We speak to many investors looking to purchase real estate investment properties. Some are seasoned professionals and some are new to real estate.
The number one priority of any real estate business is finding good deals. Yes, it is important to build your list of buyers so you can sell the properties you buy quickly. But you won’t stay in business for long without offers to sell to your list of buyers.
When you get to the bottom of it, evaluating a real estate investment deal is really a simple process. No matter what your exit strategy is (wholesale, buy-and-hold, or fix-and-trade), buying your investment property correctly is critical. Let’s take a look at the process of evaluating a real estate investment deal.
How to Evaluate a Single Family Home
Let’s look at the main elements to consider when evaluating a real estate investment deal.
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Cost of repairs to bring the condition of the house up to or slightly above neighborhood standards
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The value after repair, or ARV of the property, after repairing it
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If you’re going to buy and hold (either as a lease or rent-to-own), you’ll need the costs associated with this exit strategy. Considerations include mortgage payment, property insurance, and taxes, just to name a few.
These are the top three items to consider, though there are others to consider as well (realtor fees, whether you’re selling at retail, utility costs, etc.).
Cost of repairs
One of the most important skills to get good at is estimating repairs. If you don’t want to take the time to learn the process, make sure you get a good contractor as a member of your team. Nothing will screw up a deal faster than estimating repair costs incorrectly. Getting a couple of estimates would be even better.
After Repair Market Value (ARV)
The easiest way to get home value after repair is to ask a real estate agent to sell properties that are comparable to the property you are considering. The variables you use when having your real estate agent get comparable properties sold are VERY important.
The value of a comparable property sold is directly related to its relevance to the property in question. Comparable properties sold must be within one-half mile of the subject property, but not more than one mile. There may be times, such as rural properties, where this is not possible. The age of comparable properties sold must be within the last 90-180 days, if possible. Due to the volatility of the current market, any age may not be an accurate reflection of the current value of homes. You’ll also want to use comparable properties that are +/- 20% of the size of the property in question.
Finally, you’ll want to compare apples to apples. Do not use properties that were sold as bank property or as a short sale as comparable properties. These properties are “distressed” properties that often sell for an average of 25% to 30% of normal retail values.
If you don’t consider these variables when checking out your comparable sold properties, you will not be able to be a successful real estate investor. Make your offers too low because you are using bank and short sale properties as your offsets and you will never get an accepted offer.
Buy and Hold: Lease and Lease to Own
What if you want to buy your properties to keep them for rent? Or even rent with option to buy? There are a couple of other factors you’ll want to consider when evaluating a real estate investment deal. The main concern… will it be cash flow?
To determine this, you’ll need to know what the mortgage payment will be on the potential purchase. You will need to speak with a mortgage broker to determine this payment. Or maybe you use a private money lender. Simply enter your private lender’s rate and term into a simple amortization calculator to determine your monthly payment.
Next, you’ll want to determine how much the property will rent on a monthly basis. You can get this research in several ways. You can search craigslist.org for comparable properties. You can take a look at Zillow.com and use their Rent Zestimate. You can also talk to a real estate agent to get an idea.
Subtract the estimated monthly rent and monthly debt service and the property to determine if the property will have cash flow. You’ll also want to subtract other expenses like property taxes, insurance, and reserves for future repairs.
Calculating your offer price
The old formula, developed by Ron Legrand, is as follows:
ARV – Repairs X 70% = Maximum Allowable Offer (MAO)
This is a bit of a generalization. If your exit strategy is buy and hold and the property’s cash is flowing well, you may be more willing to deviate (go higher) from the 70% multiplier. However, if you are a wholesaler, you will want to buy below the 70% multiplier. As a wholesaler, you make money from the spread between the offer price and the MAO. A good rule of thumb is to be between 60% and 65% if you are a wholesaler.
Making and Offering
From here, just make the offer.
Just remember, the general rule of thumb in real estate is to never overpay for a property. That’s why you want your bid evaluation process to be so strict. Always keep your emotions out of this.
I hope this tutorial helps you put a few more dollars in your pocket the next time you’re evaluating a real estate investment deal.
