Love Austin Homes Investing Blog

I thought I might share with the group a startling trend I have been observing… Mistakes!

Obviously, we all make mistakes from time to time, however, over the last several weeks, an increasing high number of deals have rolled across my desk, from investors that got into trouble, and are now looking for a way out. It feels like a trend, possibly from the vast influx of newbies into investing, or perhaps just from too many people trying too hard, or maybe it’s the more sophisticated investor market?

Here are some examples (and warnings) from lessons learned:

High-End Remodels:
I’ve come across 4 deals where a so-called ‘experienced investor’ convinces a ‘newbie investor’ to get the loan (presumably because newbie has better credit). In one deal, they buy home for $720K (more than asking) and take some equity out on the buy (supposedly for the remodel and a hefty assignment fee). Then the experienced investor splits. Newbie goes on to spend $65K on remodel and finds out home is only worth $700K ARV. Loss: ~$155K! Investor is toast. I’ve picked up 4 of these deals as short-sales. I think this is basically a scam.

Lesson learned: Don’t put your credit on the line unless you REALLY know what you are doing.

Short Sales and Foreclosure/­REOs:
I’ve come across several deals where an investor buys an REO or short sale to renovate and resell. In one case a guy bought two homes for $115K each, spent $5-10K remodeling, and discovered he could only resell them for around $115K each. Loss: ~ $20K/deal. Investor is toast. This usually happens to newbie investors that rely on newbie realtors to find their deals, and a belief that making even modest improvements in any home will always magically make the home worth much more than the cost of the improvements. (I call this HGTV syndrome)

Lesson Learned: If there are lots of Short Sales and REOs to choose from before you buy, there will be lots of REOs and short-sales to compete with when you sell. Do your homework.

Rushed Deals:
I’ve come across several deals where an investor buys a home, usually in a hurry, without fully sorting out what the remodel needs. In two cases an obvious foundation problem existed ($20K!). In one case the investor never saw the inside – which was trashed ($30K). In another case, several hundred feet of space could not be utilized ($50K+). Despite the fact that these deals had margin in them, the investors made no money or lost a lot of time and a little money because they under analyzed.

Lesson Learned: Do your homework and don’t cut corners.

Second Liens:
I’ve come across several deals where investors bought homes (subject-to) without title insurance (and only having done a quick title search) only to find out later that additional liens existed. In one case, taxes were owed. In another a Genesis tax lien existed ($14K – interest baring). In another a Neighborhood Gold down-payment assistance lien existed ($8K). And finally, in one situation a past tenant showed up with a lease-option contract that said he had the right to buy at a price $50K below market value. Owch!

Lesson Learned: Get title insurance and/or don’t do transactions beyond your skill level.

Is this a trend? Not sure, but it sure feels that way… Is anyone else seeing this sort of thing?

Phill

Phill, you make some excellent points. Your recommendations seems sound.

Many investors (esp CA investors) made a TON of money last 2-3 yrs
in Phx, LV, CA, FL..even places like Bend OR, Salt Lake City Boise
ID, doing pre-con flips, OR just merely buying resale houses on the
MLS and renting them. These markets were heavily driven by
investors (as well as pop growth, job growth, low rates). The real
estate mantra for making money changed from: “location, location,
location” to “timing, timing, timing”.

Lot’s of CA investors have descended on the Texas markets as well.
Most have lower expectations for appreciation here then they did in
these other locales. And rates are higher now then they were then.
Plus, if CA home prices start declining, the investors there will
feel less wealthy and may pull back there buying spree.

Many CA investors buy in the brand new developments on the outskirts
of town (like Kyle, Buda, Cedar park, etc…). This is what they
did in all these other cities mentioned. I’d be interested in
hearing what folks think the chances for appreciation are out in
these suburban places It seems like *suburban* Texas just never
really “pops” in appreciation. Everyone says there’s is too much
land to build with too little regulations for growth to force
appreciation (of course they used to say the same things about
Phoenix that it would NEVER appreciate b/c it has so much buildable
land and it’s too hot). Plus Texas has the highest property taxes
in the entire United States, thus further capping appreciation.

So far it does not seem like the burbs are appreciating much. It
seems like all the appreciation is in close in Central Austin and
West hills. Maybe high Central prices will force more further out
to buy?

ANSWER

I too have observed the phenomena of watching CA investors come in and buy NEW construction in Round Rock, Cedar Park, Leander, Kyle, etc. They seem to be happy paying near retail. I buy in the same neighborhoods through pre-foreclosures at a big discount. I don’t understand why most of the CA investors don’t want my pre-foreclosures, which are often 1-3 years old, and at the bigger discount than new homes (even after repairs).

