By LEX LEVINRAD – If you are a new real estate investor looking to learn more about investing in foreclosures, bank owned properties and short sales then it is imperative that you understand that distressed real estate is very different to investing in “retail” residential real estate.
The main difference is that investors have to pay cash to purchase distressed properties (no mortgages allowed). Another main difference is that in many cases if you are buying directly from the seller then you are purchasing a property from someone that is in foreclosure or behind on their payments.
Follow these 7 tips below when investing in distressed real estate:
Tip No. 1: Only Buy From Sellers That Have To Sell
You should only buy properties from desperate sellers that have to sell because they are in foreclosure or their property is damaged or there is some other pressing issue that makes them want to sell right away. This includes REO’s and short sales (banks have to sell), and pre-foreclosure (homeowner has to sell) but it could also include many other scenarios where someone wants to sell their house fast and get cash. Examples include, divorce, probate, disability, damage to the property and many other reasons.
The key thing is that your seller needs to sell now as opposed to wanting to sell if they get their price. Do not waste your time with people that want to sell or are thinking about selling. Those people can list their property with a real estate agent and have the luxury of time to wait for an offer to come in.
If you want to buy distressed real estate at bargain prices and get good deals then you need to buy only from distressed sellers that have to sell. The reason that they are forced to sell is because their property is damaged or they have some other reason that requires them to sell right away (foreclosure).
Tip No. 2: Advertise To Find Desperate Sellers
The whole world is looking for deals on the MLS. There are over 1 million real estate agents in the U.S looking for bargains online. Be original. Get the seller to come to you before the property is on the MLS. This means you need to advertise to find desperate sellers. If you want to get access to deals that no one else has then you will need to advertise and market to sellers that are facing foreclosure, behind on their payments or considering a short sale.
We have been doing this for the past 12 years and we have found that the three methods that work best for finding motivated sellers are bandit signs in the neighborhood, classified ads in the daily newspaper, and postcards or letters mailed to homeowners in foreclosure. If you are not marketing and advertising to desperate sellers then you will be restricted to bidding on properties that everyone else is bidding on (like properties on the MLS).
This can be very competitive and if you have tried to purchase an REO then you know how frustrating this can be. The one thing that separates beginners from professional real estate investors is the willingness to spend money to advertise to get desperate seller leads on a consistent basis.
Tip No. 3: Understand the ARV Formula
If you are investing in distressed real estate then please make sure you understand the After Repair Value Formula. Here it is:
After Repair Value (ARV) x 65%
– Less the Repair Estimate (RE)
= Your Maximum Offer Price (MOP)
MOP is the most you should pay to purchase the property.
Hard money lenders will loan based on this formula and if you are fixing and flipping properties then you should never buy a property for more than the Maximum Offer Price (MOP). This formula is the basis of wholesale real estate. Make sure that you understand it because if you are wholesaling properties and selling them to other investors then the investors that are buying from you will be paying attention to this formula.
Also note that there are only two inputs to this formula namely the ARV and the Repair Estimate (RE). You will need to have access to comparable sales of houses that have sold in order to establish ARV (you can’t use Zillow). You will also need to understand material and labor costs in order to establish a repair estimate.
Tip No. 4: Know How to Estimate Profit Potential
If you want to calculate your expected profit on a property that you intend to fix and flip then remember to add in all the components that eat into your profit.
Use this Formula as a guide: Sales Price – Commission – Purchase Price – Repair Estimate (RE) – Your Holding Costs – Maintenance and Repairs – Your Closing Costs = Your Potential Profit.
Don’t forget to include insurance, property taxes, repairs, maintenance, interest, points, fees and closing costs and always leave some room for extra repairs that might arise that were not accounted for when you purchased the property.
Tip No. 5: Be Conservative with Your Estimates
Always anticipate the worst case scenario and be conservative with your estimates. What this means is always assume the house may be worth less than you think and the repairs may be more than you think. This is especially true when rehabbing properties to fix and flip.
Your repairs may cost more than you originally anticipated and the house may sell for less than what you thought it would sell for. It also may take longer to sell your house than you originally anticipated. And don’t forget the commission on the sale and the closing costs can be as high as 10% of your sales price. For this reason be conservative and always use the lowest retail comparable sale to arrive at a conservative number for ARV.
Using one high sale as an ARV is a recipe for disaster unless you have personally seen the house and the interior and know for a fact that the house you are rehabbing is very similar. With repairs always assume that your repair costs may be higher than your initial repair estimate. Over estimating ARV and underestimating repair costs is a common mistake with begginers that can lead to bad results when a marginal deal that should have been passed on is purchased.
Tip No. 6: Invest In Your Real Estate Education
You should be continuously educating yourself to learn as much as you can about investing in real estate. If you are a beginner make sure you understand the difference between wholesale real estate and retail real estate. Know and understand why investors would pay cash for a property when most people buy real estate with a mortgage. Understand why someone would sell their house for less than what it is worth.
Be prepared to spend some time reading as much as you can on the subject of wholesale real estate and distressed real estate. Network and work with people that have fixed and flipped houses and consider partnering with them on your first deal.
Attend as many seminars, workshops, boot camps, and real estate events as you can. These are all excellent ways for you to network, meet people and learn. Be prepared to spend some money investing in your education since the cost of your training will be a lot less than making a huge mistake on a property that you are planning to purchase for a fix and flip.
I have seen people not willing to pay $75 for a service to give them comparable sales lose $30,000 by buying the wrong house. Don’t be that person. You should network with other real estate investors by attending local real estate investment club meetings. Search online for the Real Estate Investor Association (REIA) in your area.
Understand that there is a learning curve and that it will take some time for you to learn how to wholesale or how to fix and flip your first house. You can shorten your learning curve by finding a full time real estate investor in your city or town that can be your partner on the deal as well as your real estate mentor or coach.
Offer to locate deals for them for a small fee and learn as much as you can in the process by being a “bird dog” (deal locator) for them. I did that for 2 years for two investors before I went out on my own. And the lessons learned during those 2 years were very valuable.
Tip No. 7: Know Your Exit Strategy
Know what you are going to do with a property before you buy the property. Are you buying to hold long term? Do you want to fix and flip? Have you considered your exit strategy? How will you pay for the property? What if the property does not sell for the anticipated amount? How is your credit? Could you refinance?
These are all things you need to consider before you buy your first property. Every investor has a unique situation. Consider your personal cash situation, your expenses, your borrowing costs and what your long term goals are before you buy your first property.
Attend your local real estate investment club meetings and speak with other investors. When you meet other investors that have successfully wholesaled or fixed and flipped many properties then learn from them by asking lots of questions.
Once you have established your goals then it is time for you to find your first property. Do your due diligence and research and then be ready to take action. Education without action is a waste. Procrastination and over analyzing “paralysis of analysis” are some of the fears that stop people from moving forward. Don’t be rash either. Take your time, do your research and make sure your numbers work. Action without education and research is foolish. Be prepared, do your research and then move forward if the property makes sense, fits your long term goals and you know and have a clearly defined exit strategy.