ADUs and Opportunity Zones With Derek Harms #677

Norris Bruce

Bruce Norris is an active investor, hard money lender, and real estate educator with over 30 years experience. Bruce has been involved in over 2,000 real estate transactions as a buyer, seller, builder and money partner.

Norris Bruce
January 10, 2020

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Aaron Norris is joined this week by Derek Harms today. Over the next couple of months, Aaron is going to try to go area by area and talk to some trusted voices in the market. Derek happens to be the president of the North San Diego Real Estate Investors Club, or NSDREI. He is a Compass agent and a real estate investor down in the San Diego market.

Episode Highlights

What new model have Derek and Compass been using that is beneficial for home flippers?
Is it a good idea to get your real estate license if you want to be an investor?
What attracted Derek to Compass to make him decide to work for them?
Are they looking to work with ADUs and opportunity zones in the future?
What are they warning people about when it comes to new laws that could affect ADUs?
What are some precautions you can take to avoid getting penalized?
Could ADUs work in tandem with opportunity zones?

Episode Notes

Aaron began by saying he is excited to see the realtor brands throw in their names behind the iBuying scenario only because he thinks it’s going to be the easy ones that they’re gonna be able to take down. The realtors have the local knowledge, and they actually have the long tail relationship focus where the Wall Street buyers won’t. They just don’t care; it’s about scale. They don’t care about industry or the buyers and sellers. They’re built for speed, and it’s hard to have both. It will be interesting to see when Keller Williams and the Realogy brands really get down and dirty since he thinks that’s a way more exciting model. Derek said it’s good that has been given to real estate agents recently, which wasn’t around for a long time. Some people were doing this on their own privately, but the model of being able to pay for a homeowner’s renovations in order to get their property ready for market wasn’t always around. Now the seller can net more money, and the listing agent has a higher price listing. This means more buyers who want it can participate and everybody wins.

Derek’s brokerage is called Compass Concierge. Berkshire Hathaway has a program called the Pinnacle Program as well. Essentially, it’s another tool in the belt for a real estate agent to get a listing. He personally uses it where he made an offer on a guy’s property off-market, and it took a while to cultivate this. Ultimately, what got him to sign the listing agreement was that Compass was going to put up the cash to renovate his house to get it ready for market. This is interest-free money. As long as it is no more than 5 percent of the list price, then Compass will stroke the check. As long as you bring the contractor and everybody is licensed, bonded and insured, now this homeowner is going to have a house that appeals to way more people on the open market and can sell for more money. He will probably walk away with more net money than you would have gotten because you still have to pay back the interest-free loan of whatever the renovation costs. You have a better house for the neighborhood and a more excited buyer. It really solves a lot of problems.

This type of model didn’t really exist before. This is great for someone like Derek who flips houses. He can now go in with options. He will bring an iPad in with him, and he will have a full net sheet, three different scenarios, and all kinds of data to show these homeowners. He walks through the property with his iPad in there that calculates his renovation costs, whether it’s added window counts or flooring square footages and paint. He basically shows the homeowner on site how much he is going to be paying for each one of these line items and how it all adds up. It’s all line items, so he can tell them he can pay extra for your house. Cash as is, and no closing costs. He will pay for everything, but it’s going to be at a discount because he still has to make a profit.

Another option is you can list your house as-is, and he will tell you where the thinks the market positions your home and the net amount you can take with you. A third option is you can renovate the property yourself, spend the money, take the risk, and then you’ll walk away with probably the most amount of money. The last option now is for his company to pay to have your place mildly renovated and get it ready for the market. They’re not going to do anything too major, like a full gut. That’s not part of the program. It’s more made for cosmetics. This option is really penciling out for a lot of people.

Compass makes it really easy. He is not exactly sure of the details of Berkshire’s approach, but it’s been really cool to use. He had just received an email that around 15,000 houses recently that have used this program, and it’s really catching fire.

With 5 percent, if you’re talking about a $750,000 dollar home, it’s almost $38 grand. Aaron asked what they typically focus on as part of that. He wondered what the biggest ticket items are with which they would consider helping. Derek said the beauty of it is that it’s kind of vague, and that came from feedback from the beta testing phase because if it was too rigid, it would be very difficult to do. For instance, the one that they signed on with the seller to do involved new stainless steel appliances, new flooring, new windows, new sliding glass door, new paint and countertops in the bathroom, and new tile floors. It was just a mild clean up and some mild landscape. The total cost was around $35,000 on a $700,000 house. That was the right amount to get this place to show. He had listed it before, and it’s in a very hot market in Cardiff in San Diego. It originally didn’t sell because of these reasons and because it needed work. For this type of program, the homeowner didn’t have to stroke any check out of their bank account. Granted, they had to pay back for the fees at closing. It’s up to the homeowner, the agent, and the contractor to determine the scope of work.

