Flipping Houses: A Success Story
31408 Rosenbusch
Warren, Michigan
At Ralph Roberts Realty, many of the houses we flip are foreclosure properties. We either buy the properties directly from the homeowners prior to the foreclosure sale (which we call the sheriff's sale) or bid on properties at the sale.
Although we find many of our leads through word-of-mouth referrals, we discover some of our best house flipping prospects in the Macomb County Legal News—a weekly publication that carries the foreclosure notices for the week. As soon as I get my hands on the weekly edition, I carefully read through the notices and highlight any properties that look promising.
This week's edition contained a foreclosure notice for a house in Warren, Michigan, the city that Ralph Roberts Realty calls home. The notices rarely present the property's street address, but they provide the legal (lot) description of the property, the owner(s) name, the mortgage interest rate, the date of sale, and the estimated opening bid—in this case, a little over $55,000. Because the property values in Warren cover such a wide range, that $55K could have been a great price or simply that actual top value of the property. Without knowing the actual location of the property and seeing it for myself, I couldn't really be sure, but the notice piqued my interest—it could be a great deal, a good deal, or a dud.
My next step was to locate the property's street address. From the foreclosure notice, I had the legal description of the property: Lot 53, Van Thome Park Subdivision. I have a program called Pace Net that can pull up a property's street address based on the legal description or owner's name. If you're not in the position to shell out money for such a program, you can call or visit your county's register of deeds to obtain the street address. Some counties provide the information online—with a computer and an Internet connection, you can look up the information yourself.
Upon seeing the street address, I immediately knew that the property was located in an area commonly called "North Warren," where homes commonly sell in the range of $125,000 to $300,000.
I knew that in this area, $55K could be a great price... assuming, of course, that the property wasn't completely dilapidated. Now that I knew where the property was located and that it was probably worth at least the opening bid of $55K, I was prepared to invest a little more time and effort in research.
First, I wanted to know whether the property was still scheduled for sale. After all, why do a full-blown investigation only to find out later that the sale was canceled—something that occurs frequently enough to raise concerns? Five days prior to the scheduled sale date, I called the attorney (whose name and phone number were listed on the foreclosure notice), and he confirmed that the property was still scheduled for sale.
Next, I needed to know the true market value of the property—an estimate of how much I could sell it for after repairs and renovations. Being in real estate has its advantages—it gives you easy access to property value information (sold, listed) that others don't have. (If you're not in the real estate business, you may have to hook up with a real estate agent to obtain the facts and figures you need.) I ran a search for houses that had the same basic features of the foreclosure property—lot size, total square footage, number of bedrooms and baths, and so on. That gave me a ballpark figure of what I could get for the house—somewhere in excess of $150,000. The house was certainly a promising candidate for a flip... so far.
Now, I needed to know what exactly I would be purchasing at the auction. You see, when you purchase a "property" at auction, you're not exactly purchasing a property. You're purchasing a lien placed on that property—a claim against the property. Some liens give you more control over a property than others. Typically, the tax lien (a claim against the property for unpaid property taxes) gives you the most power. A first-position mortgage (the first loan the homeowners took out to purchase the property) is next in line. Second-position mortgages (or junior liens) are next, followed by construction (or mechanic's) liens, such as financing to install new replacement windows.
I needed to make sure that the opening bid of $55K was not for a junior lien. If it were for a junior lien, if I bought it at auction, and if someone else bought the first-position mortgage at another auction, I could lose my entire investment of $55K. I went down to the county register of deeds office, looked at the title and mortgage that were recorded against the property, and saw that the lien being sold at auction was, in fact, the first-position mortgage.
On paper, the property I was prepared to bid on appeared to be an attractive investment, but I still wasn't ready to bid at the auction. I had to see the property myself, with my own two eyes. You can lose a lot of money by skipping this step. You could end up purchasing a burned-out shell of a house by getting lazy and skipping the physical inspection.
A few days prior to the auction, I drove out to look at the house. I like to go in the morning or early afternoon for two reasons: 1) to avoid a direct confrontation with the homeowners, who are usually at work, and 2) so the homeowners' children, who are usually at school, won't catch me taking pictures of their home and start asking their parents embarrassing questions. In the future, I may want to establish contact with the homeowners, and I don't want to start our relationship on the wrong foot.
First, I drove past the house, snapped some photos with my digital camera, and jotted down a few notes. During my drive-by inspection, I typically look for the following:
Red flags: Anything that may make me question the profitability of the house, such as a bad foundation, flooding, severe fire damage, and so on.
Marketability of the neighborhood: Does the neighborhood have many houses for sale or rent, meaning that I may have trouble reselling the house?
Pride of ownership: Do the homeowners seem to take pride in their homes and their neighborhood? Are the houses maintained, lawns mowed and edged, porches warm and welcoming? Is everything tidy and cared for, or does it look like a storm just rolled through?
In this particular case, the house and the neighborhood passed the drive-by inspection. The house I was considering was unkempt, but it didn't appear to have any major damage or defects. I didn't see an inordinate number of homes for sale in the area, and the neighborhood was certainly a place where a new homeowner would feel comfortable living.
Having satisfied myself with the neighborhood, I drove by the house again, parked down the road, and performed my walk-around inspection to take a closer look at the house. During my walk-around inspection, I always look at all four sides of the house, take a couple photos of each side, and note anything that needs fixing—from landscaping and other curb-appeal renovations to new roof or windows to sidewalk or driveway repairs. During this particular walk-around inspection, I noticed nothing that would require a tremendous investment. As you can see from these before photos, the landscaping was my main concern, and a little sweat investment would take care of that.
