So, you think you’re ready to engage in real estate investments. You’ve worked up the extra capital you’ll need for holding costs and repairs, and/or have found a private investor who will help you finance a loan plus repairs. You have a basic guideline now with which to search for properties. REO and Foreclosures properties are likely going to be your mainstay. This is because lender-owned properties and homes in foreclosure are homes that typically sell for less than market value.
Defining Your Target for Real Estate Investments
You’ll need to do a bit of research in order to figure out what real estate investments will fit within your parameters to make the best profit from your investment. Immediately set aside a certain amount from your total capital (your loan plus any extra finances you have to spend on the venture) for closing costs, holding costs, and repairs. Make sure that when you set aside a certain amount for repairs that you do not end up buying a home that needs more repairs than you have bargained for. This is part of defining your target.
As a beginning example, let’s assume you have $250,000 to work with between your loan and your own capital. Let’s also assume you do not want to buy a home that needs more than $20,000 in repairs (including if you use a contractor to do the repairs for you). That leaves $230,000. Your closing costs and holding costs will vary depending on the value of the home you buy, but for a home in the $200,000 range, if the home sells quickly you’d be looking at around $20,000 for these costs. Remember too that you’d like to have a buffer in case anything goes wrong. This gives you a target of a home property that is currently being sold or auctioned in the $200,000 range (or even less) that would retail (after repairs) for more than $250,000. This is just an example, but basically what you are looking for is a home being sold at less than market value, in a good area, that can be fixed up and worth more than the loan you originally took out to buy it plus the extra expenses. The amount you make for each home will depend greatly on the current market, how long you are holding, and what you spend on fixing the home.
How do you define your target, other than by knowing you can spend ‘X’ amount on the actual acquisition of the home? There are several key things you need to research and evaluate before you buy:
- The wholesale or lender asking price
- The current sales rate/holding time in that area
- The current market value of homes in that area
The perfect home is one in need of some repair that is being sold for less than the market value because it both A) needs aforementioned repairs and B) is one the lender is trying to sell quickly. This is why you want comb through the REO and foreclosed properties in a given area. When you find an area where homes are being bought and sold in a reasonable time frame- say a few months only- and a lender is offering up a home for far less than the other homes in that area sell for, that’s your cue to start the offer process.
TIP: When you make your offer, make sure that you include a contingency that allows you to inspect the home. The repair estimation will give you a better idea as to whether or not you should lower your bid based on the costs of fixing the home up for resale. It will also be a good indicator to you as to whether or not you want to continue with the home buying process at all.
If homes in that neighborhood sell quickly for $200,000 and you can buy it for $170,000 (including closing costs and holding charges), but the repairs are going to cost $20,000, then you’re barely making more than even. More importantly, you’d stand to lose money if any of the aforementioned charges end up being more than you expect, or if you end up holding the property for longer than you intended to.
When it comes to investing in residential real estate, the more you know about the market, the better.