People like Derek and others who flip houses as well as real estate investors and brokers know what is being done on the open market. They know what buyers demand right now as well as how they can get the highest return on your investment. They typically have contractors that can do it for much cheaper than if a homeowner were to Google a general contractor, get a few estimates, and it would probably be 15 or 20 percent higher than what Derek can do it for since his company does enough volume with these guys. Compass actually allows you to select which contractors you want to use. The homeowner ultimately gets the decisions since they’re on the hook for the cash at the end of the day. When you go to a homeowner and you show them your portfolio of projects that a particular contractor has done for me. You can look them up; they’re all on Zillow or Redfin or any consumer site you want to go use. You can see the work they’ve done. You can then get the estimate, and it’s all line item.

Aaron next asked Derek if you should get your real estate license if you want to be an investor. He said he gets asked this all the time, and the response would be another question: “What is it you really want to do?” “Where do you want to end up in the game?” However, he does think having a real estate license adds a little extra layer of complexity because you now have disclosure issues. You have to tread a little lighter. Per the National Association of Realtors and the California Association of Realtors Code of Ethics, you are held to a higher standard than if you do not have a real estate license. You have to make sure that you’re operating that way. It usually comes down to disclosure and marketing. As long as you’re operating above board, it’s a benefit.

Derek got started in the real estate agent world in 2011. In 2012, he was at Prudential California Realty, which then rebranded to Berkshire Hathaway. The benefit of that has provided him over the years. is the relationships that he made there out throughout that time with that brokerage is paying dividends for him today. He gets phone calls from many of those agents who are bringing deals to the table now on the investment side. Multiple deals were done recently that way, and it’s just a gift that keeps on giving. He really likes what he learned there. He learned to speak the language and how to navigate CAR forms and disclosures. The other benefit is you’re working with other seasoned agents on the other side of a transaction, so you get to see how some of these other agents are conducting their business, conducting themselves, and how they’re responding to offers, counteroffers, development situations, and properties that need to be fixed. For Derek, it’s just a much quicker way to be an expert and to know all sides of the game. This has been really immeasurable and opened a lot of doors.

Aaron typically tells people if they have no background in real estate, even if you have no plans of taking the test to be an actual realtor, you should take the three courses it takes to become an agent if, for nothing else, you get to learn the language. He wishes he had done that way earlier in his real estate career. You go to your first seminar, and they start throwing around words like REO, and you don’t know what it means. Derek said you can spend some money going to some private three-day training from a lot of the people Aaron and Derek both trust and would recommend. Having both sets of skills is important. Once you have a sphere, you’ve done some deals, you have a track record, and people know about you, even if it brings in an extra five to 10 deals a year or just purchase of sales and you get a commission check, it’s a great supplement to the business model.

Derek is 34 and not going anywhere. People in his demographic are buying houses now. Some clients are already on their second and third properties and buying investment properties. As long as we’re still operating on a high level and are still active, then they’re going to come back to us. This is going to be a profit center for the next couple of decades.

Derek recently switched to Compass, and it’s definitely one of the disruptors in the market. Aaron asked Derek to describe the Compass brand and why he decided to go over. He said the transition to Compass was almost a year ago today. It was the end of December 2018, and it was a big decision for him. He was with Berkshire Hathaway for essentially his entire brokerage career starting back in 2012. He still has nothing bad to say about them. They were a great brand and were very instrumental in his growth. With Compass, the way he likes to describe it is to picture a Silicon Valley tech company meeting a Wall Street hedge fund that mixes with a traditional real estate brokerage and all three of those got together and had a baby.

Compass technology is top of the line; and the thing that makes them different is they really focus on the agents first. There are some brokerages that are just counting commissions and MLS only. Compasss is really focused on getting agents all the tools that they need to be that level of superior service to their clients. Whether that is software that they are able to share with their clients and have interactive daily discussion is about properties or it’s the Compass Concierge program that will actually pay to rehab a house. Compass now has a bridge loan program that will basically help you get the house you want with the house you have right now. If you need a bridge loan to temporarily bridge the gap between the house that you want and the time it takes you to sell your current property, Compass will now do that for you. There are some some requirements, but it’s opening the door for more and more clients, and they’re doing it in creative ways.

It’s so cool to be in an office environment. It feels like what a Facebook campus would be like. You have a bunch of millennial savvy marketing minds running around and coming up with new ideas and creative techniques. It’s just really cool to be on the forefront of this, and it’s growing so fast. Compass is the largest independent brokerage in the United States, and it’s gained so much market share. The numbers are just astounding. When he first joined, he really looked at all the stats, facts, and just the brand itself and who was behind everything. It truly is a different experience from the brokerage space, and he is really happy to be part of it.

Compass came out of left field in today’s day and age by creating a brand from scratch and the journey of how quickly they’ve caught on. Aaron has a lot of real estate investment clients throughout California who have strategically switched to that brand. Aaron was also really complimentary of his web presence. He was just visiting derekharmsgroup.com, and he was wondering if Compass is really into the branding side. Derek said yes, and they have an image and a culture, which is one of the things that attracted him to them initially. It’s almost like an exclusive group where if you fit the mold and you have the production, then you’re part of the clique. Part of that is the Compass brand. They have a term that they use where they take whatever brand you had before and they Compassify it. It’s a whole revamping, and it gets a clean, handsome, and updated modern look to your brand and marketing. They did a lot of onsite video and photography shoots at Petco Park, which is where being a real estate partner of the San Diego Padres really comes in handy. You have to take advantage of the relationships where you can. They spend a lot of time on building the brand and having a really good web presence.

