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The Investor Buying Process
1. Build your TEAM
If there was one thing that will make a difference between a good experience/deal or a bad experience/deal…it is your team. Your team could consist of a Real Estate Agent, Mortgage Broker, Title/Escrow Agent, Insurance agent, Home Inspector, General Contractor, Real Estate Attorney, and the list can go on. We are going to start with the most important…and that is your Real Estate Agent and Mortgage Broker.
So how do you know the difference between a good team member and a bad one…we recommend the book Rich Dad’s Real Estate Advantages …in chapter 5 it covers some of the questions to ask and what to look out for. We have listed a few of these questions for you….
2. Your Exit STRATEGY (& Credit) = Loan Options
You need to start with your exit first. If we break down your exit strategies, they will fall into 2 categories…cash flow or capital gains. What is the difference? My parents have a ranch and they raise cattle for beef. They raise the cattle and sell it for a profit (hopefully) and get that profit only once. Had they chosen to be a diary farmer, the cattle would continually produce milk which equals a profit. Real Estate is the same way, I can sell it for a 1 time gain (or loss) or I can us it for a monthly income. All of the real estate investing strategies fall into 1 of those 2 categories…cash flow or capital gains.
Most mortgage brokers focus on your credit as the key factor in placing you into a certain type of loan. While your credit is important…It is your intended exit of the property that will define your loan options. If you are looking to hold this property for the long term then you may be looking for a 30 year fixed loan that is paid off within the 30 years or sooner. If you intend to only keep this home a few years, then an interest only loan may make the most sense. Why, because it will keep your monthly payment low.
No matter what your exit is, there is a loan program for everyone. The problem, most people look for the ‘best deal’ instead of the loan program that is the ‘best fit’.
Team Members Needed – Mortgage Broker, Credit Repair specialist
Tools – Mortgage Calculators , Online Mortgage Application
3. FIND a Property
So here comes the step of going out and finding a property. One of the most important parts of this process is managing your emotions. Yes, the purchase of a property can be an emotional decision…lets just be aware of that. To give you a different perspective though, it is important to understand the difference between a consumer and investor. Consumers make decisions based on emotions while an investor makes decisions solely by the numbers.
My recommendation is be both a consumer and an investor, get what you want (emotions) yet make sure it makes financial sense. So how do we make sure that a deal makes financial sense? Well that is entirely based on your exit strategy that we discussed in step #2. But lets talk about the 2 different tracks that you may look at…Cash flow vs. Capital Gain. If you want cash flow you will need to evaluate the income of the property…if you want capital gains you want to evaluate the future value of the property. Lets break these 2 elements down. Cash flow is a relatively easy formula…
income – expenses = cash flow
So why do so many people end up with negative cash flow? Simple answer…they don’t use the formula. They so often mistake different numbers for different things or don’t use the formula at all. An example of this…your real estate agents tells you the Cash Flow is $800 on a 3/2 single family home. The problem is, this number didn’t include the largest expense…your mortgage. So you got a great deal, unfortunately your mortgage turned out to be $1000 a month so you are losing $200 a month. The other problem is that so called investors are using the wrong formula…they use the formula for capital gains to evaluate cash flow. I will hear from people that the property is 20% below market value…problem is it is still over priced from a cash flow perspective. Capital Gains. How do you predict the future value of a property?
Do you have a crystal ball?
I don’t…but if you do let me know as I will pay you a lot of money to use it. So lets get real, to invest in capital gains you are not going to use a crystal ball and predict where the market is going, you have to base your decisions on where the market is today. The key with capital gains is to build in your profit before you buy. So how does this look, another simple formula of addition and subtractions.
ARV – Expenses – Profit = Your Highest Offer
- ARV = the appraised value after repairs made or what you think you can sell the property for. In a down market you may consider lowering the price to sell.
- Possible Expenses (repairs, money costs, closing costs when you buy and sell, real estate agent commissions when you sell, carrying costs – HOA, utilities, insurance.)
- Profit – how much money you want to make If you use this formula you can see where emotions may play into this. You offer may be a significant discount to make the deal work for you. But if you can not make a profit, should you do the deal?
