One of the biggest obstacles to success as a real estate investor is emotion. It’s part of being human. Imagine you are shopping for a new car. You do your research on the internet, you read reviews in various publications, calculate exactly the highest price you are going to pay and head to the showroom. With a firm resolve you walk in the door and are greeted by the smiling salesperson you have vowed to ignore. Then he begins showing you the car you want albeit loaded with every feature you determined that you don’t really need. But why shouldn’t you get them, it’s only a little more? Your firm resolve has been overwhelmed by your emotions.
Emotions come into play when you’re making investment choices just as they do when you’re buying a car. As a human being you can’t eliminate them but you can take steps to control and manage them. Your likelihood of success as a real estate investor will increase dramatically if you remove the emotional aspect from your decision making. How do you do that? By using tried and true formulas that are often ignored when you allow your emotions to overrule logic.
Powerful Formula for Rehabbers
As a rehabber I used a simple formula that told me if a property was a winner or loser. It’s not magic – it’s math. I described it in greater detail in my book, A Rehabber’s Tale, but these are the basics. To use the rehabber’s formula you need to determine certain variables and that’s the tricky part. You need to know what you can really sell the property for when it’s repaired. That isn’t what you hope to sell it for but what you can really expect to get within thirty days of putting it on the market. You also need to know what it will cost to make repairs and you need to build in a contingency for the unexpected.
ARV: After Repair Value (what you can really sell it for)
COR: Cost of Repairs (be conservative here and estimate high)
The Rehabber’s Formula:
(ARV X 70%) – COR = Maximum Purchase Price
The 70% factor allows for your cost to acquire, sell, and finance the deal. When all goes well you can expect a 10-15% profit. The formula assumes that you will hold the property for no more than four to six months. For longer holding periods the percentage needs to be lower; if you are buying with your own cash the percentage can be a little higher.
Caution is Key in Flipping Houses
Keep in mind that the easiest person to fool is you. When you enter the world of rehabbing there are three things you can count on:
- The project will take longer than you think
- Repairs will cost more than you expect
- The house won’t sell for as much as you hope
I’ve done quite a few talks at real estate clubs on rehabbing successfully. Invariably after one of those speaking engagements someone will come up to me with a rehab horror story. Often they were convinced by a real estate agent that a property was a winner. Unfortunately most agents don’t understand a thing about rehabbing. They’ll assume a listing at 20% below market is a bargain when, in reality, it’s a guaranteed loser. Remember this – if you buy a loser the agent still makes his money, it’s up to you to find the winners.
Human behavior flows from three main sources: desire, emotion, and knowledge. – Plato
Photo Credit: Images_of_Money