House Hacking: Our California Live in Flip
It was the summer of 2015 and was right around the time we began the repairs on our first deal, a long distance flip in Albuquerque (read all about it here), that we decided to buy another house.
At that point in our life we were married but didn’t have any kids yet. We were renting a mediocre at best 2 bedroom apartment in Oceanside, California for $1600 per month, and had come to the conclusion that we were wasting money by continuing to rent. So we began the home buying process. First we worked out HOW we were going to buy. We worked with a mortgage broker and got pre-approved for about $500,000 and planned to use the VA loan with $0 down payment.
VA Loan
There are some distinct rules & characteristics of the VA loan that both buyers and sellers would want to consider:
Buyers:
To qualify for the VA loan you must be a veteran or active duty military member.
The VA loan must be used for an owner occupied residence and can be used for single family or residential multifamily (up to 4 units).
When using the VA loan you are not required to put a down payment, but you usually do need to pay the closing costs. You also don’t have to pay mortgage insurance, also called PMI. Moreover, the interest rate on a VA loan is usually lower, and the credit standards are more lenient than a conventional loan.
The big catch for a buyer using the VA loan is the funding fee. The VA funding fee is a one-time fee charged to the buyer during either a purchase or a refinance of a VA loan. It is used by the VA to offset the costs of VA-backed loans that default. The amount of the funding fee varies based on the amount of the down payment and other factors, see the chart below. The funding fee can either be paid out of pocket or it can usually be wrapped into the loan.
There are two situations in which you will not have to pay the VA funding fee to use the VA loan; 1. if you have a service connected VA disability rating or 2. if you are the spouse of a veteran who died in service.
Sellers:
(Sellers are often very weary of VA-loan buyers, here’s why)
In general, sellers often think that buyers who choose to, or can’t afford to, put any money as a down payment, probably don’t have any or much money to bring to the transaction if other issues arise.
In VA transactions, it is very common for issues to arise.
The main concern is the VA appraisal. During escrow the VA will send an appraiser to appraise and inspect the house. This appraiser will be specifically a VA appraiser, he or she will determine the value of the house and will confirm the property meets the minimum property requirements (MPR’s).
The MPR’s are essentially to protect the buyer and to ensure the house is safe, sanitary, and structurally sound. If the appraiser determines the house doesn’t meet the minimum property requirements then repairs have to be made during escrow and a VA appraiser will have to visit the property again to verify the repairs have been completed. These MPR’s worry many sellers because it means there may be unexpected repair costs during escrow, and the buyer may either not have the means to cover the cost or may back out.
As for the appraised value, once the VA appraiser determines the value of the property, it will be reported to the VA and will be the appraisal that is used for the next 6 months. Also if the VA appraisal comes back lower than the agreed upon purchase price, the VA will not loan more than the appraised value. In that situation the buyer and seller have some options. The buyer can pay the difference in cash, the seller can lower the purchase price to the appraised value, or some combination of both. If the buyer and seller can not come to an agreement, the buyer can walk away without repercussion. So if the seller is assuming a VA buyer doesn’t have cash to bring in the event of a low appraisal, they will usually rather not deal with a VA offer.
In a quickly appreciating housing market like Southern California in 2015, there would be a good chance that the appraisal would come in low because the last 6 months of comparable sales (or comps) would be lower than what you could actually sell your house for at that time. Now if the buyer ended up backing out, the VA would still use that first appraisal if another buyer tried to purchase the home with a VA loan anytime in the next 6 months. That could mean that the appraisal that is being used is based off the comps from 6-11 months previously which would be much less than what you could get for it at that time.
Finding It
We originally started looking for a 2 bedroom house because that is all we needed, and we didn’t want to increase our cost of living by too much. We wrote offers on a couple of 2 bedroom condos but neither offer got accepted. 1 seller had even told us that she accepted an offer that was $10,000 less than ours because it wasn’t a VA offer and she didn’t think it was going to appraise for our offer amount.
We decided to rethink buying a 2 bedroom for a couple reasons.
If we stretched ourselves from the $250,000 price point to the $350,000 price point, and the market continued to appreciate we would make more on the $350,000 house. For example if housing market went up 10% we would make $25,000 on a 2 bedroom or $35,000 on a 3 bedroom. Also if the market turned we thought condo values would be hit harder than single family houses.
Almost all of the 2 bedroom residences in Oceanside are condos, and thus have HOAs (Home Owners Associations). The condo HOA dues ranged anywhere from $250 to $500 per month. These dues were not necessarily a fixed cost but could increase over time. They also took from our buying power in that if we were paying $400/month HOA then our PITI (principle, interest, taxes, insurance) mortgage payment needed to be $400 less.
So we started looking for a 3 bedroom, with no or low HOA, and that had higher than average days on market (in hopes that our offer wouldn’t be in competition with other cash or conventional offers).
