If you’ve missed some of the prior articles, basic guidelines on successful investing are in my book “Stairway to Wealth” available at LuLu.com.
Continued from Part 22: Emily needed to get the agent away from the property. She said, “This doesn’t look very promising. Why don’t you lock up and we’ll get coffee and pastry? My treat. We need to talk”
Emily made sure she hit all the red lights she could. She wanted Trixie to arrive early and have to wait for her. Trixie was at the door, looking anxious, when Emily arrived. They entered the bakery and sat in the café portion. They drove separate cars. Emily wanted Trixie Dixie to stew a little by herself. In the meantime, Emily mentally computed the buildable area of the lot. She subtracted front and rear setbacks from the 200 foot depth, and then subtracted side yard setbacks from the 50 foot width. She did it a couple of times just to make sure, and each time the answer was the same: she could build the second house on that lot.
Emily sat with her back to the afternoon sun. She appeared to be sad, yet thoughtful. She said nothing, preferring to let Trixie open the conversation. People talk about what bothers them, and Emily wanted to maximize those little levers before talking price and terms.
It didn’t take long. As the waitress was leaving Trixie opened with, “So, what did you think about the house?”
“It’s pretty rough, isn’t it?” Emily replied. “Not too long ago I finished remodeling a fourplex that was in a similar condition when I bought it, but it turned out to be more work than I expected. Expensive problems I didn’t know existed kept popping up and I don’t know if I want to do that again right now.” In that single sentence she established that (a) she’s experienced in restoring worn out properties, but (b) the price would have to be very friendly.
“It could be beautiful if it was fixed up a little. Maybe a coat of paint?” Trixie was hopeful.
“Well, it isn’t even rentable now, and even if somebody wanted to I don’t know if it could be restored. There’s the plumbing that has to be totally redone. The roof has to be replaced. The wiring is almost certainly not to code. And you saw that the only reason the house is still standing is that the termites are holding hands. Anybody who takes that job on is in for a lot of work. And there’ll be expensive surprises, you can bet.” Emily hoped Trixie caught the fact that she was presenting the house as a total teardown: after subtracting the wooden parts, the plumbing, the wiring, and the roof . . . what’s left?
The waitress brought the coffee and pastries. Emily had a small chocolate éclair with custard filling. Trixie had blueberry cheesecake with chocolate syrup and gummy bears. Her hips showed this was not her first time at the gummy bear bar. Trixie slipped her fork under a yellow gummy bear and raised it to her mouth.
“Before we begin,” Emily said, “what’s your relationship to the sellers?”
Trixie chewed fast. “They’re my aunt and uncle”, she said.
“So it would be very hard for you to represent me, wouldn’t it?”
Trixie saw half her commission evaporating. “Oh, noooo!” she said. “I can do both!”
Emily thought it over for a moment. “Well, maybe we can try it. But be really clear: if I think you aren’t representing me in the way I want, I’ll get somebody else. We’ll put that in writing. Agreed?”
Emily paused a moment to let Trixie answer. Then she abruptly changed the subject. It was time to throw a bone. “That house must have been very beautiful when it was new. I can imagine the morning after the first buyers moved in. Everything fresh, dew on the lawn, the roses starting to open, the smell of breakfast bacon and sautéed gummy bears coming from the kitchen. Problem is, the way things are now, if the house were a car the insurance company would total it. The cost of repairs exceeds the cost of building the house new. (Emily didn’t really know this. She was simply stating a hypothetical without troubling to say it’s a hypothetical. No sense in confusing Trixie Dixie.) So the house no longer has any positive value. The only thing that’s useful is the land. And even then, there has to be an adjustment for the cost of removing that old house.”
Trixie hadn’t been paying much attention. “You like gummy bears, too? I love ‘em, but they keep going to my hips! I wish I had hips like yours.”
A relationship was being established. Emily wanted to push it along, “Do you eat the green ones? I never do. It’s the green ones that are the problem,” Emily offered helpfully.
As TD thought that over Emily continued, “Anyway, if somebody wanted to start a big project like that, it might make sense if it could be bought for land value or maybe even less.”
Trixie immediately objected, “There hasn’t been a land sale in this area for years and years!”
“That’s the case in a lot of neighborhoods,” Emily said. “The way it’s handled is you take the prices of recent sales and subtract the cost of building the house that came with the property. Whatever’s left is the land value.”
Trixie looked like she was still thinking about green gummy bears. “I didn’t get that”, she said. Can you say it again, but in a different way?”
“Sure. The property includes the land and the improvements, like the house. So if you have the price of the property and you take away the cost of the house, you get the value of the land. Make sense?”
