I’m seeing more and more real estate investors entering this market at what I believe is a very tenuous time. Many of these investors are less experienced and they have heard the siren call of the real estate gurus with their seminars and late night infomercials.
These newer and less experienced investors are often less knowledgeable about home values and construction costs. Their lack of understanding about the market makes them easy prey for a real estate agent or wholesaler who may be trying to move a deal. They’re easily convinced that a home is worth far more than it really is and that it will cost far less than is realistic to fix up. With the misperception that home values are still racing upward, this new investor is even easier to trick.
One can hardly get through a day without hearing and or seeing ads from real estate gurus selling their “money making” systems for real estate investing. They’re offering courses and mentorships. They can easily get $10,000 out of a new aspiring real estate investor. But that is cheap compared to the potential losses one could incur by being led into a false sense of optimism and subsequent bad investments.
I regularly receive home leads from other investors. The numbers they state are often way off base. It’s particularly scary when I see it coming from a couple of the local bigger players that have a following of students. It seems like the modus operandi is for these guys to keep all of the really good deals they get and then pass off the marginal deals to their students for a finder’s fee.
The typical advertisement will look like this:
This home is worth $300,000 after $30,000 of fix up. We’re looking for a cash price of $200,000. THAT’S A $70,000 SPREAD.
Looking at the deal, I’ll find that the recent comparable sales are ranging from $250,000 to $300,000 and that the home is more likely worth $275,000. I rarely spend less than $50,000 on a home remodel. Looking at a deal like this I’ll often find that the repair budget needs to be at least $10,000 higher if not nearly double in many cases. And they always leave out your buying, selling and holding costs. Most people will pay 5 to 6 percent for a real estate agent to sell the home. On a $275,000 sale, I’d project a total of about $27,500 in just buying and selling costs.
So a more realistic advertisement of this deal would be:
This home is worth $275,000 after $40,000 of fix up and $27,500 in transfer costs. We’re looking for a cash offer of $200,000. That’s a spread of $7,500 and you better hope you’re right about your sales price and fix up costs.
And this scenario doesn’t even take into account capital costs. Most investors, especially new ones, use private lenders whose rates are usually between 12 and 16 percent with four to eight points up front. If the investor borrows 80 percent of the project’s estimated budget at 12 percent and four points then his or her capital costs would likely be in excess of $19,200 and with those costs added in the project becomes a $12,000 net loss to the investor not counting any value for the investors time, effort and suffering.
I remember walking into a home that a new investor was renovating. It was in an area where the homes were selling for $250,000 to $275,000 remodeled. The investor had removed all of the roof trusses above the kitchen and family room making a massive open great room with a vaulted ceiling and a soaring stone chimney that climbed all the way to the peak of the lofty ceiling. It was beautiful. The investor told me he was going to sell this little home for around $380,000.
That home just recently sold for around the $275,000. I don’t know exactly how the investor came out on that one but I’m pretty certain he took a pretty big ding.
There is still a lot of opportunity to find good deals in this market. If you’re considering buying or selling a home or if you are finally thinking about taking that first shot at real estate investing you need to do a little homework. Home buying or selling is an emotional process but you can’t let it be all emotion. If you buy or sell your next property based on a good foundation of market research and financial calculations, your emotional well-being will benefit in the long run.
Be aware of the realities of the current market conditions. Don’t buy based on fear or unfounded optimism. The home of your dreams could become a nightmare and cause serious damage to your financial well-being and your family’s sense of security.
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