Do you get that paralyzing feeling when trying to analyze an investment property? This is a constant struggle with beginning investors as well as some experienced investors. Let’s discuss some of the reasons that cause this problem and the solutions to overcome them.
Most investors get “analysis paralysis” because they simply don’t have the proper tools or experience to understand all the elements in analyzing a good real estate deal. Here are some of the concerns and stumbling blocks to 4 of the most common problems investors face along with simple solutions.
Stumbling Block #1
Not knowing or being comfortable with the selling price after purchasing and renovation is completed. This is also known as the “After Repaired Value” or ARV for short.
Determining the ARV is a fairly simple process and definitely the most important. This is where you should spend most of your thinking time and efforts. One of the easiest ways to do this is to get a CMA or comparative market analysis or “comps” from your realtor. When a realtor gives you comps, they show you (notice I didn’t say “tell” you) what price other houses that are similar to the one you are looking at have sold for in the past 6 months.
Here again, notice I said “sold” and not what price houses are being “listed”. Listing prices are usually the initial pricing of sentimental home owners who think their house is worth that price. In today’s market, seldom is a house sold for the original listed price. Realtors have a constant struggle with many home owners concerning a realistic listing price. So don’t get caught up in what other houses are listed at. Be concerned with what price similar houses have recently sold for.
Another way to figure out ARV is to get an appraisal from a certified appraiser. Yes this costs money, but if everything else looks good about the deal and you are uncomfortable with the realtor’s comps, you can always get the opinion of another professional. They go more in-depth when appraising properties then realtors might. However I only trust the appraisal when I actually hired the appraiser. This way I know that I have given him/her the instructions on how I want the appraisal to be completed.
To better clarify this, I can influence an appraiser to appraise a $200,000 property for as much as $225,000 or as little as $175,000. That’s a pretty big swing. And in a tight deal that can cut into your profit margin substantially. I tell my appraisers not to give me any fluff, or what they think is happening in the market place. As Sergeant Joe Friday from the show “Dragnet” always said, “Just the facts ma’am.” So if the seller or savvy wholesaler gives you the appraisal, just keep in mind it could also be just another marketing brochure to sell the deal.
As much as I like appraisals, I must admit I love an experience realtor. They not only give you more comps than an appraiser, they know what’s going on in the neighborhood. They know what people are looking for in houses in their area. But here again, you must tell the realtor not to give you a number just to make you happy. You want a price that the house will sell for in a reasonable time period.
I feel most confident and get that warm and fuzzy feeling when my ARV is the result of the following situation. A knowledgeable real estate agent has done a complete market analysis or “comps” and then I’ve listened to what the agent has to say about the neighborhood. He or she tells me the type houses that are selling the quickest, what buyers are looking for and anything else that’s relevant and can be backed up with facts to help me feel comfortable in arriving at the ARV or After Repaired Value of the house.
And to top it off, I actually go and look at all the houses that the realtor used in doing the CMA. As the saying goes….seeing is believing. Nothing makes me more comfortable than actually seeing and comparing the houses that have sold to the house I’m thinking of buying. If my house will look the same or better, it’s a go!
Stumbling Block #2
Not knowing or being comfortable with the “Estimated Cost of Repairs”.
This is another biggie. One way to overcome this stumbling block is to take a contractor with you when you inspect the house. If you do this on a few houses, you will become very efficient at estimating the cost to repair many items such as putting on a new roof, installing siding, and replacing windows and doors. You will also become familiar with costs for painting, landscaping, clean outs, new furnaces and kitchen and bath updates.
Most of these items are on a “unit price” basis meaning putting in new replacement windows will cost anywhere from $175 to $200 per window. A new roof on an average size 3 bedroom ranch would cost approximately $5,000 to $7,000. A new gas furnace would cost approximately $4,500 to $6,000 installed. And siding on this same size house would be about $5,500 to $7,000.
You can also do some practice runs. Pick a few vacant houses that are on the Multiple Listing Service and take your contractor there to give you some prices. Another way is to use the same house and have different repair professionals come out and give you estimates. For example, have a roofer come over and give you a price for a new roof. Have a plumber check the heating system and give you a price on putting in a new one. Ask a siding company to quote you new vinyl siding. Have a painting contractor give you a price on scraping and painting the outside of the house and a price for painting the entire interior of the house.
After getting these prices on a few houses, you will be able to easily compare similar houses. Use the estimates from your contractor(s) as a guideline for determining repair costs on other houses. If you received an estimate for a new roof with ripping off the old roof on a 3 bedroom ranch for say $5,000 to $6,000, what do you think the cost for a new roof on another 3 bedroom ranch the same size as the one you received the estimate on would cost? Right, five or six thousand dollars!
This would be the same for the furnace, siding, painting, clean outs, steps, patios, pavers, driveways, etc. So you see how this is one way to get comfortable with estimating the costs to renovate houses?
This method will give you a better understanding of cost estimates and will help you determine if you should continue with the evaluation of the deal. Keep in mind that your final repair cost figures should come from two or three estimates from contractors before purchasing the house.
Stumbling Block #3
Not knowing how much repair is needed. What to do and not do.
This is more of a common sense answer than a text book answer. You should do only what the price range of the house warrants and not “over do” the renovations. By that I mean, fix the existing problems without trying to reconfigure the layout of the house. Yes, you can add closets, half baths, picture windows and new wood and tile floors. But be careful when contemplating small additions, dormers and moving bearing walls. This is where you can run into higher and sometimes unexpected costs that can blow your construction budget.
I would leave those renovations to the expert investors or the true contractor investors. Also, you usually only find investors doing these type renovations in the higher end homes and neighborhoods. This is because adding larger room additions and changing the original layout of the house can be recouped with the higher selling prices. And even at that, you will usually only find these being done in pricier neighborhoods.
So basically, just fix it up nicely and add a lot of inexpensive (not cheap) features such as “goose neck” kitchen faucets, (high arch faucets to allow tall pots to fit underneath) two toned bathroom faucets, nice shower heads, solid front door handles, decorative interior door knobs, ceiling moldings in living and dining rooms, refinished wood floors, garden windows over kitchen sinks, tile floors, and nice landscaping in the front of the house. If you can patch the walls instead of gutting the whole room, you will save a lot of money. Spend the extra dollars in getting a good drywall installer to make the patched walls look like new.
Throw in a new washer and dryer, refrigerator, new stove, microwave and always add a dishwasher if you can. The house doesn’t have central air? It’s not in the budget? How about buying a 15,000 or 18,000 BTU air conditioner and putting it in to cool the house?
Look at it this way. How would you like the house to look if you were buying it? Well guess what? It’s probably the same thing everyone else would want. So use some common sense and put yourself in the buyer’s shoes. Renovate the house within your budget while making it appealing to the buyer.
Stumbling Block #4
Figuring our all the costs and a good profit for yourself.
This is another common mistake beginners make. Not allowing for all the expenses and costs involved. Sometime we forget some important things. Sure we know we need to include the purchase price and the renovation costs. But what about other costs and expenses such as, closing costs including legal fees, title insurance, property insurance, real estate taxes, and realty transfer tax when selling the house.
And don’t forget your basic holding costs. Holding costs are the gas and electric you use during the time you own the house along with any finance charges if you have any loans. Also don’t forget the real estate commission you need to deduct from your selling price. And last, what about your profit? You must figure in your profit just like it was any other expense. If you are planning to make $25,000 or $50,000, you must include it with your estimate. After all, who is more important than you!