JF1873: Working Through A Sticky Real Estate Investing Situation #SituationSaturday with Colin Douthit
Colin and Theo will work through a situation that Colin is currently going through right now. A 16 portfolio of 16 homes is giving Colin a tough time and he’s currently trying to refinance as this project has cost him too much money and time. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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“Our biggest takeaway has been doing the construction loan up front” – Colin Douthit
Colin Douthit Real Estate Background:
- Real estate investor, general contractor, and property manager
- Owns 70+ doors all acquired in the past 24 months, manages 50+ doors for other real estate investors
- Based in Kansas City, MO
- Say hi to him at colinATatlas.rentals
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Theo Hicks: Best Ever listeners, welcome to the best real estate investing advice ever show. I am your host today, Theo Hicks, and today we have a repeat guest. We’ll be speaking with Colin Douthit. Colin, how are you doing today?
Colin Douthit: I’m doing well, Theo. And yourself?
Theo Hicks: I am doing fantastic, I’m looking forward to speaking with you again. This time, as you guys know, it’s Saturday, so we’re doing Situation Saturday. We’re going to talk about a sticky situation that Colin is currently in, and dive into the details on that, some lessons learned that can hopefully help you avoid a similar situation in your real estate business. But before we begin, a little bit of background.
Colin is a real estate investor, general contractor and property manager. He currently owns over 70 doors, which he’s actually acquired in the past 24 months, as well as manages over 50 doors for other real estate investors. To learn more about how he was able to acquire those 70+ doors in 24 months, make sure you check out his first episode, which aired on October 6th.
Colin is based in Kansas City, Missouri, and you can say hi to him at ColinATatlas.rentals.
Colin, before we get into the situation, do you mind providing us a little bit more about your background and what you’re focused on now?
Colin Douthit: Sure, Theo. As you stated, I started off as an investor, I started acquiring properties, and as I was going along, I was having some troubles finding reliable contractors… So I went ahead and started a contracting company that really just focuses on rehabbing rental properties and working third-party maintenance as well for any other investors that are out there, or property management companies that need that service.
With that, we just kind of specialized in what we knew, and what we were comfortable with, which was rental properties. Additionally, we had already incorporated a Buildium, so a property management software that we had been using, so we decided to go ahead and roll that out as well to investors, so we could be a one-stop-shop for out-of-state investors if they needed to do a rehab on a home, to do property management, or whatever they needed, to help take care of them… But it was really developed out of my own personal needs.
Theo Hicks: And again, if you wanna learn more about Colin’s background, we talked about how to find property managers, how to find GCs, about raising money… We talked about all that on the episode on the 6th of October, so definitely check that out. As I said, on this episode – it is Saturday, so we’re gonna talk about a specific situation that Colin is actually currently in. Colin, do you mind just diving in and kind of painting a picture for us about this situation?
Colin Douthit: Yeah, absolutely. We were looking to acquire properties – this was back in 2018; we were still buying a lot, and buying as fast as we could find them, frankly… And we were presented with a package of homes in a smaller town near where we live. We do co-investing in the city, in Kansas City, as well as out in some of the smaller, rural towns. This was in one of those smaller, rural towns; there was a gentleman that was getting out of the real estate business. He had a number of investment properties, but due to health reasons he was leaving the business and the industry… So we said “Okay, let’s do some analysis on this.” There were 16 single-family homes in this package.
So we did our analysis, we did our cash-on-cash return, it was great… We had plugged in 20-year amortization on our calculator, making sure we’re gonna have plenty of cashflow. We knew that there was a lot of deferred maintenance. They were class C properties, and we have every intention of taking them up to a class B property, so that we had a nicer asset. We would add value and we’d be able to increase the rents over what they currently were.
During that process we didn’t really get a hard commitment from the bank, and when we were on the banking side of things, we said “Okay, we’re just gonna take out a loan for the purchase price. We’re not gonna have any additional funds out there for rehab or construction, because most of the properties are occupied.” We thought we’ll just cashflow the rehab; it won’t be a big deal. We’d just spend a few thousand dollars on each one, and that’s all that needs to be done.
As that process goes along, we get to the closing table, and we didn’t have an LOI or a commitment from the bank. They had just been kind of wishy-washy, “Yeah, that’s what we’ll do. 20 years, that’s all good…” And we get to the closing table and they throw a 15-year amortization at us. So that was the first issue that we came into – on the closing day we get that 15-year instead of 20-year amortization. We look at the cashflow, we know that we’re gonna take a hit on cashflow, but we still feel like it’s a good deal, so we still continue to pursue it, and go ahead and go through the closing process, and buy it… Because it was really either we lose all the money and time we had into it at that point, or we just go ahead and go forward with it.
