A NEW BUSINESS MODEL
There’s no doubt that Mark Wade is an expert in his market, says Bill Asdal, and that John Fries does first-rate work. Nevertheless, new business practices could help them reduce the risks inherent in spec remodeling. Asdal recommends the following systems and analyses:
Once Wade has done a detailed cost estimate and job schedule, he can use them to calculate his monthly expenses for the project. The cash flow chart graphically demonstrates when Wade’s maximum exposure occurs. It’s wise for Wade to protect himself by planning ahead so that he has some percentage more than the maximum expenditure and is ensured he can manage through the low points, says Asdal.
The money also can be used for contingencies and to expedite the job if necessary. Wade’s safety margin can come from the bank or his private investors. On his spec remodeling jobs, Asdal tries to beat the estimates; by doing so he accrues cost savings. Although construction is completed in month six, the remodeled property may not sell for several months. Carrying costs will continue to build.
Bill Asdal’s pro forma lays out the financials of a spec remodel to aid Wade in evaluating the property’s investment potential before he buys. It tests whether the asking price works, and whether the remodeling budget and plan need to be adjusted to yield an acceptable profit. Numbers for a pro forma come from the remodeler’s experience, perhaps supplemented by data from such industry sources as trade associations, books and estimates from allied professionals. There are four expense categories: purchase, improvement, sales and the overhead and tax costs that need to be subtracted out of gross profit to arrive at a net profit figure. Asdal says dozens of additional lines could be added to detail expenses as well as potential revenue opportunities--an auxiliary rental unit, for example. One important note: It’s a mistake for a spec remodeler to regard net profit as "pay for the job, Asdal says. The remodeler’s time needs to be covered in overhead, and if he works on the job, construction pricing should also be included. Profit is separate; "It’s the benefit of accepting the risk [of the venture]," Asdal says.
Does the Model reMODEL business prototype measure up? To find out, Professional Remodeler asked spec remodeling pro Chuck Moriarty, CGR, to comment on Wade’s current operation and Asdal’s recommendations. Co-owner of the Seattle-based design/build company Moriarty & Matzen, Moriarty worked exclusively in spec remodeling from 1976 to 1982. For the past 17 years, his company has continued to buy and sell real estate while doing contract work for remodeling clients as well. Here’s what he has to say about the Model reMODEL:
"Wade is absolutely right when he says as long as he buys it right he won’t lose. In speculative rehab, you make your profit when you acquire the property, because if you pay too much in acquisition costs you’ll never get the selling price you need to make a profit."
"Wade should identify properties he’s interested in and start contacting owners himself rather than waiting for properties to be listed. Chances are he’ll get a better price and maybe better terms, such as seller financing."
"Buying, selling and carrying costs can easily eat up any profit there is. If you are going to do speculative rehab you really need to be beating the bushes every day looking for that unique deal that will allow you to profit as much as your real estate agent, banker and tax man."
"Asdal’s systems can do nothing but improve Wade’s performance. They will give Wade an emotion-free decision-making process on the individual properties, which will change his worst-case scenario of ‘breaking even’ to some level of profitability. The pro forma helps you to add all those soft expenses you forget about, like loan fees, selling costs, taxes, all of which affect the profitability of the project."
"You have to develop a budget and schedule for your rehab so your decisions can be driven by cost/benefit analysis. Your own projects should be as well-planned and organized as projects you would do for Mrs. Jones--particularly because it is your money you’re wasting on lousy scheduling or lack of decisions or re-work, and there is no way to make any of it up on change orders."
"Asdal’s systems will really help [when and if] the market starts turning. As long as Wade keeps viewing open houses and is active in his neighborhood, he’ll notice the softer prices and longer marketing time and should be able to bail out before he gets stuck with inventory he can’t sell. He could also change his business model and start buying houses for long-term rental or to sell in the next housing upswing."