The Yellow Stain House (House #4)

If anyone is interested in following along on my fourth house (from my blog):


House #4: Yellow Stain House

As I mentioned yesterday, I had three offers submitted and waiting for response from sellers. Well, I received one response today, and it was a good one…I now have my fourth house!

This is the third house mentioned in yesterday’s post, the 3 bedroom, 2 bath house built in 1988 that’s in rent-ready condition, and pretty much in sale-condition as well. I’m very surprised that it went for as little as it did, considering it was in such good shape. Apparently, there was only one other bidder on the house, an owner-occupant who actually outbid me; but I imagine that my large deposit and lack of contingencies made me a bit more attractive to the seller, and helped me get my bid accepted.

I’ll go into more detail in a follow-on post, but the basic rehab plan for this one will be as follows:

* Replace the flooring (it’s currently all carpet and vinyl, in average condition)
* Replace the kitchen countertops
* Refinish the kitchen cabinets
* Replace the appliances, including washer/dryer
* Upgrade the bathrooms with new vanity tops, new hardware, and new fixtures
* Paint the interior, and stain the front and back decks

Additionally, I’m considering some other work if it’s necessary or cost-effective:

* Because the utilities are not on, I don’t know the condition of the A/C and furnace. I believe they are original (about 20 years old), but am not sure if they need to be replaced
* There is a framed, but unfinished large room in the basement that I may finish to create a fourth bedroom, office, or play-area. If it’s cost-effective, this extra finished space may be a good selling point
* The dining room is currently very small and compartmentalized. Because it opens to both the kitchen and living room, I may decide to knock out a wall or two to create a larger (or at least perceived larger) dining space. The concern here is that this would turn a formal dining area into a kitchen and/or living room attachment, which might be less appealing to some buyers

The next couple days will be spent finalizing due diligence on this one, and by then, I should have a lot more details to post…

Oh, and you’re probably wondering why I’m calling this one “The Yellow Stain House”…while the utilities are off and it’s too dark to see a lot of detail in the bathrooms, I took a couple pictures today, and the flash lit up the room enough to notice some very large yellow stains on the vinyl floor in front of the toilet and tub (they show up clearly in the pictures as well). I really hate the fact that this is the most distinguishing feature of the house, but unfortunately it is…

Or maybe not...I guess we'll see...


House #4: Maybe Not

The Yellow Stain House caused some frustration the past couple days because the seller (the bank) didn’t want to provide a due diligence period; after giving them a large deposit ($5000) and agreeing to close in 2 weeks, they refused to allow me time to do any inspections before committing to the sale. While the property seemed to be in good shape, I’m hardly a home inspection expert after only a few months, so I was very reluctant to sign the contract before getting an inspector through the property. So, I told my agent to hold off on submitting the contract until Thursday afternoon, and I made arrangements to have the utilities turned on and an inspector come out first thing Thursday morning.

And I’m glad I did!

The first thing that became apparent when the water was turned on was that there was a rupture in the main line from the meter to the house. While no water was running in the house, the meter was spinning (meaning water was flowing), and then a large pool of water started to form around the water meter and the meter box started to fill. It appears the rupture is near the meter box (making it easier to find and fix), but who knows if there are additional rupture points as well. The house has polybutylene plumbing, a rubber-like replacement for copper plumbing pipes that was common for about 15 years; unfortunately polybutylene is known for rupturing and leaking, and houses with this type of piping are susceptible to plumbing issues. While I knew this before the water was turned on, it wasn’t until afterwards that I realized that there was already a major rupture.

But, this wasn’t the worst of it…

The inspector did his inspection, and most of what he found I already knew or suspected. But, he did find one major issue that I had overlooked. In the basement, along the concrete foundation wall, was a large horizontal crack about 12′ in length. Apparently, this wall is in the early stages of a structural failure; if not remediated, the wall could collapse at some point down the road. Unfortunately, I have little experience with foundation/structural issues, so I have no idea whether this is a $2000 problem or a $20,000 problem. And because the bank didn’t want to give me a due diligence period, I didn’t have the option of bringing in additional contractors and engineers to help me better understand the problem and the solution.

