Making an offer when investing in single family real estate is a very simple process, but emotions, competition and logic systems based on the wrong map make it complicated.
Del Walmsley once said, “real estate is easy, people are hard.”
He’s right. As mentors, we spend most of our time scraping away all the gunk that clogs up people’s minds. The gunk is from a lifetime of bad advice. After it starts to clear, we have to work on the emotions…then the fear.
It would be a whole lot easier to just say, “here’s the math problem, go get it!”
So here’s the math problem:
– Rehab Costs (Best Product)
– Transaction Costs
– Profit Standard for Equity Capture
= Maximum Offer (equity side of equation)
AS LONG AS:
– 5% (Best Price)
– Monthly Expenses
– Profit Standard for Cashflow
IS GREATER THAN 0
Now go get it!
But you won’t go get it because we haven’t worked through all the other stuff yet. Let’s start with asking price.
Americans tend to be emotionally attached to asking price. If someone is asking $130,000 for a house, they want to offer $125,000. It’s psychological. People want to get one over on the other guy. People automatically assume that if the seller is asking 130, then it must be worth 130, and anything less is a deal. But what if it’s only worth 110?
What does the asking price mean to us as investors?
I can say this over and over, and people still won’t listen. They’ll go out tomorrow and start looking at all the asking prices in their neighborhood. Stop spinning your wheels.
On the flip side, what if the seller’s asking price is below market value? People still want to bid lower.
If there is a deal asking $20,000 below market value and you bid $5,000 less and I bid the asking price; who is going to get the deal? I am.
Who is going to get the $20,000 equity? I am.
Divorce yourself right now from that affair you’ve been having with asking prices.
What we need to do instead is find out what the market value of the property is by finding comparable sales. That means finding at least 6 houses with the same number of rooms, bathrooms, garages, square footage, and construction that sold within the last 6 months in the same neighborhood.
To find out comparable sales, you need access to the MLS (multiple listing service), which is the database that realtors use to share deals and track market conditions. There are some subscription-based services out there that can give you access to historical MLS data (not active listings), even if you are not a realtor.
We highly suggest learning to run your own comps (comparable sales) with one of these services, but if you don’t have access; ask a realtor to run you an unfiltered report so that you can analyze it yourself. Ask a mentor in your area to help you run your first few comps so you know how get an accurate market value for the property.
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Estimate the cost of rehabbing the property back to perfect condition. It’s a simple math problem. Once again, we need to get away from emotions and bad referral past experiences.
It’s not: I don’t do foundations, or I don’t do leaky roofs…It’s just a number. What will it cost to fix it back to perfect condition.
Perfect condition means clean and functional. Everything in the house should last at least 5 years. If the air conditioner is on it’s last leg, replace it. If the foundation is tilted, fix it.
Don’t get hung up on cutting costs. It’s black and white: if it won’t last 5 years, fix it. If it’s not clean, paint it, carpet it, replace it; whatever it will take to make it clean.
“Well,” you might think, “the deal might not work if I have to put too much into it.” Then lower your asking price. If you don’t get the deal, move on to the next one.
Once again, it’s a simple math problem, just learn it, rinse and repeat.
Estimate the cost of all expenses associated with the transaction such as closing costs, lending fees, inspections, etc. Your mortgage broker can help you with this. If you’re buying with cash, have a mentor help you estimate what expenses you will still have to deal with.
Profit Standard (Equity)
As real estate investors, we’re in business to make a profit. Figure out the least amount of equity capture that you could sleep with at night.
Equity capture is the instant, unrealized profit an investor makes when buying an asset for less than it’s worth. If a house is worth $100,000, and you buy it for $80,000, you’ve made an instant, unrealized profit of $20,000.
In Texas, most of us are looking for around $20,000 in equity per deal, but we don’t shy away from $10,000 and some are getting as much as $40,000.
When you figure out your profit standards, bidding is easy because you know your maximum.
Have you ever been in a bidding war on eBay? If you won the bid, did you have a little buyer’s remorse after? When people get emotional about bidding without a standard to go by, they can easily over-bid.
That’s why many people start their listings on eBay at $.99. eBay has actually found that listings that start at $.99 tend to sell for more than listings that start closer to the real value.
Figure out what comparable homes have been renting for in the prospective neighborhood. Market rent is found the same way as market value: by accessing historical rental data on the MLS.
We recommend sticking to rental homes in the “bread and butter” range: 3/2/2’s that rent for $1000/mo. and less.
You will usually find a range of rents in a neighborhood…for example: 8 rentals ranging from $800 – $925. Take a look of the DOM or “Days on Market”. You will often find that the higher the rental price, the longer it takes to rent. We want to be the best price in the neighborhood, so price your rental on the low end of the spectrum, something like $775.
Don’t get emotional about it! I know you think that’s a lot of money to lose, but you’re going to lose it one way or the other: Either through vacancy or lower rent. If that knocks your deal out of the math problem, move on to the next one.
What are all the expenses associated with rental property?
If you have a mortgage, you’ve got to pay the man.
That’s how the man gets paid
That’s how the real man gets paid
Protect yourself and your property with insurance. It really isn’t that expensive.
This one can be hidden! Don’t forget about maintenance; BUT, if you’re putting a perfect house on the market, you shouldn’t have much maintenance expense — if at all.
Eliminate your vacancy expense by pricing your house the lowest on the block. Like I said, you have to pay it one way or the other.
Profit Standard for Cashflow
Cashflow is king.
Del’s Rule #2 is: Don’t buy it if it doesn’t cashflow.
If you focus on cashflow, letting equity and all the other profit centers be the icing; you’ll be just fine. When you get greedy and go for the equity without cashflow; you set yourself up for failure.
Make sure that what you will be charging for rent minus all of your expenses still leaves you with a minimum standard of cashflow.
In Texas, the average cashflow on a single-family deal is around $200 per month, with some investors getting as high as $400 or $600.
We recommend sticking to properties that are within a 30 minute drive of your home or business. If you’re going to be further away from that, you might want to find a managing partner to run the deal while you remain a passive investor.
Again, people get too emotional over what kind of neighborhood they’re buying in. As long as I feel secure enough to send my girlfriend in to manage it, the neighborhood is good enough for me to invest in.
It’s Just A Number
As investors, we have to take the emotion out of it. Reduce your decision-making to a math problem, then let everything else go.
Once you’ve found your maximum bid, make a bid. If your maximum bid is above the asking price, you might be in luck! Try bidding a few thousand dollars over the asking price (as long as it’s below your maximum) to ensure that you get the deal.
Once you know the math problem, you’ll realize that every house on the market has it’s number. You can potentially calculate the price at which you would capture enough equity and cashflow for every single house on the market.
In theory, you could put out an offer to every house using your formula until you get one to bite.