This might be a stupid question but I am having some trouble with this. If total investment for the end buyer is more than the ARV is it still worth going after?
Here is the situation.
I am about to contract a house for 6k. Owner owes 2.8k in back taxes. The ARV is around 30k. The property needs roughly 30k-32k worth of work. (this might be overestimating because it is for a rental not full rehab). So, roughly, the total investment is 41k for the end buyer. The property rents out for $800 which makes a good cap rate. I know a few investors who want rental properties in the area. So the to question is...will a buy and hold investor be willing to put up more money than the house is worth in order to capitalize on the rent income?
This is also an all cash investment so mtg fees won't come into play.
Long term buy and hold investors will generally be more interested in good rental cashflow, and will care less about ARV. That said, many of them will want a property that doesn't have any issues with location, lot, design, etc that would limit future appreciation.
If the house is in a good area on a good lot, many landlords will overlook ARV in return for good rental numbers.
If they buy and hold investor can pay $41K all in for this house from you or can buy the same house next door for $30K, which do you think the investor would buy? They would be foolish to pay $41K.
Jon Holdman, Flying Phoenix LLC
I agree with J Scott but I'll add- if there are a lot of properties for sale around that 30k mark that are already fixed - it might be difficult to talk someone into buying something for more expensive AND that requires work. But those seem like great cashflow numbers. Well done!
And also, investors might be able to get the rehab done for a lot less than you are planning since they often have crews or employees or are just really efficient.
Single family houses transact based on their value, not their "cap rate", that's the reality. In this market, no one in their right mind is going to pay a premium above market value. You just never know when you need to sell, and selling will entail 10% in transaction costs. So at a minimum, savvy investors want to buy at 90% of MV, and most strive to buy much cheaper than that.
That said, $30k+ for a rental rehab sounds very high, so hopefully you're over-estimating and your investor can in fact come in under MV. Cheapo homes of this type are notoriously hard to value, because there is huge variability in condition of property in these types of neighborhood. These neighborhoods are filled with REOs and short sales. It's hard to value them without knowing the exact condition of the comps. At the same time, this inefficiency can lead to great opportunity in these areas for someone who rolls their sleeves up, looks at a lot of houses, and gets VERY GOOD at doing accurate rehab estimates on houses in crappy condition.
I certainly agree with Jon that if an investor has other inventory to choose from that is cheaper, you'll have an issue, but $800/month for $40K is great return, and I would still bet you can get it sold if there aren't better deals in the area.
Everyone's answers so far have been really great! I'd just add that good cash flows alone can justify doing a lot of deal but it never makes sense for an investor to pay more for a property than it's worth b/c that can have a negative effect on your opportunity to do additional deals in the long run.
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