Are You Planning Poorly or Positively Profiting on Your Deals?Posted on July 2, 2015 by
Calculating costs to purchase, fix and resell a house has always been a downfall for many Investors. At a recent Real Estate Investor Meeting, I heard a great explanation of how people come up with their numbers. You all need to be sure you don’t fudge your numbers and fool yourself into thinking you are going to make a profit. This Article focuses on all the things you must consider when purchasing a property, such as holding costs, cost of the money, and closing costs that you will incur on properties.
When a student contacts me on a property and says “This is a great deal,” I always ask “Why do you think so?” Their response is “because.” Well….”because” is not a good enough answer. This is how I analyze a deal. First, I look for the Sold comps in the same subdivision that have sold in the past 90 days. I will then look at a total of 6 months in that subdivision. I look at square footage, garages, bedrooms, bathrooms and pools. I then look for the Active, Active with Contract and Pendings which all affect the value of my property. I budget accordingly as if I am going to hold it for at least 4 months, which is required in order to sell to a retail buyer with FHA funding. Depending on the price point, about 80% of our buyers have FHA funding. I look at the Active, Active with Contract and Pendings and note what ‘type’ of listing they are. If they are short sales, I really give weight on these sales because it’s very possible they would not be bank-approved and could sell lower or higher than list price. If they are Pending sale which is a straight sale, I can assume that they are close to list price; however, until they sell, I can’t be sure. I will then look on MLS or REIFAX and search a half mile radius to see what other comparables I can find. Based on all the comps and the repairs in which I plan on doing, I will determine if I believe the value of the home will be close to the middle value of the comparables or the high value of the comparables.
EXAMPLE: All Comparables Range from $100,000 to $120,000 on the property – Safely you should take the middle value of $110,000 as your ARV – After Repaired Value.
I am going to give you examples of 1) when you are the buyer and 2) when you are the seller. Remember, every deal will have 2 transactions which each have its own set of closing costs even though it’s the same property.
When you are the BUYER, you can expect to pay 2% of the purchase price for your closing costs which include the closing costs charged by the title company. This figure should be added to the cost of your purchase. Obviously this is a high number, for the State of Florida taxes are paid in advance and you will receive a credit at closing. However, the standard of 2% for closing costs seems to work well when taxes are paid in arrears where you will be responsible to pay for them at closing.
So what formula do you use when you purchase a property?
ARV ($110,000) x 65% – Repair Costs = Maximum Allowable Offer – MAO
Example $110,000 x 65% = $71,500.00 – Repair Costs of $10,000 = $61,500.00
Obviously many Investors say “my house will be fixed up better than the rest so I can sell it for more, which allows me to sell it for $120,000, making the ARV and the MAO more.” I would recommend that you are conservative with your figures due to calculation errors on additional costs i.e. holding costs, repairs, cost of the money, contributions towards buyer closing costs, and of course…”the unexpected.”
When you are the SELLER, as a rule of thumb, depending on if taxes are paid in advance or in arrears, the average closing costs can be 8% to 9% that you would have to pay.
Example: $110,000 sales price – 8% closings costs (6% for realtors, title work, closing fee, title search, recording fees and tax proration) which would be $8,800.00. This amount needs to be subtracted from the sales price of $110,000 – $8,800 = $101,200.00. Please Note: We have not yet deducted from this amount the original purchase price, closing costs on purchase, cost of the money, repair costs, insurance, utilities, marketing fee, code violations, concessions towards buyers closing costs, homeowner association dues, a projected profit of $20,000.00 and taxes. You will definitely want to create a form which has all the above information on it so that you will be able to keep the numbers straight in order to make a profit on the home.
When you borrow money to buy, fix, hold and then resell the property, it is better that you obtain more than what you need, unless you are able to pay for unexpected items out of your own pocket. With our Purchase Price of $61,500 plus 2% for closing costs ($1,230.00) will be $62,730.00. Add $10,000.00 for repairs, then holding costs and then a miscellaneous number for overages. I would suggest on this transaction it would be $75,000.00
So… If you followed the above information here is how your deal will turn out…..
As the BUYER:
Purchase Price = $61,500 + 2% for closing costs = $62,730.00
Money Borrowed – $75,000.00 to cover cost of purchase, repairs and miscellaneous
Cost of Money – 2 Points of $75,000 = $1,500 plus 12% interest yearly ($750.00 mo for 4 mths = $3,000)
As the SELLER:
Rule of Thumb percentage of all the above costs = 8% of SALES Price = $8,800.00
Sales Price of $110,000 – 8% closing costs = $101,200 – $75,000 (cost of purchase, repair and misc), – 2 Points for money $1,500 – 4 months of monthly interest of $750.00 per month = $3,000 (2 points $1,500 = interest $3,000 = $4,500 plus money of $75,000 = $79,500.00) leaving the balance of $21,700.00 profit for you at closing.
Obviously, if you exceed your cost budget or sell it for more, all of these numbers change. I hope that you will apply this information immediately to a deal, as we all want to purchase real estate with BIG PROFITS! As such, we can always say that our house is worth more than the middle price range and convince ourselves; however, the buyer makes the decision on what they will pay for a house. If they only think it is worth $110,000, then that is the highest offer you will receive and you will need to close and Enjoy Your Paycheck!
Thank you so much to all of you who continue to send me your questions and topics that are most helpful for you to read about. Your Success is important to me, so let me know how I can help!!!