Trust in the numbers
I’m being conservative with my estimates and looking farther away to find deals that work. I typically need to have 20 percent to 25 percent equity in a property after renovation to make even a modest profit, whether I’m flipping or holding for rental. Those numbers are getting hard to hit in the D.C. market. I’m turning away a lot of deals that don’t make sense to me, and I haven’t done a flip in the D.C. market in more than a year.
My favorite investments right now are single-family and small multifamily income-producing properties in smaller towns where the rent-to-price ratio is much more attractive and prices are less volatile. For example, in the past two years, I have purchased more than a dozen single-family homes in southeastern North Carolina around some of the major military bases. The cash flow in these markets is excellent. I can usually get about $1,000 per month rent for every $100,000 I spend on buying and renovating the property. That’s more than double what I can typically get in the D.C. area, where you’re lucky to get $500 per month in rent for every $100,000 spent. Higher cash flow means greater security and greater ability to weather any market storms.
I also get instant equity in these properties by buying them at 60 percent to 70 percent of their value. That means after I buy a property, I can refinance it and pull out most of my and my investors’ money. That keeps liquid cash in my account. Cash is the most powerful asset in a tumultuous market, and having cash on hand means I’m in a position to capitalize on an opportunity.
If you can’t beat them, lend to them
It’s increasingly hard to hit the numbers I need to make a flip or development deal work in the D.C. market. I’ve seen what happens to investors who get over-leveraged and overly optimistic with their numbers. Flipping homes is an expensive business. If I don’t have at least 20 percent equity in a property after my expenses of buying, renovating and holding, then I’m probably not going to make any worthwhile profit. I could lose a lot of money, especially if market values decline. There are too many flippers cutting their target profit dangerously tight. I don’t want to compete with them in their race to financial loss, but I can lend money to them and make a profit. It’s much safer than doing the deal myself, it takes much less work and stress on my part, and I still make a valuable return for myself and my investors.
Say I’m looking at a home worth $500,000 after a renovation, and it needs $100,000 in work to be ready for the market. Before considering buying that home, I calculate a worthwhile purchase price like this: $500,000 minus $100,000 (20 percent of the after-repair value) minus $100,000 (renovation estimate) equals my acceptable purchase price of $300,000. It’s exceedingly hard to get that price now. But other investors are willing to pay $350,000 for that same home. I wouldn’t pay that much myself, but I’m willing to lend that money to a reputable project sponsor if the person brings a $50,000 down payment. Now I’m at the numbers I want to hit on a deal, and lending is far less work and risk for my investors and me. We give good rates to those who bring some cash to the deal, and that helps them function on their razor-thin margins.
I typically won’t lend more than about 65 percent of what the home is worth. We take a deed of trust on the property as any lender would, so our money is backed by a tangible asset if anything goes wrong. We’ve never had to, but we can take the property back, and I’m capable of getting the project finished if needed. An investment where I can make double-digit returns on my money and have it secured by a tangible asset is much better than a stock, in my opinion.
Raise capital to be ready for opportunities
There are going to be some great deals shaken loose by the uncertainty in the market. Market uncertainty is enough to start shutting off the cash spigots, and you can already see many lenders have greatly restricted their lending criteria. The best deals become available when the lending activity slows down, so I’m working to be ready. I’m networking to meet more accredited investors and creating another fund to raise money. I’m hitting the phones and sending emails to stay close to my current investors.
I feel positive about the future. I’m sticking to the fundamentals and doing safe deals, and my priority is security and liquidity. I’m not exposed to a major market correction, but I’m also not sitting on the sidelines and missing the boat. More than what the overall market is doing, what matters is the specific deals you choose to close and if you’re willing to work hard enough to find the deals that make sense.
Justin Pierce is a real estate investor and real estate agent who regularly writes about his experiences buying, renovating and selling houses in the Washington area.