Marcus LeBeof continues his list of six steps to entrepreneurial happiness in the residential real estate market. (Missed Part One?: Check it out here.)
Step #4: Do the House Flipping Math
When doing your initial house flipping analysis, you can do a little “napkin math” to estimate if the house is a winner. The first thing you need to do is determine the potential selling price of the house when it’s all fixed up – this is what’s known as After Repair Value (or ARV). Then simply subtract the purchase price, repairs and all your monthly carrying costs. What you have left over is your profit.
If all this initial math points to profitability, then you may have an excellent flip opportunity on your hands and you should consider purchasing the house.
Step #5: Manage the Rehab Tightly
Once you do purchase the house, don’t just rely on your contractor to handle and supervise all the repairs. Make sure you manage this process tightly if you are on your own, but better yet hire a professional contractor to oversee all the rehabilitation, especially if the rehab is extensive. Make sure you personally supervise the repairs to ensure that they are being carried out properly and on budget.
In the end, your profit largely depends on what you pay for the house initially, but making sure that the repair costs stay within your budget is equally if not more important. Likewise, overextending yourself by doing more than your budget allows on the rehab or taking your eye off the ball and allowing your contractor to run free are two of the quickest ways to ensure that your make profits will go up in smoke.
Step #6: Work Fast, Make a Profit
Time is of the essence when flipping houses for profit. It’s a race against the clock because the longer the rehab takes, or the longer the house sits on the market once it’s done, the less profit you make. Soft costs such as financing payments, insurance payments, town taxes, utilities and other carrying costs, all of which have to be paid at regular intervals, add up to diminish your profits the longer you own the house.
It’s simple—the shorter the time you hold onto your investors’ money, the better your profits will be, so make your improvements fast. Do the job well, but do it fast. Make sure your contractors do the job on budget and on time and hire good real estate agents who help you price the final product so it sells quickly. In all of our house flips, we estimate six months from purchase to sale, but factor in a few additional months of expenses to make sure we profit on each and every flip we do.
I constantly remind my mentees to be intentional in everything that they do. If you want a certain type of job, you need to network with the people who hold the position you aspire to so that you may learn their path and avoid pitfalls. If you want to attend a certain institution, you need to identify the members of the admissions committee and find ways to appeal to their interests so as to stand out from the crowd. With investing, be it in real estate or otherwise, it is always wise to take on a mentor (or two) so that you may benefit from the collective wisdom of those who have gone before you. And you need to assemble the right team of advisors to ensure that you can navigate the inevitable problems efficiently and successfully.
As a young married couple, my wife and I are often encouraged to look beyond our W-2 income for ways to generate wealth. Real estate is often identified as the low-hanging fruit of investments. You buy a house, fix it up a bit and then put it back on the market for more than your purchase price plus the cost of your fixes. This topic came to mind as we headed down to Houston,
Texas last Memorial Day weekend, which also happens to be where I purchased my first home—one that I still own to this day.
While it may sound simple in theory, investing in real estate can be rather complex and has risks. Consider carefully the steps to success to increase the turns of wealth generation (not degeneration). I hope that I can help shorten your learning curve and make your entrepreneurial real estate endeavors more profitable in a short period of time (Hat tip Michael Lacava’s Beginner's
Guide to Flipping Houses For Profit). The first three steps in my guide are below:
Step #1: Assess Your Cash Situation
Before you get started, take stock of your own financial resources. You need to know how much money you have to invest on your own, or whether you’ll need to find investors (or win
the lottery) first. Finding investors is an art unto itself (and the subject of many posts on this blog), but knowing how much cash you have to invest before you begin is the logical first step. Having your own money to invest is a bonus. If you don’t, there are plenty ways to flip houses with money from banks, private money lenders, and other means.
Another great way to get started if you don’t have the money to do it all on your own is to find a partner or partners who have money to invest with you. Splitting your first house flip profits with other partners is a great way to start, while building some momentum and getting your first house flip under your belt. Sure, you’ll have to split profits, but it’s far better to get 50% of something than 100% of nothing.
Step #2: Start Building Your House Flipping Team
After you finalize your cash situation you should start building your house flipping team. This team will help you to find, fix and sell the property—the right set of collective wisdom will surely help you reach your house flip goals that much faster. No matter your level of experience, you simply will not be able to do everything on your own. Enlisting your own mastermind group will not only help you be more productive, but will help you work through the inevitable problems and challenges that you’ll face.
Your team at the very least should be composed of skilled real estate brokers, contractors, architects, insurance specialists, accountants and money lenders. All these professionals can help you shorten your learning curve and get you making money flipping houses faster than you would have been able to do on your own.
Step #3: Find A Good House to Flip
Finding a suitable property to flip is certainly a challenge. This is especially true if you have decided to look in a specific geographic area—one that you’ve fully researched and which interests you. Ideally, you should be able to buy the house for a low price, eyeball it as suitable for a quick and relatively cheap rehab (so you can sell it at a higher price), and (obviously) make a profit. Knowing all these aspects in order to make the profit, you’ll need to rely heavily on your house flip team (see Step #2 above).
A skilled real estate agent can assist you in finding houses to flip. You can either focus on properties that may not need expensive repairs or you can look for properties that need more extensive repairs, but the kind of repairs that are likely to substantially increase the equity. Both real estate agents and real estate wholesalers can help you in finding both kinds of properties.
Feel like you’re just about ready? You’ll have to at least wait for the highly anticipated thrilling conclusion to this post next month. Keep reading to learn steps 4-6…
It’s been said that entrepreneurs have to think globally
to survive locally. This statement is more true today than ever before, as the competition (large, multinational corporations) is looking overseas to improve cost efficiencies by reducing overhead. Unfortunately for the local “mom and pop” establishments we have come to cherish, the economics make staying in business harder to manage.