Team Member Needed – Real Estate Agent
Tools – Real Estate Listings
When in doubt, tie up the property by getting the property ‘under contract’ and just ensure that your escape clauses are in place. Earnest money…it is important to know ‘how much’ earnest you need to put down. Truth is, all that you need to put down is $1 to $100, whatever amount is required by your title/escrow company to open an escrow account. Real Estate Agents will tell you they like 1% or some other amount because it show that you are a ‘serious’ buyer. Point is…earnest money is negotiable. Everything is negotiable.
Quick Contract tips…if you want something, be specific. If you want an ‘escape’ be broad. Two examples, I want the Viking Refrigerator so in my contract I am going to add the serial number and photograph…or; This deal is subject to my partners approval. You may not want that Viking to be replaced by a GE (no offense GE) and for the other example I never said that my partner was my dog and the property didn’t pass the sniff test.
Team Members Needed – Real Estate Agent…getting into serious contracts, use a Real Estate Attorney.
Tools – Your real estate agent will have a standard purchase agreement. In case of you are looking for other legal forms click here.
5. ANALYSIS of the Property
There are 2 areas of property analysis to consider: Property condition and property value.
Property Condition– Do you know if you are buying a dog? Do you want to buy a dog? (Believe it or not some people do as they love the concept of fixing a property up.) The point is do you know what needs to be ‘fixed’ or ‘updated’ on the home prior to purchasing. A good home inspector will identify issues or problem areas throughout the entire home. If your home inspector does identify issues, then you will want to bring in specialists to quote the work and evaluate what it will take to handle the work.
Property Value – When buying a home there is one primary number that you want to be aware of…The Appraised Value of the property. You will get this from an appraiser, but one tip…ask for (and review) a copy of the appraisal before you close.
Team Members Needed – Real Estate Agent (introduce you to an appraiser and home inspector), Appraiser, Home Inspector, any other specialists required.
Tools – Sample Appraisal
6. LOAN Analysis
Below is a quick checklist of items that you will want to know concerning your loan. You will want to compare this information to your current financial situation and your exit strategy to ensure that this loan fits your needs. It is always recommended that you talk to at least 3 mortgage brokers about your deal, as every mortgage broker may have access to a different loan program.
Here is the hit list of what should be included in a Good Faith Estimate:
-Taxes and Insurance
-Fixed or Variable Rate
-Amount of money needed to close (your check to bring to closing)
Team Member Needed – Mortgage Broker
7. CLOSE on the property
Closing takes place at a title/escrow company. As we discussed in step 6 – Loan Analysis, you will need to know how much money to bring to the closing table. There are a lot of documents, take the time to make sure you know what you are signing. If you don’t know what a document is for, ask the title agent for clarity. While all of the documents are important, the HUD 1 is very important to review. This outlines who (seller, buyer) pays what and who (mortgage broker, Real Estate Agent, Title, etc.) gets paid what.
Take a friend, spouse, therapist, family member to closing with you. Remember this can be a very emotional experience, so if you need to have some ‘support’ with you, take it.
Team Members Needed – Title/Escrow Officer, Mortgage Broker
Tools – Sample HUD 1
8. Execute your EXIT
Now that you have closed and own the property it is time to execute your exit. Is your plan to hold the house for a few years and then sell it? If so, you will want to talk to your CPA to discuss when to sell. Owning the property for 1 year and a day could be the difference between paying 30ish% tax (taxed as ordinary income) or using a 1031 exchange to roll the profit into another property, tax deferred. If you own and have lived (occupied) in the property for 2 out of the last five years, you could take the profits with no tax hit. 1 day could be the difference between thousands of dollars that you may need to pay in tax.
Maybe your plan is to accelerate your loan pay down? Your mortgage broker should have tools to help you take what is normally a 30 year payoff to a 10 or 11 year payoff by using a combination of increased monthly payments and utilizing a HELOC (home Equity line of Credit).
Team Members Needed – CPA, Mortgage Broker
9. EXPAND – What’s Next
No matter where you are starting from, there are tremendous opportunities in real estate to create and make money…even in an up and down market. It often starts with your first home, and then you build from there.
So what resources are available to you get the education and find the right team members…