You should buy an ugly home
Having trouble getting a seller to accept your offer?
Are you trying to buy a home and finding that every time you fall in love with a house you are competing with multiple buyers and even though you are offering above asking price, guaranteeing cash over appraisal, taking property as is and waiving inspections you are still getting beat out by better offers or cash buyers? Well it's not just you! Almost all my buyers are in the same boat as well, it's emotionally exhausting and most of my clients will give up after about three missed attempts. So I selfishly wanted to find a way that we could avoid these bidding wars and go back in time where you could actually negotiate with a seller and not just get on your knees and beg the seller to choose you.
Houses other buyers are ignoring
The only way to accomplish this is to look and buy houses that other buyers are ignoring. The hotter the market gets there are less and less that a buyer will ignore but one segment still remains. Ugly houses that need rehab. Here's why you want to buy these homes.
Little to no competition
Buyers that are looking to live in the house want to fall in love with the house they buy. They won't even set an appointment to see an ugly house let alone submit an offer. You need to commit to using your imagination to see what a property could become and largely ignore its current state. Your competition will generally be investors in this segment, but there are even ways that you can overcome that as well.
You can make some money
Another huge benefit to buying and fixing is that if done correctly your house should be worth more than the cost of purchase and the renovation. The remaining gap is your equity that you gained by doing the work. As an example I had a listing that sold for $112,000 they got bids to do the repairs for about $80,000 so total cost was $192,000, but the appraisal came in at $250,000 so the buyers have made themselves $58,000 in equity and in this particular case repairs were to be completed within 6 months. That's not a bad wage for 6 months. And the best part is they were the only buyer making an offer after the property sat on the market for literally years.
Of course it's not all peachy there are some drawbacks that many buyers aren't willing to face.
Many of the government backed conventional loans such as VA, FHA, and USDA-RD have minimum requirements for the the condition of a home that these ugly houses won't generally meet. And even if they did those loans won't lend you money for the cost of the renovation. You need a construction/renovation loan. These loans can really vary in their terms. A traditional renovation loan would generally look like this:
- You get an accepted offer on a property
- You compile a list of repairs and improvements and get quotes from contractors for the repairs
- The bank then has an appraisal for how much the property would be worth once the rehab has been completed
- They lend you generally up to 80% of that value from the appraisal. That percentage is called the loan to value (LTV) and it varies from bank to bank so talk to your lender to get the real numbers.
- If your purchase and repair cost fit inside the 80% amount then hunky dory you really don't need to bring a down payment you just need closing costs. If it exceeds that then you would need to bring the remaining money in cash.
- The loan closes, you have a one year term (again this varies and you can get extensions), you'll make interest only payments on the loan while the repairs are completed.
- Once finished the bank sends the appraiser back out to confirm it's worth what expected, and you refinance into a 30 year loan.
There are some other government backed rehab loans general only for owner occupants, not investors that can have better terms. For example in AK we have a rehab loan that looks more like the following:
- You get an accepted offer on a property
- You get an engineer to list out necessary repairs.
- You get contractor quotes to fix necessary repairs.
- The bank has an appraisal for what the property is currently worth to determine if your purchase price is good, and the as complete value (value after completed repairs)
- You pay 5% of the purchase price, not the total loan amount so you don't pay for the money they give you for renovation.
- They can lend up to 95% of the as complete value for purchase price and repairs.
- Once you close you have 2 months to complete any safety repairs and 6 months to complete the remaining.
- The loan doesn't need to be refinanced it is a 30 year note right from the beginning.
There are a variety of these types of loans so again speak with your lender and see what your options are because they will greatly influence what property you are able to buy.
Longer closings process and rehab time
Another reason people avoid these is the loans can be cumbersome in some cases and extend your closing windows. Here in AK we have especially long closing windows with even cash deals taking six weeks to close from an accepted offer. Many of these rehab deals reach three months before they close.Once you are officially closed up you have 6-12 months when the house is being worked on. If you can live in the house that may not be so bad, but if not you need to find somewhere to live for that time.
Still not scared off?
Well if you are still reading and willing to deal with these significant drawbacks of buying a home this way let's get into what you should look for when buying ugly homes.
To be honest this has been overused and I think quite vague. I've personally been in a ton of houses, for my job and I do kind of just have this gut feeling for a house that has good bones, but I would never purchase based off a gut feeling so I've quantified what I look for when I say good bones
- The unchangeable items. First I look to things such as the location, the neighbors, utilities available, etc... These items that you can't change no matter how much money you spend. If any of these are not to your liking then move on.
- Items that can be changed but aren't economically feasible. This is a huge grey area but if it cost more to buy and renovate the house to your liking than the home will be worth than keep looking. This generally will come up in two cases. First, the house is dirt cheap but really just needs to be plowed over and start over new. The house is not the worst condition, but you are trying to fit a square peg into a round hole and make the property into something it was never intended for and becomes so expensive it is no longer worth it. To be clear you can change the intended use of a house and get creative but just make sure it makes sense financially. For example a house that would only need a few walls added in to make into a duplex.
- Long-tail expenses. Items that will continue to cost you money as you own the property. This is less of an issue if you are going to sell quickly but if your strategy is to buy and hold. For example the property isn't on city water and you can't get a well, so your only choice is to have a water holding tank. You know that will cost you water hauling fees as long as you own it. For me personally that isn't a deal breaker as long as the income numbers still work.
What is a good deal?
This is hugely variable based on you as the home owner or investor. If you've been investing for a long time then you may already know what return you want to have. It's easy at that point to run the numbers and see if it hits the return you want. If you are just getting started this number is much more nebulous. So let's start with what a bad deal looks like and work our way into a point that you are comfortable.
Easy, the cost of purchase and renovation is higher than value of the as complete home.
You land somewhere close to the value of the home with the purchase and renovation costs. This is obviously not preferable, but in our current market may not be the worst thing in the world. Especially if you can't seem to land a contract on any other house and your other option is to rent. So the headache of dealing with repairs isn't giving you too much return but you are owning a piece of real estate. Not saying this will be worth it for you, but something to think about is if you don't buy something what is your current living situation costing you.
Most investors are looking at this as a percentage. Back in the day when you could buy things much cheaper many investors I worked with would shoot for the price of purchase and renovation costs to be 70% of the as complete value. Great return obviously. Still possible to find in this market but much harder. I wouldn't recommend making that the end all be all number. If you can accomplish it then hunky dory but don't miss a deal if it makes less.Another number many would aim for is 80% of the as complete value. This is because many banks will lend up to 80% of as complete value so you could theoretically buy and fix the house without needing a down payment.From 80% and up will be a personal decision. Look at how long it will take, and the amount of work you will put in and decide if that is the best deal for you. Let's say you have a minor fix up job on a house that will take you 3 months to complete but you will come in at 90% of value for a $300,000 house. You've still made $30k in equity in 3 months. Not a bad wage for a lot of people.
What to do now:
- Call a trusted lender and see what rehab loan options they have. If you don't have a lender call a realtor who deals with these types of homes and ask his advice. (If you are in Fairbanks, AK you know who to call!)
- Get with your realtor and let him know what your purchase limits are based on your preapproval letter from the lender.
- Start looking at houses and running numbers!