The other phenomena that seems odd to me is watching CA investors buy $175K - $225K homes as rentals. They don’t all do this, but many do, and given that the majority of the rental market is $900 - $1200/mo, it would seem like it would be very difficult to rent these and /or you would have to take a lot of negative cash flow on them.

I have kept, as rentals, some homes I’ve picked up in these out-laying areas. They have not performed well compared to my homes in central Austin. They are harder to rent. I don’t really feel like they will do as well in the future as my central Austin properties. I’ve got to find a screaming deal (<$55/ft) before I’ll buy and keep a rental in Round Rock, though I’ll flip them all day long.

I am very curious to see if the raising prices in Central spill out into the suburbs where prices have been flat or down and you really can get a lot more house for the $$. I’m also curious how all to toll roads and other road construction will affect prices. I’m personally hoping some of the CA cash influx will cause some price inflation here like it has in other places. My guess is that prices in our out-laying areas have been so low for so long, that they should begin to creep up (maybe jump up), but only time will tell.

UPDATE: We are still waiting for prices to raise in the outlying areas. As we have studies this further over the last two years, we have developed a comprehensive appreciation model - our conclusion: most of these areas are not expected to ever appreciate to a level that would make them worth owning rental property in.

Phill

We have a house that we lived in that we want to turn into a rental and
transfer ownership to a limited liability corporation. I realize
that this an legally cause a due on sale event. From your experience, as
long as we continue to pay the mortgage, does the mortgage company ever care?

Thanks.
Jane

ANSWER

Jane,
As a practical matter, it is VERY UNUSUAL for a lender to call a loan that is being paid on time regardless of whether the home was sold or not. I can give numerous examples.

My only fear would be in the even that at some future date interest rates shoot up AND the foreclosure situation subsides. In the past, in this environment, loans have been called.

Phill

Short story: Bought a house that had been moved onto a lot. Intent
was to do major remodel and flip. Inspection was performed at the
time of purchase and there were no major problems noted, except for
the fact that the house is on cinder blocks and is not bolted down.
8 months later, remodel begins. Kitchen sub-floor was torn out
showing the house sitting atop cinder blocks that have been “rigged”
and have pieces of wood between the blocks and the house that act as a
levelling device. (See photos in “Barbara” photo album.) More
importantly, the foundation beams are 12 feet apart, not 7 (8?) feet
per code which is apparent when walking throughout the house and there
are places that “give”. Before remodel can continue, the house has to
be jacked up and have posts cemented in place 6 inches below surface.
Estimates have come in between $4,000-$12,000. Not quite sure just yet
if the foundation beam problem is in fact a problem.

Question: is there any recourse? Is the inspector liable in any way?
The realtor? The seller? Anyone? Or have I just learned my first,
very hard lesson on buying a house “as-is”?
Barbara

ANSWER

Barbara,
Sorry to hear of your misfortune. I buy lots of pier+beam houses and unfortunately, many of them are propped up on cinder blocks, cedar posts, or worse. Many have improper beam spacing, rotting beams, and incorrect shims (they are supposed to be metal, and can only be so thick). If we tore down all of the homes in east Austin with these problems (or not up to modern foundation codes), it would look pretty sparse over there.

One possibility for recourse is to determine what the prior owner actually did. Were they the ones that moved the home? Did they get a permit, as required, to do so? If yes, they would have been required by law to build a proper foundation and have it inspected by the city. If on the other hand, this all happened long ago, and they have just been living in this house as it was for many years, and despite it not being up to code, it was good enough for their uses, then I can’t see that you have much grounds for recourse.

Additionally, you did get an inspection and the inspector did tell you – this house is sitting on cinder blocks, so you knew it had a sub-standard foundation. The sellers could therefore prove that you knew their was a problem – it was disclosed in your own inspection report. Furthermore, I know from my own experience that 99% of home inspectors don’t claim to know much about foundations, and usually clearly say so in their inspection reports. They almost always say “get a foundation expert or contractor to evaluate this further…”. Same goes for septic systems, wells, and a few other items.

So, I don’t know that you’ve got much to work with here, but I will offer one more suggestion - it never hurts to ask the sellers for compensation. I know that I once sold a home with some problems (that I did not know about because I only owned the home for about an hour before a flip). In that case the buyer called me after the sale and threatened to sue me. I basically asked my lawyer if they had a case, and he said “no way, but they will cost you several thousand dollars in legal fees”. So, I offered them several thousand dollars in the form of a “good will” refund, and went on with my life.

You can also sell this turkey to another investor, like me, if you’re tired of working on it

Phill