One thing I love about Minnesota is the emphasis on “locally sourced” products, as this instills in us a tremendous sense of pride in the collective sweat equity of our state’s workforce. My wife and I believe that patronizing local businesses is a great way to show our appreciation, and we are both attuned to the benefits of local entrepreneurship and how such establishments can make or break the character of a particular neighborhood.
This has inspired me to take a more in-depth look at what “globalization” means, how it impacts other countries, and whether it is the type of villain that should be taken on by the agents of S.H.I.E.L.D. (which is one of my favorite shows now that this season of Scandal has concluded). The fanciest definition I was able to find (on Google®) is “increasing integration of economies around the world, particularly through trade and financial flows,” but it is easier to comprehend globalization as the movement of people (labor) and knowledge (technology) across international borders.
In other words, globalization stimulates free trade that motivates American corporations to move operations overseas to developing countries so that they can circumvent union activity and take advantage of cheaper labor opportunities. Quite often these countries are located in third world developing countries like Asia, Africa, and Latin America. These countries have also historically suffered from high unemployment, political instability, corruption, and little—if any—government interference or regulation.
Because of this, the word “globalization” has become an ambiguous and emotionally charged term—a mixed bag of acceptance and rejection. Some see it as leading to positive free trade that leads to healthy competition, higher productivity, and economic prosperity for both the developed and developing country. Others see it as enabling a negative trade system that exploits developing nations. Whichever way you see it, it is widespread and it is here to stay.
American corporations easily find that they can contract out their raw materials to overseas factories in countries like India, Indonesia, Pakistan, Mexico, China, and Brazil because unemployment is high and many of the people are willing to compete with each other to work for less. Economists and politicians have referred to this as “downward leveling” or a “race to the bottom.” Developing countries pit themselves against each other to see which can offer multinational corporations the cheapest labor.
Accordingly, some see globalization and the rise of multinational corporations overseas as creating substantially increased demand for child labor in developing countries. While companies say that they do not condone the use of child labor, the reality is that these corporations “sub-contract” out their work to smaller companies that do use child labor as a way of competing with other companies to lower labor costs substantially.
Look, I get it: globalization ushered in free trade and open markets, which in turn encouraged multinational corporations to look for the cheapest labor markets. Who isn’t guilty of trying to save a buck here and there? But let me step onto my portable pulpit here for a moment. Shouldn’t we be tying the protection of children to free trade and the prosperity of developing countries? The progress, success, and wealth of a nation are dependent upon the education of its children. Multinational corporations have a social responsibility to live up to high standards that value children first over profits.
As a new author to entreVIEW, I wanted to write about a topic near and dear to the hearts (and pocketbooks) of entrepreneurs—money! While private capital raising remains tough, there has been a shift to alternative asset classes and the “private equity” landscape has been robust.
Depending on the type of business and on the amount of money needed to begin or continue operations, equity financing may be the only capital available for your start-up. However, it doesn’t hurt to know and understand a little about private equity funds, which could be a source of later stage capital or an exit. What follows is a summary of what we mean by private equity.
Simply put, a private equity fund is a collective investment vehicle used for making equity or debt investments. Some common attributes:
• Usually structured as Delaware limited partnerships. Under this framework, the fund is not subject to taxation on its income or gains but limited partners (“LPs”) are taxed based upon their share of the fund’s profits or losses.
• Managed by a general partner (“GP”) with capital raised from institutional investors, universities, insurance companies, foundations, endowments or high net-worth individuals.
• Key economic incentives for the GP are the management fees and the carried interest, which is a share of the profits of the fund’s investments (typically 20%), usually with some minimum rate of return (typically 8-12%) before the GP shares in the success.
• The key economic incentive for an LP is the opportunity to earn a high rate of return on their invested capital through access to a diverse portfolio of investments that are made by experts.
As with so many things, there are a host of regulations that apply to these funds, including the Investment
Company Act of 1940 and possible registration under the Securities Act of 1933, if there isn’t an available exemption like Regulation
D, which is often available in offerings to accredited
investors.
Investing in private equity funds allows groups of sophisticated investors to pool their resources to mitigate the customary risks associated with investing while attempting to maximize the synergy created by the collective “thought equity” of the LPs. These investors are known as “angel investors.” Angel investors are accredited investors who invest in businesses in exchange for convertible debt or an ownership stake in the business. These individuals or institutional investors conduct their own due diligence and make their own determinations about individual investments (like the “Sharks” on “Shark
Tank,” without millions of people watching). Like “Shark Tank,” angel investors will often make investment decisions based upon a personal interest in the business or the entrepreneur.
Of course, nobody should take money from angel investors without their eyes wide open about the potential perils. Alignment of interests between the entrepreneur and the angel is critical (e.g., what type of exit in what timeframe?). For this reason, remember that raising angel capital can be like getting married. Make sure that each side has done their due diligence so their eyes are wide open to problems (like whether
to leave the toilet seat up) and defined their rights and obligations (sort of like a pre-nuptial agreement) to ensure that everyone is on the same page. At the risk of sounding self-serving, getting your lawyer involved early in the dialogue is a good idea.
Taking on the right angel investors can actually have many positives in addition to securing capital needed to build your business. The ideal angel investor will be someone who has experienced success before (and has not just been born with a Silver
Spoon) and who brings contacts and relevant expertise. With interests aligned between investor and entrepreneur, all parties should have the incentive to see the business succeed.
