ANALYZING A DEAL
I made the mistake when I first started out of thinking that every distressed house was a good deal if I could get it under contract for a good price. That could not have been the furthest from the truth. Knowing how to pick a good deal is key to making money in real estate investing.
There are 3 major factors that go into deciding whether a property is a good deal or not. They are Area, Repair Costs, and Price.
Many seasoned investors will tell you the rule of thumb in finding investment properties is to look for the worst houses in the best neighborhoods. That might work for some, especially for fix and flippers, but for wholesaling, my best deals have come from working class neighborhoods (which some consider “lower middle class”) and “the hood”. When I say “the hood”, I don’t mean the worst of the worst neighborhoods. You want to stay away from those areas. But look for areas that are relatively safe but are high rental areas. Those are the areas that YOUR buyers, if they are investors, would be interested in.
This is where a lot of wholesalers get caught up. In order to negotiate the right price for a property, you have to be able to estimate the costs of repairs that will be needed to make it ‘rentable’ or bring it up to market value. If it’s minor repairs, it shouldn’t be that difficult to figure out, but if it’s major repairs, and you don’t know a lot about repairs, you might want to call in an expert.
You can call a contractor and tell them you are considering buying a house and would like a free estimate on what they would charge to repair it (which is “technically” true). Most contractors don’t mind giving free bids if they think they might get the work. If you tell them you are a wholesaler and just the middle guy wanting an estimate, you will probably have to pay for it, if they do it at all. If you feel strange about it, once you find a Buyer you can always turn them on to the Contractor that gave you the bid.
If you still don’t feel comfortable doing it that way, then a `quick quote’ way of doing it (but definitely not the most accurate) is to find out the square footage of the house from the tax records or Owner and multiply that by $9-$13 a square ft for minor repairs and $25-$30 for major repairs. That should give you a ballpark average.
There are also books you can read on repair costs like J. Scott’s book, The Book on Estimating Rehab Costs you can get on Amazon. The bottom line is you will have to develop basic knowledge of estimating repairs if you want to make good deals in real estate.
The actual formula many Investors use in determining an offer is:
ARV x 70% – Repair Costs – Assignment fee = Max offer
The reason you start with After Repair Value times 70% is because ideally, the investor would like to have at least a 20-30% profit margin left once repairs and all other costs have been subtracted. As in all things in real estate, this is negotiable depending on the deal. In the case study below, I will break it down further so that it makes sense.