So, I called my agent, and told her I wanted to back out of the deal before she sent the final contract to the seller. She told me she’d give the seller's agent a call, and see if they had any suggestions on how to handle the situation. My agent called me back a few minutes later and suggested that the seller (the bank) would be willing to consider a price drop based on the new information; unfortunately, I still didn’t know if I needed a small price discount for this problem or a large one. While I considered just asking for a ridiculously large price drop, I decided that I’d be unlikely to get one without additional evidence of the problem. I asked my agent for another 24 hours.

I got on the phone with a structural engineer that my inspector recommended, and he will be meeting me at the house Friday morning to take a look at at the problem and write a report recommending a course of action. Hopefully he’ll also be able to give me an idea of what it would cost to fix the problem, and then I can go back to my agent with a reasonable request for a price concession. As of now, I’m not confident that The Yellow Stain House will actually end up as House #4, but between inspections and engineering reports, I’m spending several hundred dollars in hopes that it will work out.

Hopefully by early next week I’ll have a new offer to the bank, and will have received a response one way or the other…until then, I’m just going to be happy knowing that this whole thing could have been much worse had I signed the contract before doing the inspection. Lesson to anyone still reading — always do your due diligence, even if the other party tries to dissuade you from doing so!

House #4: New Offer


I mentioned yesterday that based on the inspection report I received on The Yellow Stain House, I was planning to ask for a price reduction from the seller (before signing the contract). Before deciding on how much of a reduction to ask for, I had a structural engineer visit the house on Friday to give me a report on the extent of the foundation damage, the recommended remediation plan, and an idea of how much the repair work would cost if I were to have it done. As he pointed out, the issue is that there is a long (about 12 feet) horizontal crack in one of the cinderblock foundation walls, indicating that there has been excess pressure from the other side of the wall; this excess pressure has actually started pushing the wall in towards the interior of the house, and if you look closely, you can see a slight bulge in the wall around where the crack is.

The likely culprit is poor drainage on the house on the outside of that wall. With the ground sloping in towards the house, water collects against the side of the house, seeps into the soil, and the water-soaked soil causes stress on the foundation wall beneath the ground. Besides fixing the problem (sloping the soil away from the house and adding some drainage pipes around the foundation), there are two common ways to fix the already damaged foundation wall. Historically, a foundation company would drill supporting brackets into the wall to ensure that there is no further shifting; more recently, it’s become come to actually epoxy strips of Kevlar material to the wall to keep it from any further movement (sounds crazy, but apparently it works like nothing else).

Anyway, the engineer suggested that the fix would cost anywhere from $4-8K, plus the extra work on the outside of the house to keep the issue from reoccurring.

I also did some more research on polybutylene plumbing (the pipes currently in this house, and that have already caused some problems), and found that many experts recommend replacing all polybutylene with PVC or copper to keep the inevitable rupture from occurring (or reoccurring). There have been many class-action suits against the companies who have manufactured polybutylene, and all evidence indicates that houses with polybutylene plumbing are harder to resell. Based on that, I’ve decided that if I get this house, I would replace all existing plumbing with PVC or copper. This would likely cost about $4K.

Lastly, the inspector yesterday found several other issues relating to roof framing, exterior wood rot, and other minor (but potentially costly) issues. All told, the additional work above and beyond what I originally expected was probably about $2K.

Between the foundation, the plumbing, and the other issues, my additional, unexpected out-of-pocket on this house would be around $10-14K. Knowing that the bank would most likely counter-offer any request I made for a price reduction, I decided to ask more than I needed — $20,000. I would likely settle for as little as $16K in price reduction, but given that there could be other unexpected costs associated with these issues, I certainly wouldn’t go lower than that.

We’ll see what the seller has to say to my new offer…

Very interesting to note the a general idea of cost to repair a horizontal crack of that size.

I'll be getting quotes from a couple foundation repair companies this week, so I'll let you know more exact numbers after that...I'm guessing it depends on the extent of damage (not great in this case), the type of fix they implement, and their warranty (i.e., a lifetime warranty probably costs more than a 10-year warranty)...