We found a 3 bedroom 2.5 bathroom house that had been listed for over 200 days because it was a short sale. A short sale does NOT mean that the transaction will be quick, it means that the house will be sold for less than what the seller owes on the property. In this case the owner had bought the house for $415,000 and it was listed for $375,000. The house had already been under contract once but for whatever reason the sale didn’t go through, so the house was back on the market again, but the short sale had already been approved by the bank.
When we looked at the house we immediately realized it would be the perfect live-in flip. The distressed nature of the seller meant we could buy it with equity in place.The kitchen was already beautifully updated so the project would be fairly easy and we could keep the kitchen the way it was so that we didn’t have to eat pizza and take out every night during that part of the renovation. Another thing that caught our eye was the house was listed as 1500 sqft but seemed bigger than other 1500 sqft houses that we had looked at. And most importantly the house was plain and ugly and out dated, BUT it was functional so we were confident that a VA appraiser wouldn’t have many, if any, mandatory repairs.
The house was listed for $375,000, we offered $350,000, they countered $362,000, and we accepted. During escrow and our inspection period the only repairs that were required were the installation of smoke alarms, and the house had to be tented for the treatment of termites, which we paid for by wrapping that cost into the loan.
We also had a mortgage broker who was very familiar with VA loans, and allowed us to wrap not only the funding fee but also the closing costs into the loan. We also took advantage of a loan product in which we could opt for an interest rate that was about 0.25% higher and in return we got over $18,000 credit for closing costs. (Even with that our interest rate was still under 4%.) So we had to put $2500 as an earnest money deposit, but we got that back at the closing and literally bought the house with NO money out of our pocket.
House Hacking
Well we only needed a 2 bedroom and we wanted to keep our cost of living low so we decided to get a roommate. We painted the spare bedroom and bathroom and updated those fixtures first so that within a month that space was rent ready. We ended up renting 1 bedroom, 1 bath and half the garage for $750 per month.
So we got the house for NO money out of pocket and we were saving $87 per month. But the real value is that we were getting the loan paid down, plus we were about to force appreciation, and the California housing market continued to appreciate, and we were able to take the interest expense and depreciation as a tax write off. With all those incentives it was a no brainer to buy instead of rent, and it was a decision we should have made years before.
During the 2 years we lived there, we slowly did projects to update the house which in turn brought the value up. Also during those 2 years a couple houses in the same housing tract were bought and sold by flippers. When flippers sell property in the area the value of your house goes up as well. For one reason because the neighborhood becomes a more beautiful neighborhood, and two, because it increases the cost of the sold comps and could reinforce a higher appraisal.
Most importantly the purchase appraisal confirmed our suspicions about the square footage of the home. It was over 100 square feet larger than what it was listed as, because the master bedroom and bathroom had been extended further over the garage. So when we went to list the house we listed it as 1610 sqft. Now 100 square feet may seem like a pretty nominal difference, but when houses are selling for $300/sqft that equates to an easy $30,000 increase in value!
After 2 years, it was time to move on to our next journey. We listed the house a couple months short of the 2 year mark but made it clear in the realtor remarks of this listing that it couldn’t close until after 2 years. Because it was our primary residence for the last 2 years (the rule is 2 years out of the last 5 years) we were not required to pay capital gains taxes on the profit from the sale of the house. The house ended up selling for $474,000, $112,000 over what we had purchased it for!
“The house ended up selling for $474,000, $112,000 over what we had purchased it for!”
Before & Afters
Final Numbers & Final Lessons
So we made $64,000 tax free in a 2 year time period. Not bad at all considering it wasn’t that extensive of repairs that needed to be done.
Although we did really well on this deal, we definitely can’t claim all the glory on it. I think we did great in doing the repairs and upgrades that would give us the most bang for our buck when it came time to sell. However, a lot of the profit we made is attributed to the housing market going up regardless of whether we lifted a finger, and the housing market could have just as easily went the other way. (I was terrified when we bought it in 2015 that it might have been the peak of the market.)
With that said if you buy right (with equity already in place) and you buy a house that you can force the value up through repairs then you still will be in a good position even if the market doesn’t appreciate as much as it did for us.
One big lesson we learned during the listing of this house: great pictures drive traffic when you are trying to sell a house. Professional pictures and even staging may not be the reason someone buys the house but it will be the reason that more people go look at the house and the more people that look, the quicker you’ll find a buyer. When we originally listed the house the realtor took pictures himself with a digital camera and we got much less traffic than the same model of house down the street. That house was in significantly worse shape but looked better in the pictures because they had hired a professional photographer. Once we put our foot down and got professional pictures taken the potential buyers flocked to see it. The realtor made $16,590 commission on just the sale side of this deal (he also represented us for the purchase) but apparently wanted to save the $200-$300 on professional pictures.
“Professional pictures and even staging may not be the reason someone buys the house but it will be the reason that more people go look at the house and the more people that look, the quicker you’ll find a buyer.”
The only difference between these two sets of pictures is the photographer, but which house would you rather go see?