“So what do you think that would come to?”
Emily responded, “Right now, I don’t have a clue. But I might be interested if the property was available for land value. Do you want to help? If we did the research together, it would go faster. And even if I didn’t buy it, you’d know what it was really worth and you’d know how to justify the price. Wouldn’t that help you sell it?”
Trixie saw no danger in Emily’s suggestion. Right now, Trixie would get both the listing and the selling commissions. If Emily didn’t buy the property, Trixie would almost certainly put it in the MLS and somebody else would earn the selling commission. Trixie didn’t want to even think about Emily turning down the property.
Trixie forked the green gummy bears off to the side of her plate. She looked at Emily then raised her fork and stabbed one of the greenies. There was a pause in the conversation. “I’ll start on Monday. All diets start on Mondays,” she said.
“Ok,” Trixie said, “how do we begin finding the value?”
“Can you pull some comps from the MLS? It doesn’t make any difference. Pull them from anywhere in town as long as they’re about the same age and living area. You can go back a year or two if you have to.”
Emily knew that at least some of the sales would be from the inferior school district and bring down the overall average pricing. And she knew that the sales from a year or two ago sold for more money than recent sales, so Trixie’s own data would show a declining market. That was another negotiating point.
There were, it turned out, a dozen sales of roughly similar properties over the past three years. Four of them were in the inferior school district.
Emily had Trixie open her laptop and walked her through the process of deducting improvement costs. First, she had Trixie google for construction costs in the city the property was located in. Then she had Trixie multiply the living area of each comp sale by the construction cost per square foot, including City fees. That figure was subtracted from the MLS sales price. If it were made into a formula, it would be: sales price minus (total construction costs and City fees) equals land value. Trixie never considered that all the sales were of old properties, yet the estimated construction cost was for new properties. Emily forgot to point that out.
Then Trixie divided the calculated land cost by the lot square footage to get a $/sq. ft. land figure. It was easy to determine the estimated land value of the tear-down she was trying to get Emily to buy: lot size of the tear-down times $/sq. ft. For example, if the adjusted land values in the area were calculated at (hypothetical) $10 sq. ft. then the value of a 15,000 sq. ft. lot would be $10 times 15,000 or $150,000.
Trixie, by doing her own work under Emily’s guidance, had all the data she needed to convince her aunt and uncle to sell for the calculated land value.
While Trixie was doing her research, Emily got a rebuild estimate from Hiram Abiff. Her loan broker suggested she finance the purchase through a First Trust Deed that included rebuild costs. These are government guaranteed loans. Hiram’s rebuild estimate would be vital when Emily applied for the loan.
The loan broker suggested an initial financing (as noted above) to buy and rebuild the front house, including the minor changes. Hiram modified the plans to add enough living area that each upstairs bedroom could have its own bath. It took four months to rebuild the front house.
When it was done, the loan broker arranged to have a private money loan to fund the construction of the rear house. And when all construction was completed, a new First Trust Deed would be taken out on the entire property, retiring both the purchase money First and the private money Second Trust Deed.
The front house being rebuilt, Emily moved into one of its bedrooms. She rented the remaining bedrooms individually, just as Banana Pudding did. Six months later the back house was completed. Within a month it was leased to a three generational family (grandparents, parents, infant) who paid top rent to find a house with that many bedrooms and baths.
It had taken her a touch over five years, but she now had bought and sold a commercial SFR that she had transformed into a day-care center, and renovated (and kept) a fourplex (each unit with three bedrooms) and built / rebuilt a two-houses-on-a-lot duplex. They were franchise buildings (due to the number of bedroom / bathroom suites) in a modest archipelago. As usual she spent her birthday that year alone, reflecting on what she’d accomplished. That evening her favorite movie was playing on the Turner Classic channel. Emily opened a bottle of her favorite Beringer Chardonnay, took it to bed with her, turned on the TV and clicked through to Casablanca. When the movie ended she rolled over and went to sleep, leaving the empty wine bottle on the side table.
When she started five years ago she had nothing, but aspired to eventually having 10 mortgage-free units. She now had six franchise units (albeit heavily mortgaged). Only four more to go. Then the challenge would be to pay them off. Ten free-and-clear units would give her a reasonable retirement, maybe by her fortieth birthday.
This article is for informational purposes only and is not intended as professional advice. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya is a Commercial Mortgage Broker; Commercial Loan Broker – BRE: 00957107 – MLO: 249261. If you are thinking of refinancing or purchasing real estate, Klarise Yahya can probably help. Find out how much loan the building will support. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected].