I saw a post on one of the forums here on BiggerPockets recently where someone asked:
How will my end buyer know that my house is a good deal?
My initial response was that this person was really asking, “How do I convince someone that my house is a good deal even though it may not be?” This question just shouted “I really don’t have a clue what I am doing”.
We Were All Newbies Once
The fact is that we were all brand spanking new at one time. And if the truth be told, we all had this same thought at one time or another; that uncertain feeling down deep in the pit of our stomach right after we put in an offer on a house. Is this really a good deal? That fellow called “let’s question our decision” shows up right after we sign on the dotted line.
I believe that there is one skill that is absolutely crucial for anyone even thinking about investing in real estate to master first (and quickly). What skill is that?
You Have to Learn What a Good Deal is!
I will take that thought one step further. You have to learn pretty quickly how to determine what makes a deal a good deal in the eyes of a seasoned investor. It’s just not enough to eke out a marginal deal, or god-forbid a certifiable bad deal.
Now you might be asking; if I plan to rehab the house and sell it to a retail buyer, what does it matter if it would be a good deal for another investor? Trust me; it matters.
1. After the house is completed it will be time to get it sold. Then you will be forced to list it for a price that reflects what you have in the house rather than what it is actually worth and you already have a problem. When it doesn’t sell, you will have no choice but to lower the price even if that means you will lose money. You need to be crystal clear on one thing:
You make your money the day you buy the house
2. Sometimes life gets in the way. Consider this scenario for just a minute; maybe you haven’t even started the project and something happens that forces you to unload the property quickly. In that case you are going to be looking for another investor to take the property. That seasoned investor just isn’t going to be worried about what you paid. They will have done their homework and will only pay what it is worth to them as an investment property, and that will be determined by nothing more than old fashioned math.
Experienced investors always let the “numbers do the talking”
If your plan is to wholesale the property, your end buyer who will be an investor will expect your numbers to be correct. In order for the price you offer it to the rehabber or landlord to be correct these things must happen:
The purchase price must be right according to the standard formulas, and your comps have to be solid. (An experienced investor will be good at spotting inflated comps). There will also be some variation in these formulas from area to area, but this formula is a pretty standard starting point.
A. 65-70% of the ARV
B. Less repairs
C. Less your wholesale fee (if you are a wholesaler).
What can make this formula different? For me that could be several different variables. If the rehab is really extensive, then I will expect to run into more things that can’t be seen or anticipated, so I will want a bigger discount when I buy and a larger “fudge fund” for those miscellaneous items.
If the area is a little more marginal than I would like, I will buy at a lower percentage since I will have a smaller pool of wholesale buyers. On the other hand, I might actually increase that number (pay more than 70%) for a house that costs significantly more than the average bread and butter property. On a $300,000+ house I might use an 80% formula leaving $60,000 on the top for the investor buyer. I guess what I am saying is it just depends. It depends on the area, the level of repairs needed, and certain other factors.
If we are talking about a big old wood Victorian house that has a lot of deferred maintenance and hasn’t been updated for 50 years, even if it will ultimately sell for $300,000+ to a retail buyer, I will be looking to buy that house really cheap. If there is something you can count on it is that the repairs will always cost you a whole lot more than you expect, and the project will take longer than you think it will.
Don’t buy on emotion; the numbers tell the whole story. Period.
Don’t Use Eraser Math to Make a Deal Work
If you have to do that it isn’t a good deal
The Repairs Numbers Must Be Right
If you are a wholesaler, why would you need to figure the repairs? I was asked this question just last week. The answer is always the same. How will you know what to offer on the house?
You need to get good at figuring repairs and coming up with accurate numbers. A wholesaler’s end buyer (an investor) will always crunch their own numbers. But I can tell you this with absolute certainty; if the numbers your investor buyer comes up with aren’t really close to yours you already have a credibility problem.
The people I work with time and time again will never ask me to provide them with a repair list. They can do that as they walk through the house. Often times they will ask what number did you come up with for repairs? I always know that answer and you should too.
Recently I was given some information by the seller that the old inlet copper water line was split right where it entered the house. And where it was located, it was actually pretty hard to see. The utilities were also off in this house so it would have been easy to overlook this defective water line in a dark basement using only a flashlight to inspect the area. So I did what I always do; I tell the investor buyer all of the things I know about the house and any subtle defects I have found. You want complete transparency in this situation.
Your Wholesale Fee Takes a Hit
This is really a pretty short topic. If you get the numbers wrong and you still manage to find a buyer in spite of that, it’s most likely because you took a hit on your wholesale fee. Just suck it up, take the hit and move on; consider it “tuition and lessons learned”.
Know When to Fold ‘Em
I told someone just yesterday not to try to make a deal work. This new investor told me he had come across what he thought (by the numbers) was a pretty marginal deal. There were three comps ranging from $9,000 to about $89,000 with one of those being squarely in the middle. But this was his first real lead, so he said that he “really wanted to make this work or everyone”.
My response was, “Don’t do that”. You don’t know the area (it was 90 minutes away), the price is too high, and this is a big project for your first investment property. There really is no wiggle room for mistakes. Knowing that he was probably going to make an offer anyway, I told him. “Here are the things you absolutely must put in the contract to protect yourself if you decide to make an offer”.
The fact of the matter is, the biggest lesson you can ever learn in my opinion is to “Know when to fold ’em” as the old Kenny Rogers song said. There is a time to walk away and concentrate on finding your next deal. Just let this one die. Once your pipeline if full of potential deals, you won’t be nearly as tempted to try to make something into a deal that just isn’t one.
Photo: Tintin44 – Sylvain Masson