Once you’ve determined what target location where you want to invest in real estate and done all the research on the neighborhood, what properties sell and rent for, along with all the idiosyncrasies of the neighborhood, it's time to start looking for your first property.
When looking at properties to figure out what's a good deal or not, we need to work backwards. There are five things that you need to think about when determining whether this deal is a good one for you.
1. When you're looking at a prospective property, don't start with want the property is listed or it what the asking price is. If your plan is to renovate the property and resell it, start with what you think you can sell it for. If you're looking at 3 bedroom, 1 and a half bathroom house, the first thing you need to think about is what all if the newly renovated houses that size have sold for in the past 6 months. Don't just think about the one or two that sold the highest or the one or two that sold the lowest. Think of them all. Since you've been doing your homework on the neighborhood, you should know why some sold for more or some sold for less. With this in mind, you should be able to come up with a reliable after repaired value or "ARV".
2. The next thing you have to think about is how much the renovations will cost. If you don't feel comfortable figuring this out in your own, ask a reliable & trustworthy contractor to come with you. If you convince him that he'll get the work when you but the property, he should be willing to give you some estimates on the renovation. There are a couple things to keep in mind here.
1. Make sure your contractor is trustworthy. You don't want to buy a property thinking the repairs will cost you X, only to find out later that the contractor was under bidding you just to get the job.
2. Make sure that the renovations that you're planning will put the property in the same condition as the comparable sales that you're relying upon for value. If you're looking at a comparable sale where the bathrooms were all renovated and you're not considering fixing up the bathrooms in this property, you're provable nit gong to get the same price.
3. Factor in the unknown. In any project, things can take an unexpected twist. You may think that the heater has another 10 years of life in it, only to discover that you need to buy a new I've. You need to count on sobering not going right when you do your numbers.
3. The third thing that you need to think about is your carrying cost. Between the time you buy the property and the time you sell it, there’s going to be real estate taxes, insurance, gas, electric & water bills. Determine how long you think that you’ll own the property and how much these bills should be on a monthly basis and you’ll have the number. As I said above, things have the potential to take longer then expected. You may think the renovations could take two months, but it could stretch to three. The same thing holds true for marketing time. Make sure you have conservative estimate of how long you’re planning on owning the property and what they carrying costs should be.
4. The next thing to consider is closing costs. When you buy and sell the property, you’re going to have to pay transfer tax, title insurance, fees to record the mortgage, realtor costs and mortgage closing costs if you finance the property. Make sure that you have a good handle on these costs for both when you buy and sell the property. Between your realtor and your mortgage company, you should be able to get a good estimate of what these costs are.
5. The last thing you need to think about… and the best thing to think about is your PROFIT! How much do you want to make in this deal? It all depends on how hard or easy the deal is going to be and how much you value your own time. He higher you set this figure, the harder it will be to find an investment that works, but it will be more rewarding when you do it.
Let’s go through a practical example…
You see a three bedroom, one and a half bathroom house that needs work. It’s listed for $62,000.
You’re very familiar with the area and you know that similar homes have sold between $90,000 and $105,000 once renovated.
There are no adverse conditions to the property and it’s close to a popular church, so you determine it should sell for $100,000 once complete if you do a nice renovation job. You’ve seen the house that sold for $105,000 and it was beautiful… nicer then you’re planning on renovating this house.
You’ve spoke to your contractor and he assures you that you should be able to renovate it to the level that you feel comfortable with for $18,000. You check is references and feel comfortable that he stands by his prices. When doing your numbers, you want to budget another $1,500 for unforeseen problems bringing the total to $19,500.
You believe that the property should be sold within 9 months of having bought it and the carrying cost should be roughly $2,500.
You’ve spoke to a realtor and a hard money lender and determined that your closing costs and interest should be $16,000.
Since this is one of your first projects and it doesn’t seem that hard, you want to set a profit goal of $10,000.
$100,000 Sales price
Subtract:
$19,500 Renovations
$2,500 Carrying Cost
$16,000 Closing Cost
$10,000 Profit Goal
$52,000 Maximum Amount you can pay
From a strategy standpoint, you can choose to offer lower and negotiate, but if you’re numbers tell you $52,000, stick with hat number. One of the biggest mistakes that I’ve seen people make over the years is they get emotionally caught up in the negotiations. They’ll offer less, but when the seller wont go below $59,500, they’ll go back to their original assumptions and delude themselves into thinking that they’ll sell it for more than they originally thought or the renovations will cost less. This is a huge mistake. If your assumptions are correct, don’t change them to make the deal make doable. If the numbers don’t work, move on to the next property. If you looked at 100 properties so far and the numbers don’t work on any of them, keep looking. Remember… the goal is not to be a real estate investor… the goal is to make money by investing in real estate.
