You’ve got $150,000 plus fix-up cash, and you’re rarin’ to go. You’re goal is to acquire a home to fix up, and without using debt. Problem is, you’re in a $200,000+ market. What to do? Before we begin, the seller you’ll need to find will have to want income, and not have any debt on the property. Let’s get goin’.
How to Estimate Rehab Costs!
Estimating rehab costs accurately can make or break your real estate business, and it takes years of experience for even the best rehabbers to master the art. However, you can expose yourself to less risk and get more accurate with your projections by learning how the pros think when estimating construction costs.
Finding the Property
You locate a property in need of some fix-up. The seller will agree to a value of around $225,000 or so. They’re in their 60s and don’t mind the idea of considering a note as payment in full. The reason they’ll do this is cuz you’ve located a couple notes totaling that rough amount. It pays 10% interest, is fully amortized for 30 years, and has decent equity behind it, secured by a single family residence. So far, so good. When the seller realizes the income from these notes will far surpass anything he’d be able to negotiate on his own property, he perks up. After all, the monthly payments on the notes you’re offering add up to almost $2,000 monthly. (roughly $1,975) If he carried back a note on his property the most he’d get would likely be 6% — around $1,080 a month — barely over half of what you’re offering. He’d need 20% down in order to carry himself to feel secure. Therefore, not only would the amount of the note be less at the beginning, but the interest would be far less also.
A Scenario to Consider
You make the deal. But wait, there’s a fly in the ointment. Since you only paid $150,000 for the $225,000 note, you’d be makin’ a sizable profit IF you’re credited for a sales price of the same amount. Taxes would be owed, for sure. What to do? Here’s the way we’ve dealt with this problem over and over. The seller will very likely have no objections to lowering his sales price to $150,000. Why would he care? IF he was gonna be potentially liable for any gain, sellin’ for the reduced amount would lower that gain by $75,000. Also, it wouldn’t change the fact that he’s gettin’ a note with the face value of $225,000 and payments based upon that amount. He’s happy — and you’ve arranged to acquire a $225,000 home for your $150,000 in cash. But that’s only the first step, acquisition.
You then break out your fix-up cash and do your thing. When you’re done you have a couple options. You can choose to keep it and rent it out for the long haul, or sell it for the profit your hard work has earned. On the other hand . . .
Why Not Have Your Cake and Eat it Too?
Let’s say you now have a $300,000 home. (more or less as you prefer) It’ll rent for around $1,500 monthly. What if you put a new $175 ,000 loan against it — 4.5% for 30 years, fully amortized? Your monthly payments would be about $887 or so. You now have your acquisition and fix-up cash back. The loan is not even considered a taxable event. (Later you might hafta deal with what’s known as ‘loan over basis’, but probably not. In any case, it wouldn’t be a big deal.) You now have the option of keepin’ the house as your first long term investment property AND retaining the ability to begin the search for your next flip.
Will finding sellers willing to take a note be difficult? Oh, yeah. Can they be found? Absolutely, been there, done that, back in the day. The motivation for those kinda sellers haven’t changed. They know the place is beginning to fall apart. They want out, and they want income. But in the end, here’s why this strategy will work. They realize they can’t generate the income you’re bringin’ to the table with your note. Not even close. It’s incredibly appealing — and pardon the expression — a genuine win/win. In fact, though I don’t have time now, there’s a very simple way to structure this transaction during acquisition that will result in the seller being able to receive installment sale treatment. In other words, if it was a tax issue to him, installment sale status would allow him to pay taxes on any capital gain only as it was received in the monthly payments — NOT all at once as in a cash sale.
The seller gets much more income than he could’ve generated by carrying back 80% or less of the sales price. The interest would’ve been much less than the note you brought to the table. He has the option, if needed, of paying any capital gains taxes over a period of years, not all of it next April 15th. Again, he wins, you win.
Actually, you win twice cuz you now have the option to rinse ‘n repeat if that appeals to you.