The big reason I am very interested is slightly selfish. In the greater Denver Metro area bentonite soil is a very major problem. Over 50% of the houses I have looked at have had foundation issues. I found some very potential properties that are passed up by the avg investor for these reasons. It certainly gives another place to see a diamond in the rough.

To be perfectly honest 4-8k shocked me. From the horror stories I have heard on horizontal cracks and their costs, I thought it would be higher. Thanks again for the updates.

It looks like the bank came to their senses, and are willing to drop the price of this one considerably. Not quite the $20K that I originally asked for, but they’re willing to reduce the price by $14K. This price reduction would cover the extra costs undercovered during the inspection (the foundation issue, the plumbing issues, and the roof/rafter issues), plus I'll have about $5K left over as extra profit or to put towards additional work.

By the way, it looks like the foundation work will come out to between $3-5K. We'll probably go with the "Fortress Carbon" solution which uses Kevlar straps glued to the foundation wall to hold it in place. The straps are $800 a piece and we'll likely need 3-4 of them. To replace all the polybutylene plumbing in the house with PVC (including the run from the meter to the house) will cost about $4K. And to repair the roof framing issues will cost about $800.

So, worst case, the unexpected issues will cost just under $10K, and I'll be getting a $14K credit on the purchase. So, we're going to move forward with this one...hopefully we'll be able to close within a couple weeks...

Nice work with the bank.

Since the fixup costs are starting to add up on this property, what is your cutoff for profit? I understand the price reduction helps.

I guess I am wondering what your threshold is. At what point to you turn away from a deal? projected profit 20k or less? 80% ARV?

Does the amount of work with compared to the profit weigh in your decision?
ex: 20k work must have 20k profit...etc.


Sorry for the 20 questions. From an outsider looking in, it seemed like you got caught up in the deal numbers be damned. I know from reading your blog this is absolutely not the case, but it leaves me wondering. (If this is part of your formula you want to keep secret, by all means I understand)

This was a good deal before I found the new issues (foundation, plumbing, roof). Once I found those issues, this became a bad deal at my original purchase price. I knew that if I could get the bank to pay the cost of repairing those new issues, it would once again be a good deal. The cost of those issues approached $10K, so that was my very minimum required price reduction from the bank.

Now, given that foundation issues would likely detract from the saleability of the house on the back-end, and the fact that these issues would add work and complexity to the project, I wanted more than just the $10K to cover repair costs. I was hoping to get closer to $20K, but am perfectly happy to accept a $14K discount. This extra $4K can be considered my bonus for the extra time and effort, and the extra risk.

All in all, I think this is a better deal now than it was before, so I'm happy about the outcome. I will be happier once I have final quotes on all the work (so I can verify my assumptions), but I expect everything will look good with the final numbers.

In terms of what I look for in terms of profit, right now I'm focused on very low-end properties (the buyers in this area are looking for houses in the sub-$140K range). For that level of property, my minimum requirement these days is $15K profit per project. I obviously prefer higher ($20-30K profit is pretty realistic for this price-range of property in this area), but if the conservative analysis indicates at least a $15K profit, I'll move forward on a project. Not a huge profit per project, but that's where the scale comes in.

I'm hoping that once the market turns, we can start focusing on higher-end properties with higher margins, but right now we're just adapting to the market. The other benefit of this approach is that it's tough to make too costly of a mistake when you're buying houses for $40-80K...

Latest...


House #4: Initial Bids

As I mentioned a few days ago, the bank compromised on selling The Yellow Stain House for a reasonable discount. Based on the fact that the foundation was cracked, the plumbing needed to be replaced, and the roof framing was structurally inadequate, they offered a $14K discount on the originally agreed-upon purchase price. I thought that $14K was reasonable, and should cover my additional expenditures, and after getting quotes on the foundation, plumbing, and roof framing, I now know for sure.

