Based on my experience with new investors, this issue of losing money in a property is the second or third greatest fear. Likely they have heard war stories of how other investors purchased a property and then over-rehabbed it and couldn’t sell it. Then the investor put a ton of money in it until they had to give it up or take a loss when they sold it. Some rehabbers have resorted to renting these “unsalable” properties with the result they have to be rehabbed again a few years later.
Frankly, this does happen and generally for a couple of good reasons. The first reason is that the investor over pays for the property when he purchases it. He is often emotionally driven by the dream of becoming a successful real estate investor and making tons of money. This is a reasonable expectation but along with this comes hard work and a good dose of common sense.
Very often the seller is a homeowner who has listed his property with a realtor. The driving force for the realtor is to get the sale closed and get paid a commission – that’s how he makes his living. This is where salesmanship plays a major part in inducing the investor/buyer to purchase the property without regard for whether it is a good deal or not. If the realtor knew what a good deal was, he would be doing it himself or a least not listing the property at Full Market Value (FMV) or higher.
Finally, the investor has two more obstacles facing him – the true After Repaired Value and his cost to do the rehab. Any of these parts of the equation going bad will result in failure for the investor.
Following is a matrix of what issues can be encountered by new investors and solutions to keep them out of trouble:
Issue or Potential Problem
Investor over pays for property.
If the property needs a lot of work, make sure you get good estimates from handymen and contractors for the costs. Even if you Do It Yourself (DIY), you will only be able to keep the labor expenses under control. Make sure you don’t over-rehab the property for the price you are selling it – granite counter top on a $50,000 property!
Rushing into the purchase because of realtor pressure to buy it or a very few available in the area for rehabbing.
Your friendly real estate agent is a salesman who makes his living solely by helping people buy properties. The operative word is “salesman” and you must understand that you are the target for purchasing a property – otherwise you have wasted the agent’s time. Be careful and make your own decision based on what the market is all about, not what the agent may be pushing you into.
Unable to accurately determine what is FMV.
Don’t assume that the highest comparable closed sales are what price you will be able to sell your rehabbed property. Be conservative, then a surprise will make you more money, not get you stuck into what you can’t sell.
You cost to complete the rehab is way over budget.
This assumes that you make a budget to start which 95% of investors do not. From the repair estimates you get, make a budget of how much you can spend and still make a profit. Stick to the budget which usually goes wrong because of unforeseen labor or repairs missed in the preliminary estimate. This is the reason to use people who have done it for a living.
Unable to sell your rehabbed property because of a lack of buyers.
You should predetermine how many homes sell in the community monthly and the average Days on the Market (DOM) from a local realtor. Remember if you sell it through a realtor you’ll lose 5% to 6% of your sale price which could be 1/3 or more of your profit – so learn to DIY to start.
Your rehab cost is too high so you have to price your property too high for anyone to buy it.
If this happens, you can do a round robin auction to sell it on your own. The key is the appraisal may not come in where you want it but if the buyer has enough cash for a down payment, he can qualify for a loan. Wait for a buyer who is truly pre-qualified by a mortgage broker you trust so you don’t sign a contract and have to wait months to close and possibly not close at all.
What is a standard for evaluating what price to pay?
One age-old guideline that works with slight modification is to take 70% of the ARV and deduct your estimated repair costs from this price. If the ARV is $100,000 and your repair estimate is $30,000, your offer would be $100,000 x 70% = $70,000 – $30,000 = $40,000.
In addition, I like to deduct additional real costs of closing costs on the buy and sell side, carrying costs for the money (even if it is your money), insurance, taxes, utilities and unexpected expenses. I use a number of 1% per month of the purchase price; for example, if your purchase price is $100,000, you should include an extra $1,000 per month until sold and that time period to sell can be 6 to 12 months!
To rent or not to rent is the question when you can’t sell it.
This should be a purely economic decision – “Does the property cash flow with a renter in place including taking into account the cost of maintenance, repairs, taxes, insurance and the cost of your money in the deal?” If the answer is “almost”, the real answer is “No!” The decision now is to take the small loss now or bleed to death over time – the first loss is almost always the smallest. It may be the hardest to swallow, but it is likely in your best interest over time. Take your loss so you can move on to the next project with a vast amount of experience that didn’t end your new career.
In summary, there are solutions to every possible obstacle you will encounter in real estate investing. Some can be foreseen in advance and common sense plays a big role in avoiding these potential problems. Other issues can’t be easily anticipated and have to be resolved as they occur – these surprise issues and their solutions are what separate the truly great investors from the failures. Don’t be a failure, there are always solutions and the ultimate one is simply taking a loss and walking away to fight again another day!
To your limitless success,