after a nonpaying renter decided it was better to move.

The most dramatic change was the cleaned-up appearance of the property as you drove in—a job that took about two months to complete. Mostly, this process consisted of lots of cleanup and cutting down the overgrown trees and bushes. First, we chopped down the high grass and weeds around the houses, then we started watering all day. We sprinkled on new lawn seed to speed up the process—and, after four months, all the yards were green as the city park. Like I tell my seminar students, it’s extremely important to first make the kind of improvements that show. That means you should always haul away the junk, clean up the yards, evict the junky tenants, paint the building exteriors and fences, and any­thing else that shows, first, when you drive up.
People passing by the property will notice your work immediately, especially if the property has been a real “scumbag” for a long time. Often passersby have stopped to tell me how nice the property looks since I started working on it. Everyone appreciates seeing ugly, rundown houses fixed up and made attractive again. Occasionally a deadbeat tenant I’ve just evicted for nonpayment of rent will stop by and say to me, “This place really looks great. I don’t guess I’d mind paying the rent now.” Unfortunately, most deadbeat tenants seldom mean what they say.

To Make Big Money You Need a Profit Plan

Before I completed my Haywood purchase, I had already penciled out my profit plan several times. My “ballpark” estimate for fix-up was $20,000. That amount included all the painting, fencing for several front yards, and wood-panel siding on three houses to improve their looks. I also planned to replace four garage doors and install new carpets in six hous­es. I always install new window coverings, either drapes or mini-blinds, when I “rehab.” There were several leaking water lines to fix and several new sewer clean-outs that had to be installed to open up sluggish lines. Naturally, as with most fix-up houses, the maintenance and repairs were long overdue. According to the tenants, no one, including the owner, had ever been seen fixing anything. The tenants who stayed with me (only three) were delighted with the change of ownership.

The End of a Very Profitable Season
Two wonderful things happened to me during that summer. First, I got one of the best suntans I’ve ever had. Second, I earned about $75 an hour while I got the tan. By Christmas time, I had eight new tenants and my rents had increased from $1,650 a month to $2,940. In case you need help with the math, that’s $1,290 a month more than when I started. I consid­ered that to be a very sweet return for my fix-up work. By the way, my actual fix-up costs eventually totaled about $18,000, which even included the interest charges on my Visa cards. I was very pleased with the way things turned out—and even more satisfied that I accomplished the task for less money than I had estimated.
Waiting for “Mr. Good Buyer”
Haywood survived the winter nicely and suddenly it was summer again. Income properties in my town were scarce, and it seemed like the timing was about right to make a decent sale. I ran the following classified ad to test the water:
11 houses 2 AC. Commercial—good tenants—annual income $38,400—low dn. Great terms—10% owner financing $350,000. Call Jay today—won’t last long.

The ad was right—it didn’t last long. The second offer turned out to be the buyer. The selling price was $345,000.
I sold Haywood with the following terms: $50,000 cash down pay­ment with an “all-inclusive” note and trust deed (wraparound) for the bal­ance of $295,000. Payments to me were $2500 or more per month, all due in 13 years. You may recall the payoff date on my $175,000 note when I purchased Haywood was 15 years from close of escrow. I timed my carry­back note to match the balloon payment I would face in 13 years.

I hope you can see the financial benefits of buying the right kind of property—property that can be improved quickly, inexpensively, and with owner financing. Haywood was almost the perfect handyperson property. When it sold, I got back my $20,000 cash down payment, along with the $18,000 fix-up costs and a little extra cash to boot. Also, I was now the beneficiary on a wraparound promissory note that paid me $1,000 a month net income for the next 13 years.

Remember Haywood the next time you drive by a junky property with ugly houses and high weeds. Think about the hidden profits. Would you take on a summer’s worth of work for $150,000 profit? I’ve had many jobs in my lifetime that paid me substantially less.
To be Continued . . .

Fixer-Uppers part 1
Fixer-Uppers part 3

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