Winning Advice of the Month

Rags to Riches: From Barely Qualifying to $50 Million in Real Estate Sales

My friend Stuart Liner remembers the days in 1990 when he was panicking, holding his head, thinking, “I can’t dare take a $100,000 loss on a condo I bought for $300,000.” The house, thanks to the Gulf War economic disruptions that hit California’s hot real estate market, was then worth only $200,000. But today, Stuart and his wife Stephanie have set a new standard, going from real estate losers barely squeaking by to selling fixer-homes that now fetch as much as $12 million.

What did the now multimillionaire do when facing his first major real estate downturn? He did what I think most people should in a wobbly market -- he held on and rented the condo – at a modest loss. He even made another ill-timed move -- he bought another home, this time in Tarzana, near the epicenter of the soon-to-happen Northridge earthquake of 1994. He barely broke-even.

But what happened from here is spectacular and well worth sharing. Sure, I’ve seen a lot of folks make money at buying and selling real estate, but Stuart and his wife Stephanie, whom he married in 1991, have set a new standard. They’ve gone from real estate losers and barely squeaking by to living life in a $15 million home on the Westside of Los Angeles and selling fixer-homes that now fetch as much as $12 million. In all, they’ve lived in, fixed-up and sold homes generating more than $50 million in sales.

As analysts across the country are warn that the real estate bubble could burst, I think there is an opportunity to make money if you follow lessons learned from the Liners (and try not to make some of the mistakes they made in their first real estate ventures).

In markets like today’s, you’ve got to be extra careful when choosing and pricing properties, whether buying for yourself or to flip. That’s because sellers are still demanding high prices, which can make it tough to buy a home, fix it up, and still make a profit that’s worth all the time you’ve invested. For Stuart, the slowdown doesn’t mean he’s abandoning his strategy. It just means he’s spending even more time rummaging through newspapers, visiting open houses, or searching for pocket listings to find that listing that can yield a 7-figure profit. When you look at the market’s slowdown, you can now see why Stuart’s strategy of sticking to one major housing project at a time is a smart one.

Here are other lessons from the Liners:

1. Hold on if you can
Holding on to a bad real estate investment might sound crazy, but it may be a heck of a lot better than cutting your net worth by a third. In Stuart’s case, the loss he was facing was not one he could stomach – a whopping $100,000 -- so renting out the condo until he could sell at a decent price made more financial sense. “If the check I had to write to get out of that property was $10,000, I would have done it -- because I was already losing about $500 a month in rent,” he recalls. “But instead I was facing a $100,000 loss with the real estate downturn.\"

Holding onto a property in a weak market can also make sense if your property is in an area where there’s a high demand for rentals and/or where there are few rentals available on the market; you may be able to get a higher rent than you’d expect. Remember, too, that you don’t need to cover the full mortgage payment to breakeven. Your goal should actually be to cover 70% or so of your monthly costs (Mortgage payment, interest, and insurance) since the bulk of your mortgage is tax-deductible.

When would it make sense to sell? When you can’t financially handle the monthly loss or when you have a clear game plan for reinvesting that money and generating a higher return than by keeping it in the home.

So the real decision about selling or holding on comes down to this, as Stuart put it: “Your ability to handle the negative cash-flow from both a financial and emotional standpoint.”

2. Live in the properties while you fix them up
Live in the properties like the Liners did, sell them after some stylish remodeling, and you can easily become a millionaire in a strong market. In a slowing market, the strategy will reduce your chance of losing money.

Here’s how the Liners did it.

After selling their first home, the Liners were able to build a better home – more square footage, new construction as opposed to basic remodeling, and so on. They were also able to use the cash they had made from the first home to finance the improvements, rather than taking out a second loan.

“I wanted to be prepared to live in it,” says Stuart. “I never want to feel pressed that I have this big mortgage hanging over me.”

But there’s two other big benefits to living in properties while you fix them up. First, since the home is owner-occupied, you’ll qualify for an owner-occupied mortgage at rates that are typically about one-half percent lower than a home non-owner occupied or investment properties. Second, by living in the home for at least two of the five years prior to selling, the Liners could enjoy the profits free of taxes, up to $500,000 as a couple. Then, they could simply roll their profits into the next house and do the same. Only now, they could afford a larger home and even more improvements thanks to the profit they had made.