We buy the properties, and then as we are going through the rehabs of these properties, taking them over and starting to do management, we start getting a few more vacancies than we were expecting. It turns out the previous landlord was a very poor landlord, and had upset quite a few of the tenants just due to deferred maintenance, due to lack of contact, or any host of reasons… He was just really poor landlord in general, so we start getting these vacancies.
Then we start going in them and seeing what needs to be done, and our initial estimate on what needs to be done was maybe a little bit lower than what was actual, but we were banking on having more cashflow, so it shouldn’t have been a problem. But when you compound the fact that we have a shorter amortization and higher vacancies, that starts to make the cashflow a real issue for getting into these rehabs.
So the next step is – that kind of brings us up to present day, and right now we have been cash-flowing a number of these rehabs as they go along, doing what we can to add value to these properties as soon as they become vacant. We paint, we repair, fix broken stuff, and then when the major things come along, that’s when we really notice and really miss not having had done that construction loan initially, which is what we would have done looking back and knowing what we now know to be able to tackle some of these bigger items – putting in all new HVAC systems, putting on numerous roofs.
What we’re doing right now is we’re actively searching for another bank to work with us to do a refi out on it. We do have a lot of equity in there; plenty of equity that we could still go up to 70% loan-to-value and have a large chunk of money to then put back into the properties, and have them up and running at full speed and where we want them relatively quickly. However, not all the bankers want to lend in a smaller rural town, with a little bit lower price point on all these houses [unintelligible [00:08:19].10] closer to the city by about 30 minutes, we’d have no problem with it.
So that kind of summarizes it and brings us up to date, and that’s kind of the whole back-story on this situation that we are in.
Theo Hicks: Alright, I appreciate you going into extreme detail on that situation… So it sounds like these few challenges were 1) the loan itself, and then 2) the previous owner, and then 3) the deferred maintenance. Let’s take a step back and — so you’ve mentioned that this is an owner who was leaving due to health reasons… Was this an off market deal that you found, or was this owner actually listing these properties for sale?
Colin Douthit: This was brought to us by a realtor. It was on the MLS. They had each property listed individually, but then they had — essentially, they wanna sell this whole thing as a package was the goal.
Theo Hicks: Okay.
Colin Douthit: And the realtor knew that we were looking; he is a realtor out in one of these small towns that we work in. I actually live in one of the smaller towns, but then work in the city… So he was the connection, and that’s how we came across it. The owner actually was a realtor on the side. He basically had it just so he could buy and sell rental properties.
Theo Hicks: Yeah. Okay. So before the closing table, what sort of due diligence did you do on these 16 properties? Did someone go out and inspect all of them? Did you guys go look at all of them? What was your overall due diligence on these properties?
Colin Douthit: A little bit of background on myself – I am an engineer, and I was a project manager for commercial construction companies, and then my partner on this job as well; we actually met in school, he’s an engineer as well, and he’s a practicing structural engineer, so we have a fairly good handle on any major structural issues and general construction practices… So we were walking through the house, we went and walked every single house, we took pictures and we made notes on “Hey, this is what will need to be done once the property becomes vacant.” We didn’t note any major structural issues. We did note “Okay, these roofs are probably on their last leg, and they’re gonna need to be done pretty soon. These interiors on these units are pretty rough, but we’re not gonna go rock the boat and kick tenants out right away to start rehabbing these units.” Our due diligence was essentially just walking all the properties, taking photos and making notes.
Theo Hicks: Okay. So compared to your initial estimates from that entire process — or not even really initial estimates, but just a list of things like “Okay, here are the 20 things that we need to do”, after you took on the property, did that list remain that 20, it’s just the prices were wrong? Or did that list grow from 20 to 30 or 40? Were there things that you didn’t identify upfront that ended up being an issue after you actually closed? …just from a strictly renovations standpoint.
Colin Douthit: Yeah, from strictly a renovations standpoint I would say that it was some of the unseen stuff that really started getting us. Water leaks, soft spots in the floors that we weren’t expecting… Once we got the previous tenants out – stuff we hadn’t seen before. HVAC issues was another one that came up and was an oversight on our part for not inspecting them thoroughly enough. It’s now something that we take a much harder look at, and try [unintelligible [00:11:22].13] and budget; even if it doesn’t need to be done, we now budget for those.