The foundation work was my biggest concern. Foundation costs can run into the tens of thousands of dollars in some cases, though I was fairly confident our problem wasn’t that bad. I was hoping the cost would come in between $3-6K, and I was pretty close. To reinforce the one bad foundation wall, my preferred contractor (a very reputable foundation repair company that provides lifetime warranty on their work) quoted me $2800. They also noted (as did my inspector), some minor foundation issues on a second wall; because I plan to finish off that basement area, I decided not to take any chances, and asked for a quote for the second wall as well. After some negotiation, we got the cost of fixing both walls to just under $5000. I could have probably gotten away with spending half that (only doing one wall), but I need to be proud of the houses I sell, so that wasn’t really an option.

As for the plumbing, again I decided to get a quote from one of the most recommended contractors in the area. They have done a lot of polybutylene replacement, and after finding out that I was planning to buy a lot of houses built in this time frame (the 10 years when polybutylene was most common), they gave me a very decent price. Basically, to re-pipe the entire house — including the 100 ft underground run from the meter to the basement — I was quoted just under $4000. I think I may be able to get a better price going with my GC’s plumber or another freelance plumber, so I’ll continue to shop around. But, the $4000 is a good baseline.

Lastly, my GC (the one I’m using on The Second Chance House and will likely use on The Yellow Stain House) said he could do the roof work (and the rest of the minor issues that the inspector pointed out) for about $1000, which was about what I expected.

In total, those three issues will cost somewhere around $10,000, meaning I made $4000 on the renegotiation with the bank. Of course, the foundation issue could impact my ability to sell the property as quickly as I would like, and who knows if fixing any of these problems will uncover additional issues that need to be addressed (I don’t suspect so), so for now I’ll hold off on celebrating too much around that $4000…

Very cool man. How long until you get your 1st one sold?

- Hakrjak

Jscott,
I was updating myself on your progress via your REI blog, and I had to smile when i saw this entry :

REI Startupiscounts at Home Depot

I am glad to see you have begun using the pro-desk to your advantage, and that my tips in the other thread were able to save someone REAL money in thier real-estate ventures!

Best of luck, I always love hearing about your progress and to see that youre doing well!

Update from my latest blog post:


House #4: Flood Plain!?

The Yellow Stain House is quickly becoming the bane of my existence…

Okay, it’s not THAT bad, but it’s causing more frustration than I care to have in a house that I don’t yet own. First, there was the foundation issue. Then, there was the major plumbing issues. Now, just 24 hours before I’m supposed to close on the property, I get a call from my lender telling me that the property sits squarely in a Flood Plain, and that unless I get the potential hazard assessed, and get flood insurance, he won’t be able to lend against the property.

For those that have no idea what a flood plain is (I didn’t before today), it’s basically an area around a body of water (river, stream, creek, pond, etc) that has the potential to flood given heavy rain. Many communities are designated flood plains by FEMA, and if your house sits within a flood plain, you are required (at least to get a loan) to have flood insurance.

Now, here’s the interesting part. Just because your house sits in a flood plain doesn’t mean that it is at risk of flooding. Flood plains are defined for large areas, but not every piece of land within that area is at risk. It mostly boils down to the exact elevation and situation of that piece of land relative to the body of water that puts it at risk. So, while The Yellow Stain House sits on a flood plain, it may or may not be susceptible. If it’s not susceptible (and you get a survey performed to prove it), you can have it removed from flood plain requirements; this results in lower insurance and better resale value.

Given that we don’t have a survey of this property, and therefore don’t know the extent of the flood risk, the lender has asked that we put off closing until I can speak with my insurance company. I talked to my insurance company today, and they said that the extra flood protection would run about $600/year. While not too bad by itself, the fact that a new owner would have to pay this annual premium to buy the house means that the resale value is impacted.

So, we are planning to get a survey (or at least a partial survey that had the elevation details), and hopefully if the news is good, we will be able to get the property officially removed from the flood plain. If the news is bad, and the flood risk is high, I may have to back out of this deal, and let the bank keep my earnest money. Most likely, we’ll find that we’re still on the flood plain, but the risk is relatively low, which will hopefully lower the insurance premium (they’ll review the survey and make their own decision) and make resale not too much more difficult.