3. Understand your market
One of the smartest things you can do in real estate is to know the neighborhood well. The Liners were adamant about buying in two neighborhoods only -- that kept them constantly in touch with prices and any developments, rather than having to spread themselves thin and try to keep track of multiple areas.

As they honed their skills, they also began to learn about their market, the buyers. Stephanie’s details played well with women, who increasingly make or influence real estate buying decisions. “People would knock on our door asking if they could buy our home,” says Stuart. “They’re responding to a taste level of many women – a desirable neighborhood, the white picket fence, and new construction.”

But as the Liners kept trading up, they learned even more about who wanted what. “We realized that people in this market were not ‘self made’ but wanted turnkey homes. Most people in L.A. live a fast life. Many are in the entertainment business or some other profession taking them far away from the world of weekend projects and Home Depot. They want homes already tricked out, ready to go. Many are from the East or Midwest, and want some of those touches – brick, stone, painted white fences”

So the Liners added even more improvements – stone work, a basement and maids quarters, for instance – modest modifications that pushed up the price even further.

Whether you’re buying to fix-up and sell or to keep for yourself, you want to think about your next buyers: are they retirees or first-time buyers? Will they pay for extras in your neighborhood or would you just be throwing money away? Do what the Liners did and talk to lots of real estate professionals and buyers to know your market.

4. Find the best contractors and treat them well
Working with contractors – or any vendor – isn’t easy, especially in real estate. They’re famous for running late and over budget on projects. And that can kill your profits. So when the Liners got a call from a contractor saying “my car is broken, so I won’t make it in today,” they’d send for a taxi. Heck, for the $50 out of pocket, it was well worth it. And it set a standard that excuses won’t be tolerated. They also paid monthly retainers – a small flat fee as a monthly minimum – to keep contractors always on hand. The result: they built solid, long-term relationships with their contractors and suppliers.

Look, loyalty almost always pays. You get better, more dependable work. Workers and suppliers are on your side; they want you to be successful because it makes them successful. It is a win-win proposition. The cost of this loyalty – as in a few rides or cab fares – can be very small.

5. Don\'t get into too much debt.
I know debt is a way of life today, but except at the beginning, the Liners seldom used debt to finance their activities. They wanted to avoid forced or unfavorable sales. Before they started any project, they did a careful appraisal of whether the return would be worth the risk, and whether undesired outcomes would take them into negative territory. If the project didn’t pencil out, they’d walk away.

Investments – and business decisions – should always be approached with a calculated, or “intelligent” risk approach. I see a lot of people either (1) take too much risk for the potential reward or (2) take too little risk, and thus generate no returns. Intelligent risk means taking risks but ensuring a margin of safety all along.

By taking out a traditional mortgage on the purchase of the home but then financing the improvements or new construction with cash, they kept their debt manageable and avoided the kind of interest rate hikes that have squeezed many people’s pocketbooks.

6. Learn when to stay away
The “puffed-up prices” as Stuart calls them means you need to be ready to walk away from potential properties. In fact, these days, he’s doing more walking. “If you’re focused on the margins, today you’re going to walk away from a lot of deals and often times those are the best to not do.”

Even in my own experience, there can be big warning signs that you should walk away from a deal. Not just when the price is too high to pencil out your profits, but when a seller won’t budge on other legitimate negotiation points, like when the seller promises that a property is free of environmental hazards, but won’t put that in the contract or give you the time needed to have a test conducted. I recall a woman I was recently negotiating with who said she’d offer financing at below what I could get in the market. But after reporting back on the 7% I could get for my particular project, she then upped her rate to 8%. If that’s not a sign to walk away, I don’t know what is.

“People think I’m aggressive, but I’m really conservative,” says Stuart. “I’ve watched lots of developers get stuck with inventory and they have to go bankrupt or give it back to the bank. The idea of losing money after all the sweat equity and labor, I can’t get my head around that. I may make less money, but I’m not going to lose money.\"

“Know when to hold ‘em, know when to fold ‘em” goes the saying. Stuart does, and that’s what makes him successful.

“I know what made me successful. I kept track, and I learned to build on successes and adapt,” says Stuart. You should, too.