This week, Aaron Norris is joined by Kymberly Nelson and Derek Harms. They were very helpful back in September with Cashing In On A Boom. They renovated one chapter and added three brand new chapters to the portal. Adding Square Footage was the chapter they helped with since they had been doing beautiful work in the space for close to a decade. Aaron and Bruce decided when they were not experts at something, they wanted to bring somebody in who was actually doing the strategy in California so they could get the latest and greatest.
One of the things Aaron gets calls about is how people get into the business, both getting started and motivated. Derek and Kymberly were unique in that a lot of people have to start by forming a partnership for one reason or another. Aaron asked Kymberly how she got started in the business. She was born and raised into it. Both her parents started in the real estate investment business together when she was in the second grade. Her mother would drag her from job site to job site as she was renovating properties. She decided it was a fit and loved the transformation process and real estate side of things. She continued down into San Diego.
In 2014, Bruce and Aaron ran around with a talk and specifically spoke about the strategies. They used Kym and Derek’s projects down in San Diego as the pictures they showed to display what was possible. They had such a beautiful design aesthetic, especially when they were doing a lot of interior work and tearing down walls. Derek was at a meeting when Bruce started talking about Kymberly’s dad Jim and how great the work is they do, and Derek made sure she knew.
Jim was in the business a really long time and was a key reason his daughter got into the business. She actually got to work with him quite a bit. She started in the business working with mailers and running errands. When she moved to San Diego, she asked him for the opportunity to flip properties down there. He was more than thrilled to open San Diego up to her and gave her the tools to run a successful flipping business.
Aaron often gets asked how he is able to work with his family. Kymberly said she was never asked this. She was really blessed to work with her father since he was an incredible mentor and very empowering. His approach was he would give her the necessary tools, but it was her business and San Diego was her territory. She needed to go out and create it herself. He was her greatest cheerleader and supporter and always there for her in difficult situations. She could not have asked for a more loving and supporting mentor.
Derek Harms pointed out how Jim may have not been a household name, but he was what people would consider a guru. He had such a knowledge of real estate and tactics and abilities. He knew about flips, notes, rentals, and lease options. When Derek was about ten, he went to a Los Angeles meetup group, and Jim was sitting in the corner as one of the Ask A Pro type guys. If you had a question about a deal, he was your dealmaker. This was the first time Derek met him, and he has been instrumental in helping him get to where he is now. Aaron said a piece of what they are always wanting to do is create a legacy. Some of what is created sticks around for decades. This is not just the physical properties, but also what you pass on to generations. It is pretty special.
Aaron asked how Derek got started, if he grew up with it too, and how he and Kymberly ended up working together. Derek said he does not have the family lineage in terms of being in the family business. However, his dad did get into real estate later in his life and was instrumental in helping Derek get into the business. When he graduated college in 2008, his dad bought him a piece of land in Arkansas instead of the trip to Europe he wanted. He was a 21-year-old kid and did not know what to do with the piece of land. But, his father coached him on what to do with it. They cleared it and offered it to a developer, and he received a few dollars on it. This got his wheels turning about the opportunity, although he did not quite jump in to the space.
When he first graduated from college, he started as a bartender. After doing this for a couple years, he bought a duplex in Barstow for $22,500. This was in 2010 at the bottom of the market, so they were almost giving them away. Six months prior to buying this duplex, he went to a seminar by Tony Alvarez. He got his book and took his class, and he had learned everything from buying at 70% of ARV. He was getting on the phone with REO agents and was sounding like a rookie. One of the first agents he called told him he sounded like he had just gotten back from a seminar. He gave him a couple pointers on talking to the next agent; and after buying the duplex, he briefly learned how to be a landlord. He sold the duplex to a regular at his bar for $56,000. He realized here that real estate was the way to go and quit bartending.
Aaron next asked Kymberly what she studied in college, to which she said she studied English. Derek originally went to college for baseball, but he was a Sociology major. He did not have any real estate ambitions in college, but there were things he learned from Sociology that he was able to apply to real estate. This is especially true with forming relationships in the business.
Aaron asked because everyone is approaching the real estate business from different points. Aaron is a retired actor from New York City, and people wonder how he got into the business. It’s really that everyone got there in different ways, but you bring the skillset you learned into the business. Derek started in the fix and flip model.
Aaron wondered when the two of them met. Kymberly said he received a call from Jim saying that a good friend of his had a son who was moving down to San Diego. Jim thought they should meet to see if they would click. The meeting happened in 2011, a year before Derek completely moved down there. Derek’s dad took a class that Jim offered, and they became friends after this. Derek’s dad was getting into the real estate investing business as a cameraman in the motion picture industry. He retired from this to get into the investing business. When Jim found out he was moving to San Diego, he connected him and Kymberly.
He moved to San Diego from Florida at the time and was buying properties from auctions and renovating them. When they met, they got along really well and were speaking the same language. They both had the same desires to be successful in this space. Up until that point, they had been working with median-priced homes and had not stepped into the higher-price point. Their bread and butter was primarily Los Angeles. Derek brought Sonoca their first true high-end flip. Derek had his license and was working at a brokerage in San Diego. This made him the missing link where he was actively in the field buying properties. This was how the relationship started: he was an agent on behalf of Sonoca.
Aaron gets told by people a lot that they wished they had gotten their sales license a lot earlier in their investing career in order to understand the legalities in California. When Derek received his license, Aaron wondered what his first deal in San Diego looked like and what year it happened. Derek said it occurred in 2012. The rehab came in at $220,000, and Jim turned sheet white when he saw it. This was well out of the bottle in which they had originally been operating. It was about a 3,000 square foot house within an affluent section of Northeast San Diego. It was in a gated community and cost $800,000 at a resale value of $1,350,000. At the time, that was not Sonoca’s model. However, when he walked through the house for the first time, he really felt like there was a deal there.
