First Time House Flipper Nightmare

CJ Daniels is a young father and husband living in the Washington area.  He works a regular 40-hour per week job and shares the parenting and household duties with his wife who also works a full-time gig.

Like so many others, Daniels has heard the siren song of real estate investing and was determined and bold enough to try his hand at home flipping.  With the help of a friend who was a real estate agent and an experienced real estate investor he purchased one side of a small brick duplex in Prince George’s County.

The project was ideal to Daniels because it seemed affordable for a novice.

“I bought it because the acquisition price and rehab price [were at ] a good entry point for a first-time flipper,” Daniels said. “We estimated that we would make 30 to 33 K if we stayed on budget and finished and had the project sold in six months.  Figured the rehab was a three-month project.”

Daniels and his agent negotiated with the bank a purchase price of $102,500.  They also went through the home and noted all of the needed repairs and created a scope of work from which they derived a construction budget of about $35,000.

To finance the deal, Daniels took out a home equity line of credit on his personal residence to cover the renovation costs and he lined up a hard-money loan — a loan from a private individual or a broker who pools funds from private individuals — to finance the purchase price. The hard money loan carried an annual interest rate of 14 percent plus two points or two percent of the purchase price. This meant that Daniels had to pay the hard money lender a onetime fee equal to two percent of the entire loan amount up front. Daniels would have to pay for the renovations separately and the lender made him escrow the renovation funds of $35,000. He would be able to withdraw the money as the renovations were completed and inspected by the lender.

Daniels and his agent analyzed the market and the comparable sales and estimated that with all of these renovations complete the home would easily sell for at least $190,000.

Calculating the time it would take to complete the work and find a buyer, they budgeted for a four- to six-month turn around on the project.

Everything seemed to be falling into place. Daniels closed on the deal and set his contractor to work.

At first Daniels was pleased with the contractor. But two months into the project, he said, the work was only about 50 percent complete and the situation only got worse from there. Work slowed to a crawl as the contractor began showing up on site less and less and the work quality plummeted.

Daniels said he strongly suspected that the contractor had taken on other work and no longer valued his project quite so highly. The contractor started sending strange people to work on the project. For example, Daniels said, the contractor hired his uncle to do the painting and it looked horrible.

The conflict with the contractor and the project itself dragged on well past the original project deadline. Frustrated, Daniels started doing some research on the contractor. He pulled up his construction contract and got the company owner’s name and license number. Daniels had never actually seen this person on the job site. After a few Internet searches, Daniels was able to find a phone number and gave the man a call. It turns out that Daniels contractor was not associated with the man whose license they were using and they did not have permission to use the license number.

“I felt angry when I discovered that they weren’t showing up to do work and that they had been working on other projects and put mine on the back burner, as well as when I discovered the contractor license they included in contract and ID was of a contractor they worked with once or twice several years prior,” Daniels said. Daniels said he reached out to the contractor whose name was used. “He was baffled and upset they were using his name and license.”

Now Daniels found himself in a really bad situation. The project was about 75 percent complete and months behind. If he fired the contractor his project would be further delayed and another contractor would probably charge a strong premium to come in and finish someone else’s work. Daniels attempted to cajole the contractor but the revelations about the license did not scare the contractor straight, it only exacerbated the problem.

With the project about 85 percent complete,  Daniels finally fired the contractor and finished up the remaining work with the help of a friend. All together the renovations ended up taking about eight months rather than the three he’d originally estimated. His total renovation costs came in at about $37,000 which was very close to his original budget. The costs probably would have been higher but Daniels jumped in and did a lot of the remaining work himself to save money.

What did Daniels do about the contractor? He didn’t do anything other than withhold some of the money in the end. And this is very common. That’s why unlicensed contractors continue to operate this way. A homeowner is left with no good options in these situations.

He thought about taking legal action, but then backed off.

“ I did seek free initial meeting with a real estate attorney who told me to send [the contractor] a certified letter,” Daniels said. But going to court could prompt the contractor to put “a lien on the property” which would “prevent me from selling it.”

Problems with any construction project often multiply. The first and most obvious problem created by the delay is the finance costs. The longer the project takes the more interest expense piles up.

Daniels said he realized at about the three-month mark that the project was not going well and that he was going to get eaten alive by interest expense on the hard money loan. Luckily for Daniels he had parents who could help.

Daniels was able to get a loan from his parents to pay off the six-figure principal on the hard money loan. His payment of about $1,200 per month on the hard money loan was reduced to a $300 monthly payment to his parents.

There was one blessing for Daniels. As the project dragged on, the market values were going up. As the project finally neared completion, Daniels and his agent looked at the recent comparable sales and believed that they would now likely get a sales price of at least $200,000. But one more stroke of bad luck was visited upon the newbie flipper.

Just before Daniels listed his house, a similar one nearby sold for $180,000. The home was an outlier in the comps but it was the exact same layout as his house and had similar renovations and upgrades. It was probably a flipper who got a really good deal on the home or who just had to get out fast and dumped the place. Being that this was such a direct comparable to his house it greatly influenced the appraiser’s calculations. Daniels said he and his agent strongly believed that the house should have appraised for at least $195,000 but the appraiser gave them a value of $185,000.

Stuck with the appraised value, Daniels had no real choice but to reduce the price and to pick up the buyer’s closing costs since it was common practice in this particular neighborhood.

Daniels finally sold the house approximately 10 months after he purchased it. His sales price was $185,000 and after closing costs and agent’s commission there was about $167,000 remaining. After paying off his parents and paying back the line of credit on his house he was left with about $12,000 instead of the $30,000 he’d originally expected. A $12,000 in profit may not sound like a bad deal to most people. In reality it’s pretty good to walk away with that big of a profit on your first flip.

On my first flip I lost about $5,000. But it’s hard to explain the stress and the pain of these experiences. If you add in the time it took to find this house and close on the purchase then this is probably at least a one-year ordeal. If Daniels paid himself just $20 an hour for the work he put into this house, plus his overhead expenses like gas and marketing you’d probably find that his return on his investment was very little if not negative. So that means Daniels didn’t have an investment. Daniels bought himself a stressful job that doesn’t even pay well.

But Daniels was also helped immensely by his parents. Many of us don’t have parents who can come in with more than $100,000 in cash. Without the help of his parents, Daniels would have paid at least another $6,300 in finance costs which would have cut his profit by more than 50 percent.

Daniels went on to do another flip after this one. He again made a profit — but it was less than half what he originally anticipated and he had big problems with the contractor. This time Daniels’ buyer found some work in the home to be faulty and, of course, the contractor was nowhere to be found, leaving Daniels to worry about the liabilities and to negotiate with the buyer to resolve the problem.

Daniels still has dreams of being a successful real estate investor but as of right now he’s in no hurry to do another flip. He is continuing to network and educate himself on the subject in the hopes that he’ll be more prepared for the next opportunity that he finds but he has no project right now.

“My advice: Always get permits, do things according to the law of the county you are in,” Daniels said.

“Hire knowledgeable contractors who have references that you personally know,” he added.  “Cheapest bid is usually going to cost you money in the long run.  You’re better off paying the experts to do things right and up to code and not spend time trying to do it yourself, especially if investing isn’t your full-time gig and you can only make it to your property on weekends.”