Flipping Challenges into Cash in South Central LA!

On this episode of Realty Talk, we're diving into our wild journey with a tricky investment in South Central LA. It all started with the surprise discovery of squatters and a seriously damaged foundation. With repair costs threatening to blow our renovation budget, we had to get creative to tackle this financial headache.

Join us as we turn a potential loss into a profitable venture. We'll walk you through our experience converting the property from a single-family home into a duplex with additional ADUs. We'll also discuss securing permits, planning the development, and various exit strategies, like building and renting out the units or selling the property with approved plans. 

 Tune in to see how creative solutions and strategic pivots can help tackle even the toughest challenges in real estate investment. 

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Stephen Couig:
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Transcript

Speaker 1: 0:00

The day after we close, we go to do our first inspection, and I can tell you it was a very, very interesting inspection.

Speaker 1: 0:05

We walk inside of the house and we're not alone. Welcome back, episode number three of Realty Talk, doing something a little bit different today. As most of our listeners know myself, suzanne and Steve we all run different businesses. So Stephen Kuig runs Center Street Lending, very focused on lending capital to fix and flip investors ground up investors. Suzanne runs Innovate Realty. It's a retail brokerage working on a lot of really cool new products, representing buyers and sellers in single family space. And then I run full time a company called Bye Bye House. We are a single family value-add investor. We define that as we buy real estate, we fix it up and then we either sell it or rent it out to someone long-term, and so from time to time we'll have smaller segments or episodes focused on each of those businesses, and today you get the opportunity to hear about a nasty project, one that you know has got a lot of hair on it and is a unique one. So for listeners that have never invested in single family real estate, this is a great lesson to learn. I'm going to give you a few different pointers on how to avoid a situation like this property specifically. So we will go all the way back into July of 2022. That market is red hot, right. So we are in the Southern California area. This property, specifically on 43rd we'll call it the 43rd property is in South Central LA and inventory's really low. Inventory has been low for a couple of years.

Speaker 1: 1:51

Coming out of COVID and investors like Bye Bye House are actively working very, very hard to identify new assets to purchase, and so we had at that time in our business cycle, multiple ways that we were acquiring customers. For the most part, we were advertising direct to consumer on TV, radio, traditional direct response sources, but at that time we were also working heavily with real estate brokers to help source deal flow they thought would be investable, and so in this specific property's case, we had a realtor that we'd done some deals with and this property came up on a probate list. So for listeners that don't know what that means, the person that owned the property passed away and the property has to go through what's called the probate process. It's a legal proceeding where the property can be sold to anybody but has to get approved by the courts and the assets of the estate are then distributed by those courts, and so in a probate scenario it's very different than a typical transaction and there's different ways that a probate transaction can take place. This one specifically was brought to our attention very late in the probate process and so when we wrote an offer on 43rd, our offer had to be fully non-contingent, which meant that we could not do inspections. We actually couldn't go into the property inside physically. We had to waive our appraisals and loan contingencies. It meant that we had to buy this property within seven or ten days from writing our offer. If they accepted it. We offered specifically on the 43rd, $510,000. They accepted our offer and we purchased the property. So this is a single family residence, south Central LA. You know we're thinking 70, $75,000 in rehabilitation. Bring it back to market in six months. You know our typical return profile is somewhere in that eight to 10% return on revenue range, and so you know we think that we're gonna sell this thing for, you know, high sixes, low sevens, very quickly six months.

Speaker 1: 4:24

The day after we close we go to do our first inspection and I can tell you it was a very, very interesting inspection. We walk inside of the house and we're not alone. During that closing timeline there had been some homeless people, some people taking drugs, that had built a little encampment at the property and so, as you can imagine, the police were called and we got really lucky. You know, they did not try to establish tenancy, they were just staying there. So we actually got away on that one you know that specific first issue pretty easily. They just vacated the property as soon as the police showed up and we were able to secure it. For those of you who don't know, in the rest of the United States, you know Los Angeles is incredibly tenant-friendly. So if they were to have claimed that they were tenants of the property, it could have taken us a year and $100,000 in legal fees to get them out, to evict them, and so we kind of dodged a bullet on that one. But I can tell you we certainly have a lot more challenges ahead at this time.

