Systematic Review--Charts and Cash Flow

There’s no doubt that Mark Wade is an expert in his market, says Bill Asdal, and that John Fries does first-rate work.

October 02, 1999

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:

 

 

  • Investment pro forma. A profit projection based on itemized accounting of acquisition, improvement and sales costs plus overhead and taxes, this is the singular most important document, says Asdal, because it gives a "go/no go decision" on whether to purchase the property. Wade used a pro forma analysis for the first time on the Model reMODEL. "I probably will use it from here out," he says.

     

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  • Construction estimate. Fries and Wade arrive at a general construction cost estimate based on experience. Using industry standards, Asdal generated a detailed, computerized estimate for the Model reMODEL. He says such estimates verify your assumed cost before you buy a property, and that gives you a chance to do less improvement or offer less in order to make the numbers work. With a detailed breakdown, Wade says, "We can estimate all our costs more closely so we don’t borrow more than we need. Not paying extra costs to borrow money--that’s a biggy." He adds that the itemized estimate gives a more standardized approach to determine if costs and subcontractor charges are in line, and negotiates accordingly.

     

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  • Cash flow schedule. Asdal’s analysis projects Wade’s financial exposure from purchase through sale of the Model reMODEL. In any property purchase decision, he says, you want to have an exit plan that enables you to sell early if construction costs go up, delays raise costs, interest rates rise, or some other situation arises. The cash flow analysis reveals "how deep a trough" Wade will be in at any point, and allows him to plan ahead for emergency bailout.

     

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  • Computerized production schedule. Until the Model reMODEL, Fries scheduled jobs the old-fashioned way, "doping it out on paper" and retaining it in his head. For this job, Asdal helped Fries create a schedule on a laptop computer. Fries says the computerized version lets him see how changes affect the rest of the schedule so he can reschedule subs and make other adjustments as necessary. Up until now flow charts have seemed kind of scary, Fries says. "[Now] I’m getting a computer."

    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.

     

     

    Model ReModel Pro Forma
    (18-Month Ownership projection)
    Purchase Price: $350,000
    Closing Costs:  
    Attorney Fees: $1,500
    Title Insurance: $1,500
    Inspection Fees: $600
    Mortgage Fees: $2,000
    Improvement Costs: $350,000
    Carrying Costs:  
    Taxes: $5,000
    Utilities: $2,000
    Mortgage expenses, purchase: $52,000
    Mortgage expenses, improvements: $26,250
    Insurance: $4,000
    Marketing Costs: $10,000
    Sales Price: $1,200,000
    Comissions: -$72,000
    Less purchase, improvement carrying costs: -$805,050
    Gross Profit $322,950
    Overhead: -$120,000
    Taxable Income: $202,950
    Taxes: -$79,150
    Net Profit $123,800

    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.


    EXPERT OPINION

    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:

     

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  • Buying right

    "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."

     

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  • Targeting properties

    "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."

     

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  • Financial analysis

    "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."

     

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  • Monitoring the market

    "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."

    See Also:

    Systematic Review

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