What price is the right price for investment real estate?
December 23, 2012
Ask any experienced real estate investor what constitutes a “good deal” for an investment property and they’ll share this simple formula with you:
ARV x 70- 75% (-) Repairs = MAO.
Or, After Repaired Value (ARV) multiplied by 70-75% (depending on the property and the market area) less the cost of repairs will give you the maximum allowable offer (MAO).
So what does this formula mean? And how can you make it work for you in your real estate investment ventures? Let’s break it down.
ARV stands for “after repaired value.” This refers to the value of a property after it’s repaired to market condition. Market condition is best determined by comparing your house to those properties selling at top market value in any given neighborhood. After repaired value is determined by assessing properties similar in size, year built and other features, in the same part of town (preferably in the same subdivision). You’re objective here is to compare “apples to apples.” Once you’ve found this information, you’ll be able to determine what the house will be worth after it’s repaired, and what kind of repair budget you should consider.
Read below for more information on determining repairs.
After you’ve determined the properties’ after repaired value, you’ll then deduct 25-30% from that number. Why 25-30%? This discount is the standard reduction that most investors consider appropriate. It includes the 6% realtor’s commission you’ll pay when you sell the house, closing costs when it’s time to sell and any holding costs like insurance, utilities, HOA fees and taxes while holding/ remodeling the property. Most importantly, this discount also accounts for your profit margin.
This discount is always the same because if you’re in a higher end investment, the costs to hold it are greater. On a lower end property, the costs are less. But the percentages you’ll pay a realtor, the closing costs, the taxes and other expenses will always be calculated by a percentage of the value. If you’re buying the house to hold as a long-term rental, you still want this cushion for selling expenses because at some point, you are likely to sell the property.
Also, it is important to have this discount so you are sure to have room for error in the repair budget and room for any other unexpected holding costs. As long as you have this discount, you need not worry about loosing money in your investment.
Last, after you’ve calculated the after repaired value and you’ve discounted the house by the standard 25-30% discount, you’ll need to budget and deduct the cost of repairs.
So, how to determine what it will really cost to renovate you investment property.
First, you’ll want to consider your exit strategy. If you’re holding the property to rent, then you’ll want to put sturdy, less expensive finishes in the house. Consider that every time you rent the property, you’ll have to do a fresh “make-ready” which is likely to include new paint, carpet, sheetrock repair and service to the major system of the house (A/C, furnace, roof repair, hot water heater, etc.). It’s best to maintain the property while holding it for rental income, and then upgrading the finishes when you decide to sell.
Regardless of the cosmetic remodel, a wise investor will always repair any major items first. Foundation, roof, siding, air conditioning, etc., should all be in operable condition before any other repairs are considered. When you purchase a distressed property, it is important to bring all these major systems up to code so the property won’t continue to deteriorate.
It’s also important to contemplate what an appropriate level of finish out is appropriate. You wouldn’t put granite and stainless appliances in an $80,000 rental property, but if your investment is going to be worth $200,000 after repairs, then you’ll need to budget for the nicer, reasonable finishes in order to attract the right buyer or tenant.
So where can you find these discounted properties? Some agents can help you search for listed foreclosure. You could even attend the foreclosure auction. However, the investment market is very hot right now, so there is a lot of competition and it is more difficult than ever to get these bargain deals. Often times, the best sources for properties that meet these criteria are wholesale real estate investment companies.
There are a few reputable, reliable firms like this in the Houston area. Big State Home Buyers is a leading source for discounted properties. We can help you determine the after repaired value of your property, point you in the right direction for contractors, appraisers and lender, and we offer a variety of investment options that will suit your needs.
Check out our website www.BigStateHouseDeals.com or call one of our agents at (713) 263-7466 for more details on building your investment portfolio. We are here to help!