Exercise caution on ‘fixers’

  • Steve Tytler / Herald columnist
  • Saturday, April 1, 2006 9:00pm
  • Business

Question: I have always been handy and have done most of my own remodeling work. Now I’m considering buying and refurbishing old homes and selling them for a profit. I know a lot about building, plumbing, etc. – but nothing about tax laws, financing and what have you.

T.H., Everett

Answer: Be very, very careful!

There are great opportunities in fixer-uppers, but there are also great risks. The fact that you know a lot about construction will come in handy. However, I would still encourage you to hire a professional building inspector before you purchase any property. A competent inspector will spot defects in the house that you might miss in the excitement of making a deal.

Since the inspector is not emotionally involved, he or she will not rationalize their way around serious problems, as so often happens when an investor thinks they’ve found a hot deal that is too good to pass up.

Another prerequisite for success in the fixer market is a thorough knowledge of the real estate market in your area. Visit dozens of open houses and ask a friendly real estate agent to give you a computer printout of all the homes in your target price range that have sold within the past year.

Drive by these homes and compare them to the homes on the market. After a while, you’ll become an expert on the market value of homes in your area. You should be able to drive up to a home and quickly estimate its probable selling price within 5 percent. If you can’t do that yet, you’re not ready to start investing.

Once you have a good feel for market value, you will probably start to realize that the single most difficult challenge you face is finding a decent deal. In a hot housing market, it is very, very difficult to find any home that is selling for less than fair market value – even run-down fixers. And unless you can buy below market value, you will probably not make a profit when you sell.

I advise you to concentrate on lower-priced homes, because that’s where most of the buyers are. I have seen novice investors buy $500,000 “fixers,” spend $100,000 in repairs and upgrades, and then try to resell the homes for a profit. That might work in an extremely hot housing market, but it is very risky.

The market for lower-priced starter homes is always relatively strong. But homes in the middle price range, the so-called move-up homes, are much more subject to the whims of the housing market. They sell quickly when the market is hot, but they can stop selling when the market cools. You don’t want to be caught with an expensive home for sale in a market downturn.

Stick to the cheaper homes, and you will always have a ready market of first-time home buyers, and you have less money at risk if the investment doesn’t work out.

Another common mistake is overimproving the property. You’re looking for homes that are primarily in need of cosmetic repairs such as new paint and carpeting. Since you have experience in remodeling, you should have a fairly good idea of how much it will cost to bring a given house up to move-in condition.

Your goal should be to increase the market value of the home by at least $2 for every dollar you spend on improvements. Don’t spend a lot of time and money on a fancy kitchen remodel or on intricate detailing and expensive fixtures that most people won’t even notice. Just make the house neat, clean and presentable.

As for financing, you obviously want to tie up as little cash as possible when you buy a fixer, so you have enough money to make the repairs.

Your best bet is to find a seller willing to carry a contract. Ideally, you would make a small down payment and small monthly payments with a balloon payment for the loan balance due in three to five years. Even if you anticipate selling within a matter of months, try to get as long of a balloon period as possible in case the house doesn’t sell quickly.

If the house is in rough physical condition, obtaining a conventional mortgage loan will be next to impossible. If you have lots of cash to invest, you can find money through lenders who will loan approximately 60 percent to 80 percent of the home’s purchase price – but at very high interest rates and loan fees.

Rehabilitation and remodeling loans are available from conventional mortgage lenders, but only if you intend to live in the home as your primary residence. If you get a loan under the pretense of living in the home, then turn around and sell it within a couple of months after closing, you could face fraud charges.

As for the tax laws, this is a business investment, and you will be subject to short-term or long-term capital gains taxes, depending on how long you hold the property. Consult an accountant for more advice.

Finally, always to go into any real estate investment using worst-case scenario estimates. Too many people make overly optimistic profit projections, and that is a sure road map to financial disaster.

Mail your real estate questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206. Fax questions to Tytler at 425-339-3435 or e-mail him at economy@heraldnet.com.

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