Yesterday on the radio with Richard and Jo on AM 600 WREC we talked about what makes a real estate deal. How do you, as a real estate investor, determine what your asking price for a property should be to ensure that you get a good deal? In case you missed the show or were not able to listen, I wanted to jot down some our thoughts for you here.
First, let me start off by saying that any real estate deal is made when you buy, not when you sell. Selling is simply a part of your real estate investing strategy. There are three basic strategies to real estate investing. One strategy is to get a property to retail to a retail buyer. The second is to wholesale to another investor. The third strategy and my favorite is to buy and hold in your landlord portfolio.
The numbers for all there strategies have to be backed into. In other words, there are several other pieces of information you need to know before you know if you have a deal. Let’s look at a retail deal first, then wholesale deals and next time I will write about buy and hold deals.
A retail deal’s most important number is the current market value for the property. What would the property sell for to a retail buyer in today’s market? To determine this number you need to examine the most recent sales comparables, or comps, of other similar properties that have sold in the last three months. Look for the average sales price for square foot and then do the math to determine a retail sales price for the property you are interested in.
If for example after examining the comps you find that a property’s retail value is $200,000 you can then begin backing in to your price. First subtract the amount needed for any repairs or upgrades. Was the property last renovated in 1985? Does it have the dual bathroom sink everyone wants now days? Is the kitchen clean, modern and functional? Was it beat up during the foreclosure process? Is the property neatly landscaped? The answers to these types of questions will of course determine the repairs needed. For the sake of our example here let’s say the property needs $20,000 worth of work.
Next, you need to subtract your holding costs. Once you acquire a property, only in exceptionally rare circumstances will you be able to immediately turn the property over to a retail buyer. So there will be holding costs such as paying for the utilities while renovations are completed, keeping the grass cut, paying the property taxes and insurance. You will also likely have to pay real estate commissions and some closing costs. A quick rule of thumb to use here is to figure on about 10% of your sales price going to these holding costs. So deduct another $20,000 from our example.
Finally, and this is the good part, you need to deduct your profit. You are not doing this for free are you? I did not think so. In any deal you should make at least $10,000 or 10% of the retail sales price, whichever is higher. There is risk in taking on a retail project. All sorts of thing can happen from the property not selling to vandalism. You need to make sure you are compensated. And the bigger the deal, the bigger the compensation should be. So for our example let’s take 10% or $20,000.
So what is the deal in our example here? That $200,000 retail property is a deal if purchased for no more than $140,000. Hopefully it is easy to see how I got to that number now by taking the retail sales price of $200,000 and subtracting $20,000 worth of repairs, $20,000 of holding costs and $20,000 profit.
A wholesale deal is similar except you are planning to quickly resell the property to another real estate investor. The difference being the investor may want to retail the property or buy and hold the property. So you need to know what your investor’s strategy is to be able to provide them with a good deal and make a profit for yourself.
Here again you need to figure out the after repaired value (ARV) or retail value using the latest comps available. If your investor buyer plans to retail the property the most you can pay for it is 60% of the ARV, less any repairs needed and less your profit which should be $5,000 to $10,000. You can take less profit here than in the retail deal above because you are in and out of the deal quickly and there is therefore less risk.
So if you find a property with an ARV of $100,000 that needs repairs of $10,000 the most you can pay for the property is $40,000 to $45,000. That is 60% of $100,000 or $60,000 less $10,000 for repairs less $5,000 to $10,000 profit.
If your investor buyer is looking for properties to buy and hold, a quick method to determine your base price is to multiply the gross monthly rent and then divide by two. So if a property generates $800 per month in gross rents. The base price works out to $800 multiplied by 100 or $80,000 which is then divided by 2 for a base price of $40,000. Then you can subtract your profit for your offer price.
Why you may ask would anyone take such deep discounts for their properties? Well there are many reasons. People go through various stages in life, they get married, have kids, move, get divorced, pass away, etc. These stages create opportunity because people may need to unload properties quick, not want to do necessary renovations or repairs, or just want to walk away. So don’t think that you are stealing anything, many times you are providing a valuable service and the seller is more than happy to have your offer in hand.
Next time, I’ll go over how to determine a good buy and hold deal. Until then, work smarter not harder.