Anyway, I have a lot to learn over the next couple days about flood plains, and a lot to do to try to position this property as best possible given the current designation of being in a flood plain. I’ll let you know what turns up…

I have a feeling I’ll be posting a lot about The Yellow Stain House this week…

Best of luck my friend.

Based on some recent events -- finding out the property is in a flood plain and getting my rehab bids back a bit higher than expected -- I've decided that doing a quick rehab and resale isn't the best exit strategy on this property -- at least not right now.

Luckily, I ensure that every property I purchase has multiple exit strategies, and I have several Plan B options on this one...the most appealing scenario at this point is to rent the property for at least the first year, and in the meantime, work to get the flood plain designation removed.

Note to all new investors: Always have multiple viable exit strategies..the more the better!

So, I might have my first rental property!

Here's more from today's blog post:


House #4: New Plan

As I mentioned yesterday, The Yellow Stain House is currently in a flood plain, and I have no idea how that will affect resale value and future insurance premiums. I do have enough information to know that the problem is probably not too bad, but it will likely take several weeks to get a land survey engineer to do an evaluation and then hopefully be able to make a recommendation to FEMA to remove either the entire lot, or at least the structure, from the flood plain.

In the meantime, my closing date is next week, and I have a feeling I’ll be unsuccessful at getting the date pushed out without incurring a substantial monetary penalty. That leaves me with essentially two choices: close next week with the issue of the flood plain unresolved or back out of the deal. And given that I have a pretty big earnest money deposit on the property, backing out would be expensive. Oh, and I still think that even with the flood plain issue, this is a very good deal.

The immediate question though is whether I think this is still a great deal as a flip? Or do I think there is a better exit strategy for this property?

I try to ensure that all my acquisitions have multiple exit strategies, just in case “Plan A” backfires or hits a snag. In the case of The Yellow Stain House, there are actually multiple backup strategies, each potential profitable.

Here are a couple of them:

* Hold the property as a rental. Even with the work that must be done to make this house rent-ready (foundation fix, plumbing fix, roof fix), this property should cash-flow very well. I’ll write another post later in the week with more detail about the rental analysis, but suffice-it-to-say, this is a very viable short-term — and even long-term — option.
* Sell to another investor. Given the nice discount that I am getting on this property, there is enough equity that I could likely do a couple of the major fixes (foundation and plumbing), and then sell to another investor for a profit. While I think this would likely result in a relatively small return, the effort involved would be small, so it would be a quick profit.
* Get a renter in-place, then sell to an investor. Another option is to make the rent-ready repairs, get a renter in place, and then sell the property to an investor as a turn-key investment. Assuming we could get a decent monthly rental rate, I think we could likely attract a number of investors who would love this turn-key opportunity.
* Make minimal repairs, and sell to an owner occupant at a steep discount. While there are some issues that would likely turn off many buyers (flood plain, foundation, etc), if we were to do some minimal rehab to FHA standards (as opposed to the full rehab and basement finishing that we originally planned), stage the property nicely, and then list it well below fair-market-value, we could very likely attract some owner-occupant buyers who would be thrilled to get a very nice property at a great price.

Of course, I’m not sure yet which of these options would be most optimal in terms of ROI; but given the flood plain situation, it seems clear that doing a full flip with only a resale as an exit strategy is not the way to go. So, I’m running various financial scenarios on each of the exit strategies above, and will try to figure out which way seems most profitable. It’s fun to think that I may have my first rental property…we’ll see…

I remember the first house we bought, where this issue came up, like it was yesterday. We were buying cash (no financing) so there was no requirement to have a flood policy in place UNTIL we went to secure the HELOC, after rehab was complete on the property.

My immediate reaction was one of panic. I had never considered a flood zoning (unless you were within blocks of the ocean).

The good news is that this is extremely common down here. In fact, since then, we have purchased other rental properties which were in flood zones. However, I did add it to my list of rules - always check, before purchase, with my insurance agent. Although she may not be able to tell me what type of flood zone (requires elevation certificate), she is able to tell me if it is a flood zone or not.