Except for the landscaping, the front of the house was in good condition
The back yard was in need of some landscaping work, as well.
At the opening bid price of $55K, the property was certainly worth the money, but now I had to figure out just how high I could afford to bid—my maximum bid amount. I went back to the office and pulled up listings of comparable homes in the same area—both current listings and listings of recently sold homes—to check their values. Now that I knew more about the neighborhood from my short visit, I could come up with a more accurate estimate of the home's value. This takes some experience, because I have to add value to my house for features that comparable houses don't have, subtract for features that comparable houses have and mine doesn't have, and account for variations in the condition of the properties. After fiddling with the numbers and doing some guesstimates, I figured I could sell the house for $164,400 to $175,000.
Starting with that lower (less hopeful) estimate of $164,400, I worked backward. First I divided $164,400 by 1.20 to determine the maximum total amount I could afford to invest and still earn a profit of about 20 percent—a total profit of $27,400. The result showed that my total investment could not exceed $137,000.00. Next, I subtracted my costs, based on my expectation to hold the property for no more than three months:
$137,000.00
-$5,300.00 (financing costs and interest)
-$16,000.00 (repairs and closing costs, estimated at 10% of the retail
repaired value of the home)
-$6,400.00 (utilities, property taxes, and insurance)
-$9,300.00 (real estate commissions)
$100,000.00
The maximum I could bid at the sale was $100K, and that's exactly what I ended up paying for the property. A competitor was also bidding, but it didn't trouble me too much, because I knew if he bid more than $100K, he probably wasn't going to earn much of a profit. Apparently, he realized this as well, because he dropped as soon as I bid $100K. I paid my $100K and received the sheriff's deed to the property.
In Michigan, the homeowners and other lien holders have up to six months after the sale to redeem the property. In other words, the homeowners or another lender who has a claim to the property could pay me the $100K I paid at the sale plus interest and any additional expenses I paid in property taxes and insurance, and essentially buy me out. The homeowners were very unlikely to redeem, because if they could have paid the $55K they owned on the house, they would have done that already rather than waiting and having to pay me in excess of $100K. The house did have a second mortgage, but the lender was going to be able to collect the excess proceeds from the sale—the $45K I paid over and above what was owed on the first mortgage. The lender could redeem me, but since the lender was getting a good chunk of money and probably didn't want the hassle of taking ownership of the property, that was highly unlikely.
My job at this point was simply to sit and wait or contact the homeowner to work out a deal in which the homeowner would agree to vacate the property before the six-month redemption period expired. In this case, I chose to simply keep an eye on the house in case the homeowner vacated the premises or something needed tending to. (A vacant house can be dangerous, and you should take steps to protect your investment if the house becomes abandoned.) During this time, I also paid the property taxes and took out an insurance policy on the property. I filed affidavits stating the amount I paid in taxes and insurance premiums, so that if someone did redeem the property, I would be reimbursed for these expenses.
The house did go vacant shortly before the end of the redemption period, and so I made it a point to go by more frequently to check on it. It was in a good neighborhood, so I wasn't really worried about it being vandalized, but I wanted to make sure that the house was secured and someone couldn't get in and hurt themselves or damage the property. I didn't start renovating the property, because if someone did decide to redeem it, I could lose anything I invested on the renovations.
Immediately after the redemption period expired, I went inside the property, changed all the locks, and started renovations. I usually begin by sprucing up the outside of the house, so the house can make a great first impression on any passers by who might be in the market for a house. I had the yard cleaned, the lawn mowed and edged, the flower beds tended to, sidewalks and driveways swept clean, shrubs trimmed, and so on.
A little landscaping is all that was needed
Some cleanup and landscaping made this backyard look much more livable
Inside, this house didn't need a lot of work, but it did require some minor and moderate updates. I decided to pull out the old ceramic tile and lay new ceramic tile in the bathroom, install moldings throughout the house, replace the front door, replace the lighting fixtures, install new carpet, and paint the whole house in neutral two tones. I had the basement and garage painted as well. A fresh coat of paint and some quality updates go a long way.
A thorough cleaning in the kitchen, new moldings, and a refinished floor made this kitchen look brand new
New tile on the walls and floor made this bathroom look immaculate
With freshly painted walls and a refinished floor, the living room is a showcase
The entire renovation was done in less than three weeks at a cost came in below budget at about $6,500. We were now ready to place the house on the market.
We first listed the house at $164,900, which was a little higher than we initially thought was realistic, but inline with current home values in the area. The house attracted some interest, and we had a few showings, but the housing market had slowed in the area, and we weren't seeing the level of interest we expected, so after a few weeks, we dropped the price to $154,900. This made the property much more competitive and generated quite a bit of interest.
After only a couple weeks at the new price, the property sold for $152,900, earning us a profit of $25,700:
$152,900.00
-$100,000.00 (purchase price)
-$5,300.00 (financing costs and interest)
-$6,500.00 (repairs and renovations)
-$6,400.00 (utilities, taxes, and insurance)
-$9,000.00 (real estate commissions, etc.)
$25,700.00
Because our expenses came in lower than estimated, we were able to sell the house faster for less money and still meet our goal of earning a 20 percent profit:
$25,700 profit divided by $127,200 total investment equals 20 percent
If you're fortunate enough to spot a deal like this, you can quickly realize a profit. In less than two months with an investment of a little over $127,000, we were able to earn over $25,000, and we didn't even have to work full time!