AMA - How to recover from a bad contractor

Love the show. I could use your advice.

Last August I acquired a property in a tax auction at a bargain price in a class c neighborhood in a different state than where I live. This was my first venture into rehabbing a property and figured this might be a good way to learn with a fair amount of cushion for mistakes.

I found a contractor on Craigslist who was willing to work in this address (several were not). Work got underway quickly. Flooring, painting, kitchen updates and other misc repairs were all needed based on pictures the contractor sent over. He estimated about 20k worth of work. That seemed reasonable and he pulled permits and work got underway quickly.

As work progressed bigger problems arose. Contracts were drawn up for each project successively. He would call me at least weekly with updates to what was doing, supplies that were needed and different things that code inspectors wanted to see updated. Every time I thought everything in the house was finally ready something else would be found.

This all culminated in me finally growing very suspicious. I called the code office to find out where things stood and was devastated to learn they had never stepped foot inside the house. Moreover all the permits had been pulled in MY name without my knowledge. I had an investigator walk through the property and send more detailed pictures and the place is a mess. He did 85% of the siding work but cropped pictures of the final job and big chunk of the back of the property is unfinished. Lumber and materials are lying all over the job site. Between materials and labor and dumpster fees I have now put in about 2x what the property is worth fully renovated and really have nothing to show for it. Many of the materials I bought appear to be missing.

This is a big hit for me. Is there anything I can do? At the very least maybe I can get a tax write off?

I am obviously rethinking real estate altogether as an investment choice.

JP, This unfortunately is all too common a situation.

I’d like to zero in on a couple of things that you said. You’re talking about rethinking real estate investing. I’ve got bad news for you. What you’ve been doing is not real estate investing. You put yourself into the house rehabilitation business. That’s an active business that’s pretty similar to the construction business. You got into the construction business without even knowing it.

Your construction business had no quality control because nobody was staffed to fill the position. If that position had been staffed, there would have been no surprises.

I understand how painful this is right now. But if you stop, you’re going to lose 100% of your investment. If you have debt on the property, you’re going to be on the hook for that too.

There are only three viable paths from here.

1) Fire sale the property as is and take a substantial loss

2) Bring in a partner with additional capital to complete the renovation and then sell the completed property at a loss. This may be a smaller loss than a fire sale scenario.

3) Complete the project, and rent out the property as a long term hold income property. You told me in a subsequent email that you’re looking at a total investment of about $125,000 and a monthly income of about $1,400. That means you’re collecting about 1.1% of the property value in rent each month. That’s a good percentage. It has the potential to carry the expenses of the property and pay down the debt. You will want to get a low interest rate permanent financing structure in place at the highest possible loan to value ratio.

If there is still work to be done to complete the project, the ownership of the building permit isn’t a problem per se. In fact, in this instance it gives you the freedom to fire your contractor and you can hire someone else without having the original contractor transfer the permit.