My advice would be to talk to the neighbors, if you can. Ask them if their properties flood in big storms. Ask them if they are in a flood zone and, if so, which class? I would also check for water damage (from the floor up) throughout the property. It is likely that repairs would have been made and it very well may no longer be visible - but sometimes signs are left behind, within a mudroom or even a garage, etc.

You might also want to talk to people at your REIA to see how common flood zonings are in your region. If they are a dime a dozen, it should not affect resale (we have since sold a house in a flood zone and the buyer (a JAX native) never even flinched).

It will add to your expenses up front - as you said, $600 give or take for the flood policy - and we also pay 300-400 for the elevation cert.

Good luck!

Why weeks, J?

Have you asked someone at your title company to recommend a survey Co.?

In FL, we can get this done in days (often 2-3). Remember, you are certainly not the first to have this situation come up right before closing. These folks are accustomed to working in a pinch.

(got caught up on the phone while I was typing my last post... and missed your latest post)

Hey PhlGirl --

Thanks SO much for all the info!

We've learned a lot about this in the past two days, and our research is encouraging. First, our next door neighbors are going through the process of getting an elevation cert right now, so we've been trying to catch up with them to see what the preliminary results are and which land survey company they're using.

We've spoken with several engineering and survey companies, and they basically say it will take about a week to get an elevation cert (which isn't a big deal), but assuming our elevation is above the flood line, it will take another couple weeks to get a Letter of Map Amendment (LOMA), which is basically the survey letter that tells FEMA to write their flood maps and remove this specific property. I'll talk to them about whether than can pull this schedule in, as you suggest it can generally be done more quickly when there's an impending closing.

The preliminary info from both the insurance agent and the land surveyor that we're going with is that part of the property lot will likely remain in the flood plain, but there's a good chance that the actual structure can be removed via a LOMA. So, that's good news.

But, I'd like to know for sure whether we'll get the LOMA for the structure (which will reduce insurance rates and hopefully then not impact resale value) before we decide what our exit strategy will be on this property.

Going with a traditional loan vs the rehab loan just gives us some added flexibility in terms of when we exit this one (i.e., whether we hold it as a rental long-term).

Thanks again, and I'll keep you updated!

Even if you do get the property approved for removal from a flood zoning, you may want to consider keeping a flood policy on the home.

The removal of the flood classification will make the policy even cheaper (my guess would be $200-300 per year) and it certainly helps you sleep during the busy storm season.

Our quadrant of FL is the least susceptible to hurricanes - in fact, Jacksonville has not been hit by a hurricane since 1964. BUT, if a hurricane were to roll through and the damage was primarily from Water coming up and not Water coming down (or wind), your standard policy will likely not cover the damage. I only mention this because being from PA, I did not understand the rules on this, until fairly recently.

We now carry flood policies on all of our homes - the vast majority of which are not in flood zones. The average cost, per year, is $230. We have only had to file a claim once and it was after a tropical storm in August 2008. We just see it as an extra safety precaution. It's not for everyone but I just thought I would mention it. With a larger portfolio of homes, a flooding scenario on multiple homes at the same time (with no coverage) could potentially wipe out an otherwise healthy reserve.

Also, if you do not instate a flood policy on the property at closing and choose to do so at a later date, there will be a mandatory 90 wait for obtaining the policy. Pretty sure this is a FEMA regulation, which is intended to prevent people from picking up policies for storm season and then dropping them immediately after. I can only speak to FL, of course. GA might be different.

That's a really good point about getting flood insurance anyway, especially considering the surrounding area is definitely a flood plain.

I'm not so much worried about paying the flood insurance premium myself (I just prepaid $600 for the next year based on not having an elevation cert, so I imagine once I have it the price will drop even more)...I'm more concerned about any potential future buyers not wanting to buy if they know they will be forced to carry the insurance (or if it will be more than $200-300/year)...

So, my concern is more from a resale perspective than from a hold/rent/flood damage perspective...