Guest post by ERIK DWYER
My client, Erik Dwyer, recently closed on his first condemned property purchase. He did so much research and taught me so much during the process I asked if he would be willing to share his experience here. I was delighted when he said yes. We hope you will find it helpful!
In 2012 I bought my first investment property. It was a one-bedroom condo that was move-in ready located in the Stevens Square neighborhood of Minneapolis. It was a great time to buy and it was also a short sale. Then, in 2016 I decided to sell the property and use the proceeds to pay off my student loans.
What I learned from owning a condo is that the homeowner’s association (HOA) is a variable that you cannot control as an investor. The HOA controls the association fees and can come up with anti-investor rules at any time such as move-in and move-out fees every time you get a new renter. While I did come out ahead in the end, my cash flow was at the break-even point.
Overall, I would certainly invest in a condo again. It should be noted that I did well with a big help from the rising market, which is something that cannot always be predicted. It is also a very easy property to manage since the association takes care of every aspect outside of the unit’s walls. However, if I were going for maximum cash-flow, I would shy away from condos and look more toward single-family homes and duplexes.
Mysteries of Financing
In early 2017, I started going to local investor meetings and talking to other investors in the area. This gave me ideas on alternate ways to come up with financing and also other kinds of properties that are available that most people tend to shy away from.
I also reached out to the real estate developer responsible for the Solar Arts Building and asked him to sit down with me to discuss his beginnings and how he came to acquire and rehab a large vacant warehouse in Northeast Minneapolis. To my surprise, I did end up getting to meet the developer and learned about how he had started out purchasing, rehabbing, and holding both single family homes and duplexes. He then sold all of his residential properties to finance the acquisition and renovation of the now Solar Arts Building that houses several artists, an event space, and a brewery.
The idea of a property needing repair usually brings up the image of someone that purchases property for cash, rehabs the home, and sells it for a fast profit. This is not what I want to do, nor do I have a pile of cash hidden in a mattress somewhere.
How do these mystical beings come up with the financing to acquire a distressed property? As an investor using traditional banks, you can’t easily find financing for anything other than a move-in ready property. But – there is a way.
Meet Hard Money
I’ve known about the term “hard money” but I always thought it was investor folklore, until recently.
Hard money is basically a private money lender that will finance a distressed property at a high interest rate, high origination fee, and a short period of time, maximum of 9 months.
I was able to find a lender that would finance 70% of the ARV (After Repair Value) of a distressed home at 15% interest for a 9 month term. During the course of the term, interest-only payments are made. The idea is that this financing covers your purchase and the cost of the rehab. Then, once the work is complete, you refinance with a traditional mortgage and pay off the hard money lender.
The lender does have a few hoops for you to jump through though. The series of hoops looks like this:
- Get pre-approved to refinance out of the hard money loan
- Find the ARV of the property via comparables
- Submit a list of comparables
- Determine the rehab costs via contractor estimates or your best judgement
- If there is structural damage, get a structural engineer’s report ($500 to $800)
- Submit a scope of work with detailed repair costs to lender
- Order appraisal of property from lender (typically $500)
After this checklist is complete, the hard money lender can close in about 3 weeks and fund 70% of ARV. Depending on how good of a deal you found, you could end up acquiring the property with no down payment.
Here is some math to find out if you got a good deal:
- ARV of home is $100,000
- $100,000 x 0.7 = $70,000 (that is the amount the lender will finance)
- So, $70,000 minus repair cost of let’s say $30,000 gives you $40,000
- Arriving at $40,000 means that this should be your maximum offer amount if you do not want to bring any of your own money to the table
This formula is very watered down though simply to show the general idea and does not account for closing costs, holding expenses, and any fees from the city.
Onward to the Condemned
A boarded up property, for many, is an automatic deal breaker. There must be something terribly wrong going on if the city declared that it cannot be inhabited.
With the right financing, a condemned property might be the perfect property to look at. A building is typically condemned due to code violations, excessive neglect, or unsanitary conditions.
There was recently a condemned duplex in Saint Paul that I looked at that was mostly just a massive cleanup job. Squatters had been living in it, trashing the place; in addition, because there was no running water, they defecated in pots and soup cans. It smelled terrible, but the bones of the building seemed to be in order.
Both Saint Paul and Minneapolis have a different process for buyers to go through that must be followed before making a purchase, Saint Paul’s being the more extensive of the two.
Saint Paul requires the following:
- The purchase must be approved by the city before closing
- Buyer has to pay for a purchase review, about $280
- Code compliance report must be obtained, about $500
- Provide financial proof that repairs can and will be completed
- Submit estimate of repairs and a schedule for work completion
- Once approved, the sale can close (approval may take up to 6 weeks)
- After closing, the repairs must be executed according to the proposed schedule
Minneapolis requires the following:
- The buyer must sign acknowledgement of responsibility at closing and it should be sent to the city within 24 hours of closing
- City requires that a general contractor pull the building permit
- You can pull your own permit if you are qualified to do so
- If there are structural issues, buyer must have structural engineer’s report
- Buyer must schedule a meeting with the city and bring a $2000 deposit
- The deposit is returned unless the work takes longer than 6 months; in which case it is forfeited and another $2000 deposit must be made
Both Saint Paul and Minneapolis inspections departments are incredibly helpful and answer both phone and email very quickly. I am seriously impressed and am glad that the city’s speed isn’t too big of a road block to getting a condemned property back in business.
I would just make sure that the seller is going to be paying all tax assessments and any pending assessments such as the vacant building fee of nearly $7000 per year.
The key to succeeding in the purchase, rehab, and holding of a condemned property is to know the rules that each city has that are specific to buyer requirements for both before and after closing.
You’ll need to understand your financing options and have any issues or outstanding questions settled before even making an offer. You could have a contractor come with you to showings for a typical charge of $200 to $400 per viewing. Some contractors then credit that amount back to you if they end up getting the work.
With today’s inventories being so low, vacant buildings may be the perfect opportunity for an investor or even a potential home owner willing to wrangle the hoops of bringing a property back to life.