Speaker 1: 5:31

After we get the tenants out, or the not tenants, the squatters out, we start to do our inspections to understand exactly what we have, and after that first week we were hit with some crippling news, and that was that our foundation it was a raised foundation. Typically we don't have a ton of issues in those scenarios. But this particular house had a tremendous amount of settling and what that means is that the foundation holding the property up was no longer viable and the quote to get that repaired and fixed so that we could continue on with our standard rehabilitation was equal to what we had anticipated spending on the full renovation. So we were hit with anything from $60,000, that was our cheapest quote all the way up to $125,000 to redo the foundation on this property. Thousand dollars to redo the foundation on this property, which was obviously terrible to hear because you know we anticipated spending seventy five thousand dollars in total.

Speaker 1: 6:27

You know, before we go to market, you know at this point we decided to take a beat. You know we we decided to take a couple of weeks and really sit and kind of noodle and consider, you know, what is the best pathway forward. You know we're, as I mentioned, a business that is very focused on generating return. We do not have a lot of emotion attached to any specific property and so at that point in time our most logical pathway forward, with a market that's still very hot, was to take it to market and try to let somebody else go and deal with those issues. Obviously, you have to disclose those issues. We knew what was wrong with it and so we thought man, if we can let somebody else that is very aware of what's happening go and resolve that, then so be it. And sometimes the best deals you do are the ones that you take a little sting on and then you move on. So we were willing to take a small loss at the time and go put our dollars at work in a better project.

Speaker 1: 7:25

As we brought it to market, one of the thoughts that we did have that we hadn't really noodled on early in the process was hey, this is obviously in an area of the city that is having heavily or heavy heavy supply issues, meaning there is a need for housing and there's a huge need for affordable housing. And so, as we brought it to market, as we were testing to see if we could unload this and get out of it, we also started to do the research to see if we could tear the house down and develop a larger number of units, which is a great exit strategy. It's a great business model in and of itself because you're creating a lot of value. Depending on what cap rates sit at in that moment, it can be a really great return profile. It's obviously different from buy-by-house's business model.

Speaker 1: 8:17

We buy stuff, fix it up and sell it very quickly. Knocking something down, getting it entitled, fix it up and sell it very quickly. So knocking something down, you know, getting it entitled, and then rebuilding something and taking 18 months to go and you know, work through that process is not, you know, not our business model. So it's not the first thought, but fast forward, we don't end up finding a buyer. You know at any number that we were willing to, you know, to stomach the loss at, and so that is the process that we ended up electing to go down, and so we took the property off market.

Speaker 1: 8:46

We secured the property with a fence and we went through the process in LA City to get a plan to build a unit with more density, and so where we ended up winning on this property is that we got a duplex with an attached ADU approved on the small lot, so the lot itself was about 5,800 square feet. The original house was about 1,200, so a smaller property, and there were some code changes in 2023, early 2023, that allowed for additional density, and so where the project sits today is it's RTI. We actually demoed the project. We tore the house down just over a month ago. We have a permit to build a duplex with the attached ADU, the detached parking garages, and we have the initial approvals to go and build the two more detached ADUs. So that will take the property to five units.

Speaker 1: 9:49

And it's pretty interesting because a year ago and obviously the return profile is really unique on this one, I mean, we're usually in and out in six months. So when we identify these foundation issues early on, we think, hey, bare minimum, we're gonna lose, you know, 20, 30 grand to let somebody else go and build this. And then at one point we thought that loss was going to be even higher, right. And so you know, I think you know the lesson to learn on this project is that you know, with some creativity, even if you find some problems, you can kind of work your way out of those issues. And obviously you know I'll share a little bit more of what that means in terms of math Like we actually have to put more money in to the project to make it, you know, become a viable, profitable project, but to get to a place where you have five rentable units, even if those properties were to go.

