Here’s an example of a call that I got last week. A newbie investor and called with a scenario that he wanted me to finance. He told me that he had a property under contract for $50,000 and wanted to put $30,000 worth of work into it. I asked what he thought he could sell it for once completed and he told me that he could sell it for $100,000. Before I could say a word, he told me how great the deal was and that he would make $20,000 profit. I asked him if he had figured out closing and carrying costs. The answer was no. I explained to him that after the realtors costs, transfer tax, title, appraisal, carrying costs, etc. He probably wasn’t going to make anything and the deal wasn’t so good after all. Then he said something to me that really threw be for a loop. He said “Well, I’ll just sell it for $120,000 then!” After my shock slowly wore off, I realized that he has missed Real Estate Investing 101. He was very sincere and believed what he was telling me, but he just didn’t get it… so I started from the beginning.
There are three major elements to making money flipping properties:
1. The buy
2. The work
3. The sale
That’s basically it. There is always financing costs and turn around time, but they’re minor compared to the big three.
Let’s spend a little more time going over the “big 3” and what we can control. Let’s start backwards:
3. The sale – Chances are the property is going to sell for what other comparable properties have sold for in the neighborhood. The quality of work has an impact on the sales price, but only to a certain point. If the nicest houses in neighborhood sell for 200,000, then no matter how nice we make out property it’s not going to sell for too much more. We can install platinum toilets, but they’re probably not going to yield that much higher of a sales price. Anything that far above and beyond is called “over improving” and will get you very little in terms of extra dollars at closing. The sale pretty much is what it is and we can’t have that much of a positive effect on it no matter how good of a job we do. (Yes, we can have a negative affect on it, if we do a shoddy job) Back to our example, a property isn’t going to sell for $120,000 when other comparables are selling for $100,000 just because we could use the extra money.
2. The work - Just like the sale, the work is going to cost what it costs. Yes we can do a job better or worse or put in those extras that make the house a little nicer (granite counter tops, hardwood floors, etc). There is also a decent variation if we use a general contractor or sub-contractors. The cost of contractors will improve as you grow and get more experience. For the average investor who does not have their own construction crew, you generally get what you pay for. Cutting corners on the work is only going to hurt yourself when you go to sell the property.
1. The buy – This is the only major element that we can have a huge impact on. We have little effect on the sale (aside from the quality of construction). Unless you’re a major investor or can do the work yourself, we have little effect on the work. (The more we cut corners, will catch up with us when we close). The purchase price is something and the only thing that we have complete control of.
Just like this article…. When looking at properties, work backwards.
1. First figure out median values in the neighborhood.
2. Then figure out the cost of work it would take to bring this property up to par.
3. Then after subtracting out the work, your closing and carrying costs, and your desired property, you’ll reach the maximum price that you’re willing to pay for that property.
(Or you can use the simple formula of being into a property for no more than 65% of the After Repaired Value) When you’re out there looking, just remember to work backwards and that your profit is made when you buy the house.
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