Aaron asked what percentage of their business at this point is the brokerage side of the business where they are not fixing and flipping. He said it is about 25%. One out of four are buyer-seller clients. He still loves it, and what he loves the most is helping people that he knows and loves. For buyers, even though it’s a lower time return on investment, these are buyers that they care about, want to spend time with, and are lifelong friends. They are helping them to buy a property that will act as a wealth vehicle long-term for them. It really helps them, and it will make them feel good because the process can be muddy. There are a lot of people out there who are not very good at what they do, so being able to hold people’s hands in this process, especially when they’re acquiring real estate, is one of Derek’s favorite things. You end up getting a very unique perspective of how valuable a realtor can be and how valuable an investor can be depending on the situation because you straddle the seats as well. Derek has a very interesting perspective, and he’s a millennial. He’s like a unicorn.

One of the last houses he helped a friend get into two months ago was a flip, and they happened to know the flipper who did it. Even though there were eight offers on the property, they ended up getting it through a relationship. It all circles back. Being a realtor and being a real estate investor harmoniously work together, and there’s just so much that can apply to both avenues.

To round it out, Aaron asked Derek about opportunity zones and accessory dwelling units and whether he is looking at any of those as part of his projects in 2020? He said absolutely. They have two in the pipeline right now with the city of San Diego. In regards to accessory dwelling units, he doesn’t have anything here, but a friend of his in San Diego is probably the largest opportunity zone player in San Diego. He has a lot going and is extremely dynamic. He was actually one of the industry panelists at their holiday party.

Going back to the accessory dwelling units, they are seeing a lot of success with it. The two particular projects they have hit the roadblocks. They were density-based roadblocks; whereas in both scenarios, even though these seem like cookie-cutter accessory dwelling unit deals, just because the density in that particular area was was high, they had to build a legal “third unit” rather than actually get a third unit ADU. These are both duplexes with attached garages. In one scenario, it’s a one-car garage in an awesome place in San Diego. They bought the duplex, renovated those first, and now those are being Airbnb’d. They are cash-flowing on those while trying to get this third unit pushed through the process.

They barely didn’t make zoning. In this particular case, there was one unit per fifteen hundred square feet, and they had a 4600 square foot lot. They were a hundred feet off from not meeting the density requirement. Hence, they had to build a third unit. They didn’t have any other relaxed property line and set back issues that the ADUs did. They didn’t get any of the discounted fees and the meters. That essentially killed the deal.

These ADU laws were supposed to change on January 1. He searched as much as he could to find what actually changed. He wasn’t able to find anything, but he was told by a contact in development services to not make any financial decisions until after the New Year. There will be some new laws coming into play, and density is going to be involved in this. Derek is still curious to see how all this is going to play out. We were warned earlier on last year to not make any moves until the laws pass in January because you weren’t necessarily going to be grandfathered in if you had already started the project. If it’s below a 750 square feet, you should have very minimal if any impact fees. Setback requirements are less as it’s five to four feet now. A lot has changed.

The thing that Aaron warns people about is there are still going to be some outs for some cities. This includes things like health and safety, utilities, historic. The cities have come back with very creative ways to squash deals, so everyone just has to be careful. He thinks you will find an easier time now. He was calling some cities before he spoke on ADUs late in 2019, and they hadn’t even looked at it.

Derek asked Aaron about projects in the pipeline right now and if his advice would be to put on the brakes and see how this shakes out. However, Aaron said he would actually move forward now, he just wouldn’t buy anything. Assuming you can build an ADU, he would really go in there and ask whatever city or municipality you’re working with to get it on record what their ordinances are. The other thing that’s really changed is the affordable housing goals. The cities can now count ADUs toward those goals. With the new things states have built in, if cities don’t comply, there are cities saying that they’re going to sue the state because they’ve lost all control. Aaron released his Forbes article during the Christmas break that talked about the NIMBYs and how the cities have basically lost control of development in ADUs. They’re not very happy about it. Just because you can doesn’t mean you should. It doesn’t mean that you ultimately will be able to, but you have to be careful. You really have to go in and get to know the city and their stances. If you’re holding properties for a long time, he would want to know if they’re pro or con. Five years from now, if he makes a one hundred and fifty thousand dollar investment and they mess with his cash flow later on, he won’t be very happy.

When it comes to opportunity zones, Aaron thinks ADUs could possibly work very well in tandem with opportunity zones, which could be very interesting. If you build new construction and you’re in an opportunity zone, as long as a new construction doesn’t have the certificate of occupancy yet, you can buy a new home and it will count as that doubling of the basis as long as it doesn’t have the C of O yet. If the ADU doesn’t have a certificate of occupancy, that might work as well. You can build something, and the ADU would count towards that doubling of basis, which would be an interesting play.

If you want to find out more about Derek and NSDREI, you can go to www.nsdrei.org. If you want to go to his personal Web site, go to www.derekharmsgroup.com.

The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669. For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.