I get asked this question probably more than any other. People watch the Gaines family on HGTV and think it looks easy enough if you have a little know-how and are willing to work hard. They’ve saved up enough money to begin and have started looking at properties, unsure when to buy. If this is you, do not buy a property before you read this!
You make money when you buy, not when you sell. If you buy it right, you can guarantee money in the bank. Things will go wrong. Always. Except when? Never. So, we figure that right into the mix and buy accordingly. We also figure in holding costs, delays, contractors not being reliable and extras that will come up. Otherwise you will be paying for the job of rehabbing and not making any money, just praying to break even. These are the things you must consider when buying:
- Location - Is this a neighborhood where people want to live? Is it safe? Are there a lot of houses with bars on the windows or businesses nearby with extra security? Are there shoes over the power lines? (a sign of drug trafficking). If you’re unsure but there are other investors buying and fixing up properties in this area, this is a good sign of an up and coming neighborhood. If it is a neighborhood that feels safe (I recommend also driving by at night) it is probably a good neighborhood to rehab in. It is important to remember that it doesn’t have to be a place where you’d want to live – only that someone wants to live. We are not judging the property by your standards but through the eyes of a young family who is just starting out. They’re not looking for your house, just a nice, safe, place to live. If you can, buy the ugliest house in a decent neighborhood and by making it the prettiest house, you will greatly increase its value.
- Be brutal with your numbers - MAO is a term coined by my mentor Ron Legrand which means maximum allowable offer. Almost every seasoned investor I know now uses this formula. You cannot afford to fall in love with a house or to get your emotions involved. It’s a business transaction. When you’re offering to buy an ugly house that needs work or even a house that needs a lot of updates, you need to buy it right. This is where MAO comes in. You’ll want to figure out the very most you can get for the house if you sell it with a realtor and it’s the prettiest house on the block. Once you have that number (don’t exaggerate but be realistic) you’ll want to make an offer of 70% of that value minus the amount of repairs needed. So, if a house would be worth 200,000 all fixed up and needs 30,000 in repairs, you’re going to make an offer of 110,000. Also don’t overestimate the amount of repairs. This may seem low to you, but you are going to have to hold the property, probably pay realtor commissions, have fees on the money you’re borrowing and closing costs. If you do it your way and just wing it, you will be taking, what we in the business call, a seminar. A long, painful, scary seminar where you’re praying just to break even.
- Finding money is easy – If you have followed rule #2 and have found the property for the right price, finding a hard money lender or private investor is easy. This is a safe investment for them as it is backed by real estate – they either get their money back from you or get the property. It is a win-win for them.
- Be realistic about the work needed. Do you know who will do the repairs needed on the property? Do you have someone reliable? If it’s you then I say your good to go. If it’s a contractor, (I don’t care how well you know them) do not pay them up front. Give them a draw like your hard money lender will give you. If you’re doing the repairs, consider the house in the type and quality of upgrades you’re putting in. If you’re putting in hard wood floors and marble countertops in a 100,000 house you may just price the very people wanting to buy out of your home and eat your profits to boot. Generic colors with contrasting white trim and a nice clean kitchen and bathrooms with fresh paint and flooring goes a long way to selling a lower end home in a neighborhood where people want to live. On the other hand, on an upper end house do not cheap out. You want to make your home the nicest home on the block for top dollar when you’re selling. You’ll want to keep in mind the individual home – not your personal preferences - and factor it all in to your estimate of the repairs needed before reaching your MAO.
- Lastly, do not buy from a tax sale or at an auction – If you hear nothing else I say, please hear this! This is not for a beginner. Do not buy from any kind of auction until you have some experience under your belt and know how to research the title and hidden pitfalls that may be there. We all have stories of first-time investors losing their life savings at one of these events because they didn’t know the pitfalls. Especially in the DFW area, people tend to pay more for the houses at auction and tax sales than they’re worth. I’ve seen it time and time again. The auctioneer starts out at a too-low price to get the investors there and then their competitive nature kicks in and they want to win. Meanwhile, they’ve won a mess!