If you’ve spent much time around people who invest in Real Estate you know they all have their favorite rules. In Investment Club meetings, online chat rooms, even at the corner coffee shop, you catch snippets of conversations including phrases like,
?Location, location, location,?
?Buy low, sell high,?
?Invest in what you know,?
and many others.
While these are all important, in my experience (and that of many other seasoned investors) there is one rule that, if followed consistently, will save you from almost all of the potential pitfalls investors commonly encounter. What is this pearl of wisdom?
Simply this: YOU MAKE YOUR MONEY WHEN YOU BUY.
?What?s that,? you say? ?Everybody knows you make your money when you sell.?
?Not so fast,? I reply.
Think very carefully through what I?m about to say. Etch it into your mind and heart. Follow it faithfully and you will come close to guaranteeing your investing success. Forget it at your peril.
YOU MAKE YOUR MONEY WHEN YOU BUY. Very simply, this means that your profit is literally created at the time you purchase a property, through the price you choose to pay and the terms you negotiate in your purchase offer. There is no other time in the life cycle of an investment when you will exercise such tremendous control over your potential profit.
There is no other time when you can come so close to guaranteeing your success, and also no time when you can virtually guarantee your failure.
Buy right, for the right price and terms, and you will be able to weather virtually any unforeseen or unknown defect in the property. Sure, some of your profit may be eaten up correcting the problems, but there will still be something left for you- something to allow you to move on to your next project.
Buy wrong, spending too much on the property, and even if you do everything else right you will be hard-pressed to make money.
This Rule Almost Makes The Others Obsolete
Even if you?ve broken most or all of the other so-called ?rules? of Real Estate investing, if you follow this one magic rule, you can emerge victorious, a little wiser but unscathed by crippling losses. Let me illustrate.
Recently I purchased a single family home, and in so doing I broke many of my own rules. I bought a house nearly an hour from my home, I bought a house for the wrong reasons (I really, really liked it), and I bought a high end house in a low end neighborhood (a classic no-no). I also bought it without having a clearly defined exit strategy (another classic blunder). I just knew I could do something with this house.
Additionally the house had one of the most investor-unfriendly features I have ever had the misery to run across- an indoor swimming pool. When I wasn?t busy finding and repairing leaks in the liner, I was struggling to refill the pool using the property?s seriously overtaxed well, which I had to keep waiting for to recover. I still have nightmares about it.
This house took me three times longer to sell than I first imagined, and holding costs were eating me alive.
But? I owned this house right because I had bought it for the right price. I had foreseen that this house, with all it?s beauty and features, could also be a very difficult house to rehab, hold, and sell. Based on that, I structured my offer with plenty of room, which is a good thing, because much of that ?room? was eaten up before I was finally able to sell.
Much, but not all.
Why was I able to withstand all of those expensive problems and still walk away with a tidy profit, and some hard-won wisdom? Because I recognized and applied the first and most important rule of Real Estate investing- YOU MAKE YOUR MONEY WHEN YOU BUY.
I believe that if you will etch this principle forever in your mind, and think of it always when making your offers, you will safeguard yourself from almost all potential investing disasters (acts of God excluded).
Two Things You Must Know
To put this principle into practice, you absolutely must acquire knowledge in two key areas- market values and repair costs. While each of these is worth an article on it?s own, I will cover them briefly here.
First, market values. You must thoroughly understand the market values in the neighborhood where the property is located, so that you can project an accurate After Repair Market Value (ARMV). In other words, how much will this property sell for after all needed repairs and upgrades have been completed. While it is beyond the scope of this article to cover market value in-depth, I will simply note that the one best way to determine the ARMV of a residential property is to compare similar properties in the neighborhood which have sold recently (called comparables or ?comps?).
If you don?t know the values in the neighborhood, STOP! Don?t invest there until you have come to understand the values by looking at lots and lots of properties, and talking with Realtors and others who know the neighborhood. Then you can proceed from a position of strength, certain that you know what you are doing.
Second, repair costs.
Once you know the ARMV, you need to be able to work backwards to arrive at an offer that makes sense. To do this, you must know what any needed repairs and upgrades will cost you. You don?t need to know to the penny, but you must come reasonably close, and you can only learn to do this with experience. If you don?t have this experience, and you?re not an expert, hire one.
You will need to befriend a contractor you trust, or partner with one on a few deals. Either way, let someone who knows this stuff bring you up to speed. Get a contractor on your team.
It shouldn?t take you more than a few deals before you can walk into a home in a neighborhood you?re familiar with and, after spending no more than 10 minutes or so, know what it will cost to repair and what it will sell for after you repair it. Knowing you can do that equates to freedom and power.
How To Structure Your Offers
Armed with that kind of specialized knowledge, you will be able to confidently structure offers that others can?t, because they just don?t know what you know. Once I have this knowledge (ARMV and repair costs) I use a very simple formula to structure almost all of my offers on residential rehabs. Feel free to use this formula for your offers.
ARMV ? Repair Costs ? 30% = My Offer
Here?s an illustration. I recently looked at a single family, split level foreclosure in a middle class neighborhood I am very familiar with. Knowing the values for similar homes in that neighborhood were around $90,000, I next walked through the house and estimated repair costs to be about $12000. Here?s how I structured my offer:
ARMV ($90,000) ? Repair Costs ($12,000) = $78,000
$78,000 ? 30% ($23,400) = My Offer ($54,600)
Did it matter to me that the asking price of the house was $84,000? Not in the least. My offer (and therefore my profit) has absolutely nothing to do with how much the sellers are asking, or how much someone else might offer. My offers are based on my specialized knowledge of market values and repair costs.
If someone else wants to offer more, that?s fine by me. Their circumstances might be much different than mine. Perhaps they are going to live in the house while they repair it. Maybe they are ignorant of market values or repair costs, or both. It doesn?t matter. I won?t let their mistakes become mine, and you shouldn?t either. There are plenty of houses out there.
You?ll get plenty of offers accepted, because you know what most others don?t. You know that- YOU MAKE YOUR MONEY WHEN YOU BUY.
Now, go make more offers!
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You are welcome to share this report, unedited and in its entirety, with anyone you like. You may not remove this text. ? 2006 by Tom Dunn