I actually just had a phone call with my A/C repairman today, that a compressor on one of the houses that’s vacant right now [unintelligible [00:11:30].28] and the air conditioner wouldn’t fire off… And the air conditioner compressor is completely locked up, so we’re actually having a new compressor installed this week.
Theo Hicks: Best Ever listeners know, I can totally relate with the HVAC issues. I don’t wanna talk about it too much, but I bought three fourplexes and the boilers were all completely shut, so I had to drop like 20k in the first few months to get the boilers to actually work… So I totally understand. Moving forward, I’m getting a boiler expert and an HVAC expert to inspect all of that stuff. So I can relate with you on that front.
Moving forward, just to wrap up with renovations – what are some things besides obviously making sure that you’ve got an HVAC person (or you) inspecting those more…? Do you have any other lessons you’ll apply moving forward? Do you need to have a contingency just to cover these unexpected things?
Colin Douthit: Yeah, we’ll put a much larger contingency in the construction budget, knowing that on a class C property there’s gonna be more stuff that you don’t see, that’s gonna pop up once you get the tenant out and start digging into it. There’s gonna be roof leaks or pipe leaks that you weren’t expecting, HVAC is probably gonna be dated… Single-pane windows or storm windows are really common out in this area with a certain aged home, so if you replace all those, are they all working? A larger contingency and a larger construction budget would be what we would do now, going forward.
Theo Hicks: Alright, so that was one of the aspects. The other one was the loan. You’ve mentioned that you didn’t necessarily have a hard commitment from the bank up until closing, because they kind of pulled a switcheroo on you, and said one thing and ended up doing another thing… So what are some lessons learned, some safeguards to put in place for a future deal, so that you don’t have that switcheroo happen at closing?
Colin Douthit: Basically, now that bank still has our loan, but we’re not pursuing any new loans with this bank… But we are making sure that the lenders will give us some sort of commitment, an LOI if it’s a bigger package or commercial loan. Even if it’s a smaller property through a hard money lender, they give us a terms sheet; they analyze the property and give us a terms sheet within 24 hours, and say “Yeah, here’s what we can do, here’s what you’ll need to bring to the table, here’s what your monthly payment is gonna be, and here’s what your interest and amortization are.”
Theo Hicks: Yeah, because 20 to 15 – that’s a huge difference in debt service, for sure.
Colin Douthit: Yeah, 15 to 20 is a bigger jump than 20 to 30. So yeah, that was a real kick in the teeth.
Theo Hicks: And then on the construction loan aspect – so you’re looking at a deal… How are you going to determine in the future whether you’re going to do what you did for this deal, which was just take out a loan for the purchase price and just front the renovations with the cashflow, or maybe a budget threshold or a per-unit threshold that you say “Okay, we’re gonna go ahead and include renovations in this loan and then refinance out once we’re done”?
Colin Douthit: It’s very much a case-by-case basis. If it’s gonna be a property that just needs $5,000, maybe a fresh coat of paint and a little bit of touch-up here and there to get it rent-ready, we’d probably just roll it right into a typical, traditional 30-year loan. If it’s something that’s gonna need more extensive work, we are starting with construction loans right away, putting together estimates, putting cushions on those estimates, and then making sure all those numbers still work when we put it in our proforma, to make sure it’s gonna be a good deal and that we have plenty of give…
And frankly, when we are doing a lot of stuff for our turnkey or hyper-turnkey customers that we work with (out-of-state investors), we’re gonna tell them “Hey, let’s start out with a rehab loan here, and if we think the work is gonna cost 15k, we’re gonna put 20k-25k on the spreadsheet to make it work”, and hope that we can overdeliver and cut their construction costs.
Theo Hicks: Exactly. Alright, and then the third point was — I guess we’ll call it previous management. Obviously, when you’re dealing with single-family homes… I know on the one hand you can look at this as a 16-unit building, but it’s really not, because on a 16-unit building you’ve only got one roof, maybe a few water heaters, a few boilers or HVAC systems, whereas for SFRs you’ve got one of everything: 16 roofs, 16 HVACs, 16 yards… So whether you’re looking at multifamily or you’re looking — I guess my point of saying that is one vacancy on 16 single-family homes is a lot bigger deal than one vacancy on a 16-unit building, especially when you’re doing rehabs.
Colin Douthit: Yeah, it can be. At the end of the day though, we have enough (and still try to have enough) cushion that we can sustain a 25% vacancy rate and still be just fine.