Speaker 1: 10:42

Section eight, a section eight housing the cap rate would be somewhere around five and a half or six and a half percent, you know, without adjusted growth, and which is a pretty attractive return profile for a lot of investors not for everybody, I mean, you know, for parts of the US you might be targeting. You know a low double digit cap rate In LA stuff trades for. You know one or even two low double digit cap rate In LA stuff trades for, you know one or even two, you know, in certain markets, and so it is an attractive product for a lot of different people. You know for us what that means is that you know we end up having to spend $25,000 or $30,000 tearing the property down. You know, obviously going ground up requires a different loan structure, so we have the cost to go and refinance the project. Then ultimately we've got to build 2,800 square feet of new structure with really nice rental grade finishes. That might cost us another $700,000 or $750,000.

Speaker 1: 11:47

To to get a project where you thought you were going to lose, you know, $40,000 or $50,000, maybe worse, you know, depending on where we were at during that year and a half all the way to a place where now we think we've got, you know, at least $100,000 or $200,000 of profit built in if we continue with the build, you know, is a nice thing. Obviously we had to carry, you know, interest payments during that window of time as we held the property. So there are a few different exit strategies at this point. We can go and build it, rent it up and then sell it to an end investor. We can build it, rent it up and then hold it, you know, and depreciate the asset over a long period of time, you know. Or, at this point, we can also test the market and sell it, with RTI plans, to another developer that chooses to go and hold it long-term.

Speaker 1: 12:33

I think the moral of the story for everybody is that what could have been a really negative event and certainly was a unique situation to be in where you buy a property, we knew we were taking some risks not being able to inspect it, not being able to go in and actually see what the structure was like beforehand. We knew there was a fair bit of risk doing that. We thought it was calculated risk because it was on a raised foundation. Most raised foundations are fairly simple to correct. This one just had a lot of challenges with it, but a lot to learn and unpack from that. But you know, the biggest takeaway is obviously if you find yourself in that situation. You find yourself in a position, you know, a little bit of creativity goes a long ways and it certainly wasn't, you know, unpainful, like we had a lot of pain as we, as we carry the asset and as we identified, you know, exit strategies, but we're back in a place where we can have a positive return profile and a positive end result.

Speaker 1: 13:31

I think the major takeaways here are number one when you buy single family real estate, get an inspection every single time, no matter what. Find a way to work in an inspection window, even if you only have a day or two. Scramble around and find a new inspector. Do whatever you can to have the property inspected by a professional before you purchase single-family real estate, I think. Lesson number two if you have the time, I would go beyond a general inspection.

Speaker 1: 14:03

For us as a business, we like to inspect as much as we can. So we'll get a foundation inspection, we'll get termite inspections, we'll look at plumbing. You know different sewer issues. We'll certainly look at the roof. You know all of those things are going to get you into a position where your construction estimates can be a little bit more accurate. And then number three again.

Speaker 1: 14:26

I think the biggest takeaway is just be creative. So if you do find yourself in a situation where you didn't anticipate having to complete a scope of work and that item is really expensive and it kind of breaks the project down, take a step back and think about other ways that that property might have highest and best use. And sometimes that means going in a completely different direction adding square footage, adding a different number of units, or in certain scenarios you might just have to take it on the chin and take a loss and move on. For us, 43rd was a really great learning opportunity. In our business we don't ever think that a mistake is good or bad, it's just a learning moment. So 43rd is down in our book of learning scenarios, as mentioned. We like to get inspections on everything before we can at this point and we try to think creatively about highest and best use. And if you come into our operation to talk to anybody, they all have access to the. You know the horror stories and 43rd is one of them, but we like to think of that as a positive outcome because you know it allowed us to get very creative and now we have really great relationships with architects in the city and you know we're viewed in a way that you know we're actually providing value to the community versus, you know, just tuck tail and run out of a negative project.

Speaker 1: 15:49

Check back in the future. That is episode number three. As we close that project out, we'll certainly give you guys an update. You know I'm not really clear on what that means. We might sell it. If we go and build it, it'll be another year or so before we have a strong update for you. But yeah, check out the pictures, check out the videos that we have in the video and we'll see you next time on Realty Talk.