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What Determines Price You Pay For Investment Property?
The comparable sales in a one-mile area around the property will be the ones you want to be looking at. This is a general rule. There are many areas where you have do comparable sales block-by-block, or street-by-street. A comparable sale would be a similar property that has sold in the last six months compared to the one you are buying. For example, if you were going to buy a 1000 square foot, 3 bedroom house, brick, with attached 2 car garage, and full basement, you would want to look for similar properties in that one mile radius or closer, in some cases. If you are looking at a house that differs in size, square footage, bedrooms you will need to make adjustment in pricing to have a comparable to the target property. For example if the target property has a 3 bedroom house with basement, and you are using a comparable 3 bedroom house with no basement, you might have put a downward adjustment factor of $10,000 to compensate for the missing basement in order to get a real value of the comparable sale. You need to look at the amount of time the house was on the market (the number of days it took to sell the house). You don’t want to be basing your buy on a house that was on the market for long periods of time. If you use comparable sales that all took 10 months to sell and you are looking to buy the house, fix it up and sell it in 3 months, you sure don’t want to use these houses as “comps” that took 10 months to sell. So we now know how to determine what the house we are looking at would sell for.
I am going to suggest that if you are getting into this business to be a landlord that you treat your rental business as if it were the business of finding, fixing, and reselling. I say this because most landlords will be selling at some point in time. So don’t just look at buying houses based on cash flow, or tax benefits. You need to look at it from the point of view that if you were to get sick tomorrow could you resell the property at a profit.
Let’s talk about profit, after all this is a business and that is what you are after. So what is the profit you want to make in this business? That’s right; profit is where you want to start! Let’s assume that I am looking at houses that sell in 3-month period for $60,000. Let’s say we are looking at a house that needs a new kitchen, paint and carpet. If all those repairs were done, the house would sell most likely for $60,000.00 in three months based on comparable sales. So another way to say this would be that the after repair value of the home would be $60,000.00. Some nonconforming lenders and HUD 203-k mortgages use what is called a “subject to appraisal” (which is another way of saying the after repair market price). So we have a minimum profit goal for this $60,000.00 after market value home of $12,000.00.
So we now build the model to determine what the maximum $ we want to pay for the house we found are. You now have to start adding in your cost? The costs you need to add up are as follows:
a. Your time - What is your time worth? How much time are you personally going to be spending on the buy, rehab and etc? Put a dollar figure to your time.
b. How much is the rehab going to cost? I have seen a lot of people in this business that are very experienced. The majority of them will tell you that their rehabilitation cost will run 1 ½ more than they expected or estimated. It’s a must to build in cost over runs. If you are a new investor take your estimated cost and double them for figuring your rehab.
c. What is cost of your holding time? You need to look at how long you think it will take you to rehab the property. If you think it will take you 3 months to fix the property up – double the time to 6 months when doing the financial analysis. If comparable sales show 3-month selling time – double that time and cost. So if your property insurance, lights, gas, gas cutting, house cleaning, alarm system, mortgage payment are running you $800 month you need to take that cost times 12 months since we have double our 3 month rehabilitation time, and double our 3 month expected selling time.
d. What kind of reserves for breakdowns have you figured in? I once had a partner in the rehab of a house where he put up the money for rehab up as his contribution. I chose a contractor (this one actually had been with me for awhile and did good work) and purchased the supplies. The contractor kept giving me updates but coming up with problems that needed more money to handle. The reality was that the contractor had actually returned for a refund all the supplies or sold them and took off to parts unknown after going through all the allotted money my investor had supplied for the rehab.
Or this one---my partner researched the property at the city but “Oops, I don’t know why the condemnation notice wasn’t in the file but it is condemned and now requires a city team inspection which quadruples the cost. In addition, we are now on our third contractor—each of which requires money up front to get started.
Or, you are almost done with the rehab and someone breaks in and steals all the Kitchen cabinets, the furnace, or all the siding off the house. At one point in my life I found out that rival contractors that I hired were breaking into each other’s jobs and stealing everything. (Not a good idea to have them all meeting on one day of the week to collect their checks—it gives them opportunities to know their rival’s business.)
Or, oops, I am sorry the city water department read the wrong meter reading and you house is the one that had water flowing for a year because of squatters and you owe $3,000.00.
Oops, that wall in the basement that just needs to be straightened out and supported is actually crumbling from a chronic water problem and you will have to dig a new basement. What if, half way through the rehab you find out you have a problem that requires you to “quiet the title” to make it clean and sellable?
e. Don’t forget you might have mortgage costs for the buy and sell. You will also have other closing cost like commissions to realtors, title insurance, title fees and recording fees. All these need to be figured in your cost on the buy.
f. Don’t fool your self into thinking you will be able to buy fix and sell a house in 6 months. Base your buy on cost over runs! If you do bring your project in on budget then you are going to be smiling.
OUR EXAMPLE OF SETTING MINIMUM BUY PRICE: $60,000.00
Real estate commissions based 6% (3,600.00)
closing cost seller pay 6% allowable closing
subject to appraisal (after repaired value)
project profit (12,000.00)
cost for buyer, (title insurance, recording fees etc) ( 4,800.00)
Cost of mortgage on buy (appraisal, mortgage cost) (4,600.00)
use 12 months (taxes, gas, electric, grass, mortgage payments) ( 9,600.00)
Rehabilitation cost – est. $7,000.00 (Double cost) (14,000.00)
price you purchase property for: (11,400.00) 60,000.00
This may appear as extreme example of cost over runs. I have doubled your cost and assumed that you had a realtor sell the house. I am clear as a person who has seen a lot of people come and go in this business, you need to figure your cost high and you need to be able to do your own comps (comparable sales) I recommend that people get real estate license. Why? Because the advantage is that it will give you access to MLS (listing service), which will give access to sales reported to the MLS. More importantly, it will train you to be a knowledgeable buyer and know first hand what is required to have your real estate transactions comply with federal, state, and municipal restrictions. Plus, you will learn what is necessary to have the transaction be complete and within integrity guidelines. In addition, you will be putting you license with a broker who will be there to train you while doing your beginning deals. It requires 40 hours of classroom on Michigan real estate, plus passing a test to get your license---even if you don’t end up getting your license. The knowledge you get in these training courses is invaluable.
I prefer to work with licensed investors, especially with challenged properties, because it assures me that the person you are working with has at least a basic level of knowledge of Real Estate. The more knowledgeable a person is, the more likely they are to achieve their goal. In fact some of the investors that have worked with me generally end up getting their license and sometimes even become licensed under the same broker I am. There are many reputable real estate schools.
If you are not a realtor and you are looking for comparables, you can go on to your Internet server and look under real estate, there will be comparable sell section you can use.
Ralph Marcus Maupin, Jr. (Mark Maupin), Speaker, Professor, Co-founder National Real Estate Network LLC (REIA), Get Free Real Estate Forms, Terms, Articles and Real Estate Club Locations at: http://MegaEveningEvent.com