Property Values

In the late 1980s in California, Steve Jordan was remodeling foreclosed houses for banks when he realized that instead of working for the banks, he could create a similar system for himself by purchasing, renovating, and renting houses. He shut down his remodeling company and started Rebuilding America, at one point owning 40 houses. When the real estate values in California became too high for investing, he relocated to Pensacola, Fla., where in three years he amassed 190 rental units.

Jordan honed his investment evaluation skills by remodeling almost 5,000 houses in less than 10 years for the banks. “It's like making McDonald's hamburgers,” he says. “They're not that tasty, but they are consistent — they all taste the same all over the world. I had been a high-end remodeler, so I had to shift my thinking on getting things done quickly and economically.” Jordan's criteria for purchasing properties are based on features that renters find attractive. Most of his houses in Pensacola are a 15-minute drive from downtown, a 15-minute drive to the airport, and within a mile of the beach. “Rebuilding America is the name of my company, but rebuilding a small part of Pensacola is who we really are. We know that market intimately,” he says. In addition, he notes, since he purchases houses within a small circumference, every house he renovates raises the value of his other houses.

He has five subcontracted crews and uses a systematic approach to renovation. “We only buy two types of light fixtures — one for the ceiling and one for the bath. We only buy one exterior paint color and five interior paint colors. We replace all the carpeting with 14-inch tile. We have to watch every penny because we have a large volume of inventory,” Jordan says.

Almost at the same time that John McCloskey started his Pittsburgh remodeling business, J. Francis Co., he began operating a real estate development company, J. Francis Restoration. He has run both for 20 years. The development company has 20 rental properties. “There is a wonderful synergy between the two companies. I buy houses that need to be renovated, stockpile construction materials we pull out of remodeling projects, and wait for downtime at the remodeling firm. Then I use the investment properties to keep our personnel busy,” he explains.

Jordan and McCloskey have gone beyond most remodelers' investments, which consist of purchasing a property to house their offices. Twenty years ago, Gary Deimler of Deimler & Sons Construction in Harrisburg, Pa., purchased a piece of land that had an existing building where he located the firm's office. He added apartments to supplement the cost of the office space. Five years ago, he built a new building on the property to house the office. He and his wife own the property and lease it back to Deimler & Sons, says his son Craig Deimler, who now manages the company.

The firm pays a rent that is slightly above the market rate, which provides a good income for the couple. “It allows them to receive income from the company without paying taxes on the income,” Craig says. “The company is basically paying for the mortgage and taxes, so when the property is paid off, it gives them passive income for their retirement years and passive income is not taxed at the same rate as active income.”

Financial consultant Steve Maltzman, president and founder of SMA Consulting in Redlands, Calif., says that most of his clients who own property purchase it in their name. The main advantage of this is asset protection for the company. “If the firm owns the property, should a customer sue the firm, they can go after the office building, which has a lot of equity,” Maltzman says. Remodelers should also treat the renovation of their office space as a job. “Set up a budget and create an estimate so you won't go over budget,” he says.

When Andy Wright first moved to Grass Valley, Calif., 20 years ago, before he started WrightBuilt, he worked for a real estate development firm that built speculation homes. After learning from the owners of that firm, Wright decided to invest his own money. He purchased a property and built a house that he sold, then purchased and renovated a house for himself. He also owned some other land, but did not have funding to build another house. “When you build a spec house, if you have to borrow money for the land, and then pay a real estate agent to market that property, you're giving up two-thirds of all your profit. And the small amount of money that is left, you do not receive until the end. The margins were not great. I decided I could do better as a professional remodeler,” Wright says.

Remodelers who do choose to invest in real estate can use their knowledge of neighborhoods to find properties and use their crews to remodel them. Deimler says that many buyers can't see a property's potential or can't afford to purchase a property and put additional money into remodeling it.

McCloskey says that remodelers' estimating skills serve them well in selecting houses. “They can look at the house and know the value of the work that needs to be done,” he says. McClo-skey has a 3,000-square-foot storeroom where he keeps surplus materials from remodeling projects for use in his investment properties.

Jordan says that most remodelers are good at sales, a useful skill for renting or selling the properties. Their knowledge of systems is especially useful in property management and maintenance.

The Deimlers own a separate corporation that purchases property for rent or to sell. They currently purchase and renovate one property per year. “It's not our primary focus,” Craig says. They use their construction crews to renovate and maintain the investment properties. “Things were slow over the winter, and even though we did not have work for them in the construction company, the crew was not laid off,” he says.

McCloskey often sends his carpenters to his investment properties to work under the supervision of the full-time subcontractors. He says the properties also provide a good training ground for his crews, as the low-pressure work is not custom or for specific clients.

But it's important to make sure you follow tax rules. “If you're doing work for a related party, the IRS likes to see you charge a profit or at least cover your overhead,” Maltzman says.

“Once you understand how it works, it's simple,” McCloskey says. “The hardest part is tracking the paperwork and getting started.” He says the development company is the core of his retirement strategy. “Right now, I could not live off my rent on the rental properties. I'm trying to time my mortgages — where almost all my equity is — to my retirement.”

Partner with a local bank. “Use local banks that specialize in real estate lending, not mortgage bankers. We're close to our bankers, and they know our business,” says Steve Jordan of Rebuilding America, in Pensacola, Fla. John McCloskey, of J. Francis Co. in Pittsburgh, says that setting up a line of credit can also be helpful — and possibly using the equity in your primary residence.

Work with a tax specialist. They are especially helpful in setting up the best way to invest. In addition, says Andy Wright, of WrightBuilt in Grass Valley, Calif., they can advise you on depreciation, repair deductions, and capital improvements.

Negotiate and lowball offers. McCloskey often offers 20% less than the asking price. He says that real estate agents like to sell properties to him because it's a quick sale without contingencies. Craig Deimler, who manages Deimler & Sons Construction in Harrisburg, Pa., and his father work with real estate agents or find houses for sale by owner. Jordan often markets directly to homeowners in the community where he wants to buy. He offers to pay cash and close escrow in 30 days or less.

Learn to manage the rental properties or hire an outside firm. Jordan says that the true income on the properties is rental income. He has four full-time staff who collect rent and schedule maintenance. McCloskey hired a property management firm to handle the leases, credit checks, and maintenance on his rental properties, as well as to pay the mortgage and utility bills. “I also have the option of retaining them to fill each unit,” he says. The firm charges a percentage of the gross rent for each property. McCloskey has even found good subcontractors for his remodeling business through the property management firm.

Maintain the development company as a separate entity from the remodeling firm. “The more space and protection you can give to yourself, the better,” Craig says. Financial consultant Steve Maltzman says remodelers should view this type of investment as they would any investment, such as a stock purchase or mutual funds. “Look at risk versus return,” he advises.

Begin by purchasing an office for use by your remodeling company. “Becoming your own landlord is smart. Buy bigger than you need now, rent out part of the space, and grow into the building,” Jordan says.