You know the deal and the numbers best. Here’s what I would want to know and how I would do the exercise.
- Build your network and relationships
- Create your investment thesis before buying anything (make a business plan)
- Perform your due diligence
- Make your offers
Network and relationships:
Hopefully you already did this and have a strong network to help you get this deal done. But for clarity if you didn’t already do it; here goes.
A trusted GC and sub contractors can do the construction work for you if you don’t do it all yourself.
Reliable suppliers will provide materials at the lowest possible prices. If you do this well, your contractor really becomes more of a construction manager.
A good lender should know what kind of deals you like to do and has already reviewed your financials. Bankers (and private lenders) usually underwrite by looking at the borrower first then the borrower’s financials then the specific deal points. They want to know that you are a good guy, have the means to pay them back and found a good deal that makes money for both of you.
A competent real estate agent, property manager, insurance agent, title company and lawyer are critical to your success. You actually need a few of each. Good agents will help you find more deals than you can just by yourself and more buyers to get you out of deals.
You can get a better price from a PM if you give them a bunch of deals but then all your eggs are in one basket. But you can keep PM prices low by spreading you deals among several managers and getting competitive pricing.
You can do the same thing with the title companies except you can find one good attorney and give them all your title work. A good attorney can give you a good rate in exchange for all your title work. They can also bring you deals plus other investors, lenders and partners. A good attorney is really valuable to you.
You may be better off doing all your deals alone because it is riskier doing deals with partners. But having a few trusted investment partners if/when you need them is a great backup plan if a deal pops up that you can’t take on alone.
Return on investment thesis:
To do this deal effectively you need to know
- How much money goes into the deal,
- How long the money stays in the deal,
- How much money comes out of the deal and
- What is your targeted internal rate of return
You can also compare how buying this property compares to buying a different property as well as the opportunity cost associated with alternately investing in stocks, bonds or a business.
Due diligence:
Work backwards to solve for the purchase price. Research all your numbers, then apply your investment return and you wind up with the offer you’re willing to make that meets your required return.
The ARV is a good indication of value but isn't relevant unless you can back it up with market prices. Your agent should give you sale comps in the immediate market. Start with 90-day comps and go back to 180-days or further if you can't find enough sales to show a large enough competitive set. Look specifically at cap rate / rent multiplier, then price/SF. Don't look at list prices except to see the sale price to list price ratio. But even that isn't really important.
Make sure comps are similar in age and features and make adjustments for any differences between your property and the comps. If a comp is 5% better than your property then subtract 5% from the comp's value. If a comp is 10% worse then add 10% to the comp's value. This is what an appraiser does. Agents can give you a simpler version of this like a BPO (broker price opinion) or CMA (competitive market analysis). Both are unlicensed, stripped down versions of appraisals. But these adjustments get you to an apples-to-apples comparison.
A good agent will tell you if the market prices are going up, going down or staying steady over the past 3-6 months; 7-12 months and 12-18 months.
Many BP members argue that market comps don’t matter to your offer price. They argue that you only make your offer based on your investment criteria and it doesn’t matter what the sale prices are around you. We also know from the stock market that past performance does not indicate future prices.
By itself, making offers based on your internal rate of return is a good argument. But it’s only one piece of the investment puzzle. You have to know where the market is when you come in; you have to know if prices in the market are going up, down or staying steady and how long are you going to hold before you exit.
Think about these possible scenarios among others:
- 1.Purchase, renovate and sell at current market prices.
- 2.Purchase, renovate, hold and sell after some market appreciation.
- 3.Purchase, hold, increase rents and sell at same or increased cap rate.
- 4.Purchase, pay down debt, depreciate the asset, 1031 into a new deal in 3-5 years.
Take your trusted contractor with you to determine your cost of repairs. Everything is important but structural issues are deal killers. Check foundations, roof and MEP (mechanical, electrical, plumbing). Take a look at water and sewer if possible. Pay attention to asbestos and lead paint if it’s an old property. Then you can worry about interior repairs and upgrades. Again, see if you can walk some of the listings in the neighborhood so you don’t renovate above what the market is offering.
Make sure you or your GC talk with the building department and you know how new building codes will affect your renovation. Updating HVAC, electrical, plumbing and fire protection could kill your MEP budget.
Look up the real estate taxes. Make sure the tax value is based on sales comp values. Find a tax consultant and see if you can file an appeal with the municipality to reduce the assessed value.
Call your insurance agent and get a quote for hazard insurance plus general liability as a landlord. Do you need extra coverage for flood, tornado, etc.?
Does your lender know you're putting your HELOC money into a new property? Should you do a cash-out refi instead? How are you financing the renovations?
You need to always be upfront and honest with anyone lending you money. You don’t have to confess all your sins to your lender but don’t ever hide anything from them and always answer them in an upfront and honest way. Share bad news early. You will go a long, long, way if you are trustworthy (even if your deal doesn’t perform as well as you originally claimed or hoped).
You need to always show your lender that you’re competent and know your facts and figures forward and backwards. And don’t forget to share your conviction about the deal. If you don’t believe, no one else will.
Call your lawyer or title company to find out what your closing costs will be. A lot of the fees and costs are fixed and probably much higher than $1,000. Call your agent and see if they'll share an Excel version of a HUD form so you can enter your numbers and get a ballpark on the transaction costs.
Making offers:
There’s a lot of different ways to make an offer. Usually keep it simple. But think about adding the right kind of contingencies so you can walk from the deal.
Who is the seller? What are their pain points? Is the property distressed?
You can go with a low cash offer and quick close if the deal’s a no-brainer. You can offer a large deposit to demonstrate credibility but always make it refundable. You can use a letter of credit instead of cash.
The best offer is the one that makes the seller feel most comfortable. The seller may pick you over lower offers because they need the money. The seller may pick you over a higher offer because they know you will close.
Conclusion:
If I’ve done my homework and wind up with your numbers and I feel good about the deal, then I’m probably doing the deal because the returns look good.
If I’m looking at this as an investor, I’m looking for evidence that all the homework is done and that it hits the investment target.
Bottom line; you gotta do all the homework to convince someone to do the deal with you (banker, HML, JV partner). And the #1 investor is you. Build your network. Make a business plan. Create your investment thesis so you know why you're investing and what your targets are. When you know what properties you're looking for and you know what markets you're comfortable in, then you build systems that help you find a property, run your "back of the napkin" figures and decide if you want to write an offer and start doing some serious homework.
Good luck! Keep us posted.