Theo Hicks: Okay.
Colin Douthit: But one vacancy – it is very similar if you have a 16-unit multifamily building, just from the debt service aspect and the financial aspect… You’re still getting paid the same note, because it’s a portfolio loan. If you have 16 different individual loans, they’re owned by different LLC, if you put each property in an LLC; then you might feel the pinch a little bit more. But since it’s all in one company… We own a few other properties – this is the bulk of the properties that this company owns – we can kind of wash the vacancies out a little bit. While we’re not gonna be making the money that we want to be making, we’re still gonna be able to cover all of our expenses and then continue to slowly cashflow the rehabs on the other properties.
Theo Hicks: Okay. Earlier we talked about the physical due diligence of a property… Is there anything you can do to determine the mindset of the tenants that you’re inheriting, and estimate “Okay, on average, if we’re buying 100 units, we expect 10 to leave. But if we do this, and find more details, and we figure out that the previous owner was really bad, a lot of deferred maintenance, half the tenants have issues that haven’t been addressed in years, so instead of 10 people leaving, let’s project that 25 are going to leave.” Is there anything you can put in place to do that, or is that something that’s just kind of random, and if it happens, you’ve gotta figure it out?
Colin Douthit: I think that you need to go into it with a plan, instead of just winging it. And we’ve done this on future renovations, with properties that we’ve owned, as well as with out-of-state investors that we’ve worked with. Personally, we’re working on the rehab of six duplexes, all in one package, all in one area, and a lot of deferred maintenance; 60% and — 75% vacancy, actually. So there was only four occupied units at the time of the purchase, and we knew we were gonna be getting rid of them… So we did cash for keys for one, and then one split, one is still there, and one just decided to leave recently as well.
But if we’re rehabbing this property and bringing it up probably two levels, to be honest with you – if you’re gonna be doing that and you have an extensive renovation, and you have properties that are really dilapidated, and it’s multifamily, I would go ahead and plan on kicking all of them out, or asking them to leave, or cash for keys; if they’re month-to-month, give them a 30-day notice. We’re doing that with an out-of-state investor that’s got an 8-unit building and had one vacancy… So we’re starting this week on the rehab for this one vacant unit, but we’re gonna go ahead and give 30-day notices to two of them, probably the two lowest-paying tenants, and start rehabbing those units, and then start doing two at a time… So we’ll get two vacant, rehab those… It won’t take too long – about a week, a week-and-a-half per unit – then get them back on the market and get them occupied, and give the 30-day notice to the next set. We’ll kind of phase it in and out… But I would plan ahead of time on a complete turnover, and that’s what we plan on all the future projects. If it’s already occupied and we’re gonna be bringing it up a class level and renovating it, I’d just plan on at some point having every unit go vacant.
Theo Hicks: Well, Colin, is there any lesson learned as it relates to this situation that we haven’t talked about already?
Colin Douthit: I would say no, not really. We dove into all aspects of it. Our biggest takeaway has honestly been just doing the construction loan upfront, instead of trying to cashflow it. That’s the most important thing that we learned. When we were coming up and learning the game a year ago, we hadn’t been exposed to that idea. Then we got exposed to the idea and it made total sense. So I guess it’s one of those “learn the hard way” things, but we try to share it with as many investors as we can.
Theo Hicks: Alright, Colin, I appreciate you coming on the show and sharing this situation with us. Again, some of the lessons you learned from this deal, as you’ve just mentioned – pursuing that construction loan if there’s going to be a lot of repairs that need to be. You’ve had the switcheroo from the bank at closing, so the lesson there was to get an LOI or some sort of harder commitment from your bank, so you know specifically what the debt service is going to be, what’s the amortization, down payment… Essentially, all the loan terms before you go to closing, so you’re not surprised and feel rushed and have to make that decision around the closing table.
We’ve talked about from a vacancy perspective – if you’re doing a value-add, going in there with a plan, and that plan might be getting rid of all the residents, and renovating all those units and bringing in people completely new.
And then lastly, we talked about the actual physical due diligence, and some of the things that you look at in more detail now, as well as making sure that you are having a contingency budget, especially when you are looking at the C-class, lower-class properties.
Again, Colin, I really appreciate it, I enjoyed the conversation. Again, as always, Best Ever listeners, thanks for listening. Have a best ever weekend, and we will talk to you tomorrow.
Colin Douthit: Thank you, Theo. Have a good night.