Aaron was really complimentary of their projects and really enjoys the design. Aaron asked what they are involved with in the partnership. Derek said the design is mostly Kymberly’s role. She bounces some ideas off Derek and they collaborate; but for the most part, Derek sources the deals and Kymberly is to project manage and make sure the design is dialed in and appeals to the majority. She is a great designer, while Derek said he does not have an eye for this. When she bounces ideas off him, it is more from the side of what the buyer will look for in terms of feasibility and functionality rather than color and design. He does the research to determine what the house needs to have in order for them to have the number they want. Kymberly then goes to work in creating this.
Aaron said this is a very different skillset for somebody with an English degree. Aaron asked Kymberly how she ended up in the design side. She thinks she actually inherited the skillset from her mom, who was incredible at transforming properties. Growing up, she would get picked up from school and be on a job site until dinnertime, so she saw the whole process. She always had a passion for it and loved it.
Derek said an important point for this year is to not necessarily flip as many houses as possible. A $200,000 renovation budget on a 3,000 square foot single-story ranch house can go up quickly. A tile roof can be $40-$50 grand, and all that flooring could be another $30. With just the sheer volume of material, and you’re looking at a high budget. Kymberly said adding a bedroom adds more internal structural asset, which makes it even bigger.
Aaron next asked how things have changed since they basically went through an entire cycle. When they started getting into this in 2012, they were well into Quadrant 2. The downturn happened, and it did not seem like it would be a great time to do the high-end things. Now, we are at a tail end of Quadrant 4 where we are warning people that now is not the best time to do that $12 million rehab. It is time to wind down these types of projects. Aaron next went on to ask them about the journey. He wondered what the market was like in 2012 when they started their high-end projects. Derek said the market was strong, especially in San Diego County. It was not quite where it was these last 24 months. However, he brought to the table all the research, numbers, volume, and metrics. Poway has one of the best schools, so there is always a demand for family-style homes out there.
When you look back, there are certain properties that made sense before but do not now. With the right price it might, but is definitely a different feeling out there today than it was back then. You have to be really careful right now what you get since you decide the deal. Kymberly said they are not looking at projects right now that are anywhere near the first one they did together. Aaron said he is getting the same feedback from a lot of the former investors he knew that were doing high-end things, especially the things he knew would take a lot of time along the coast and could trigger an environmental review. After the accessory dwelling units regulations came out, this seemed to be the hot topic. Aaron was hearing about them being very backed up, particularly in San Diego. A lot of investors were not expecting the timelines that they are seeing now that are landing in their lap, especially these kinds of projects.
Derek said if you have a very large monthly debt service payment, you are going to be in trouble. He had heard a podcast that talked about the difference between debt and equity. If you had the right investors who are equity partners and not in front of this freight train of debt payments every month, you might be able to find something that works for you if the numbers make sense. Most people are getting hard money or private and typically have to get in front of that freight train. It’s scary.
Aaron said in 2013, he remembered a little softness in the market that happened over the summer. He ran into a guy in Orange County who had 5 or 6 multi-million-dollar rehabs going on at the same time. Aaron said as a hard money lender, he was calculating in his head how he had over $100 grand in hard money payments every month. When you are in a market like right now, it is a little scary to know that people will be going into those situations. They are not thinking that the market can soften, so it is a little scary.
In 2012, the market had done its crash and gone up a little. This was a good time, and Derek and Kym were chasing the right inventory in the right neighborhoods. Aaron asked if they were still performing in those same neighbors but throttled them back to make them more median income flips. Kymberly said they have not abandoned the neighborhoods, they have just shifted gears a little. They are focused more on median-priced properties and not doing a lot of things involving plans and permits. They are working with quicker deals and entry-level properties. Derek said they have more than one exit strategy. Ideally, you may not want to rent something out that would not pencil out as a good rental. If you have a $3 million house in La Jolla, good luck renting that out. You have to consider how long you can hold onto something you get caught with that does not work as well as what you can do with it.
A lot of people in San Diego now are nervous about their large portfolios. Just last week when Bruce was speaking at the SDCIA meeting, a couple people Derek knew asked Bruce what they would do if they were in the situation he described. Right now in talking to a lot of the guys on the acquisition side, Derek said we are seeing people factoring longer hold times and lower resale values on their initial underwriting. As long as you build in the proper margin of safety, you can be ok. He went back and looked at all the sales numbers in San Diego from 2009 to 2010 to see how many were selling at the bottom of the market after the crash. Back then you had a lot of price damage due to foreclosures. However, it should be different this time around. Homes should still sell if you are in the right price points and the right neighborhoods. As long as you underwrite your deals properly, you still have product.
The Norris Group has a few speaking engagements in January. They will be in Glendale, California on January 9 at the 2019 Los Angeles Real Estate Summit. This will be in conjunction with Robert Hall & Associates. Bruce will be presenting his 10 Decisions to Make Before The Next Downturn. On January 17, he will be doing that same talk in Costa Mesa with OCREIA. On January 26 is our big market timing event California Real Estate: On Borrowed Time. This is Bruce’s prediction for the next few years that he expects to happen in the California market. Sometimes it is not about the ultimate destination, but the journey and trajectory along the way. You can find out more about that at www.thenorrisgroup.com/ticktock or on our website under training.