In Fred Bernstein’s excellent article Looking for Eye-Catching Profits From ”Ugly Houses” [NYT] he explains how this concept works.
HomeVestors, a company that specializes in buying houses from people who want or need to sell them quickly. In the 30 states where it operates, HomeVestors is known for the bright yellow billboards that announce: “We buy ugly houses.” The billboards feature a toll-free number that brings calls to the HomeVestors headquarters in Dallas. From there, the leads are passed on to the franchisees.
Franchisees pay an initial fee of $46,000 and agree to pay monthly fees as well as fees for every purchase. They also pay into an advertising fund to support the billboards. Over all, a new franchisee is expected to commit about $200,000 to the business, according to Mr. Hayes.
They buy property at a steep discount, then fix them up and sell them, leaseback to the previous owners, etc. They target the low end of the market. Its a very specific niche and its 250 franchisees bought and sold about 6,000 houses in 2005.
The founder said:
The trick is to buy homes for 60 to 65 percent of what they would be worth in good condition.
That seems to be quite a leap of faith. It makes me uncomfortable just thinking that my franchise success would be determined by getting that type of discount on every purchase.
This niche would appear to be a high risk franchise investment if the market declines in a given market. The founder made reference that there is not much of a bubble in $80,000 houses. Of course there is. Houses in that price range see smaller swings in prices but can be ultra-mortgage rate sensitive. The entry or low end of the market can be the first sector to stop activity if mortgage rates jump.
If an investor buys a house as prices drop, they are stuck with the property and since the franchisees have financed at 9% through HomeVestors, it can get expensive. However, franchisees claim they are doing well.
When we start seeing this sort of activity, I get nervous. I suspect many of the franchisees are not savy real estate investors or they would not be paying a franchise fee at all and, most importantly, many have not seen a weakening real estate market before as an investor.
Lets hope their pockets are deeper than the former owners of their properties or its going to get ugly.