Buying a run-down house may not be a good idea for people looking into investing in real estate for the first time but for well-informed investors, a distressed property may just be the perfect diamond-in-the-rough deal. It is not a bulletproof investment, however, and plenty of costly mistakes can happen if the investor is not careful. Knowing what to expect, what to look for and do will help investors avoid errors that will create a serious impact on their bottomline. Rehabbing distressed properties can be quite lucrative, so learn how to avoid these common risks and mistakes.
Knowing the (Legal) Environment
Apart from having a good perspective about the neighborhood, every investor must invest some time in understanding and familiarizing themselves with local laws, particularly when eyeing foreclosures. There may be changes in the industry that could have a significant impact on one’s ability to buy and sell, and being caught unawares could be costly.
Estimating the Profit Potential
One of the most important keys to successful investing is knowing how to make an estimate of the profit potential of a certain property, particularly if it is a fix-and-flip deal. Potential Profit is what is left once all the expenses are deducted from the sales price. These expenses are the purchase price, repair estimate, holding costs, closing costs, maintenance and repairs, and commission. There are also other stuff that investors have to figure in, such as property taxes, insurance, interests, maintenance, fees, points and extra repairs. Keep these in mind to develop a clear picture about the true value of a potential buy.
Having an Eye for the Worst Case Scenario
No one invests in real estate only to worry about how much he stands to lose. However, it pays to have a good head on one’s shoulders when it comes to making estimates. The house may seem like a good deal but there is that very real possibility that it could sell for less than the asking price. It may also take a while to sell. Keep things real by being conservative with the estimates.
Cheap is Not Always Best
Snatching a property just because it is the cheapest thing on the block does not make for a good investing decision. Many new investors make this grave mistake. If something is cheap, always go the extra mile to find out why. An investor’s goal is to spend money to make money and every property that goes into one’s listing should be able to provide a return. Keep in mind that distressed properties come cheap because they need to be fixed, and fixing means spending. Rehabbing is part of making an investment but it should not lead an investor down the path to a significant loss. Investors should keep an eye on the ROI and to always watch their numbers. All houses hold secrets and distressed properties have more of these than the average home.
Understanding the ARV Formula
ARV stands for “after repair value”. The formula is simple ARV multiplied by 65, less RE (repair estimate) is equal to the MOP (maximum offer price). The MOP represents the maximum price that the investor should pay for the property.
Real estate investing that relies on the success of flipping properties should always consider the MOP. To determine the ARV, investors should know how much the prices of similar properties are in the same neighborhood or area, and have a clear understanding about the cost of labor and materials to come up with a good repair estimate.
Underestimating the Cost
Rehabs can be expensive and one of the worst things that investors can do is to underestimate the cost of repairs and reconstructions. It often feels safer to low-ball the figures initially but there is always that risk that the true cost of rehabbing might be higher than expected.
Avoid this mistake by having a clear view of the requirements of the property and preparing the proper construction documents that will detail the scope of work, schedule, material list and budget. It is best to prepare a high budget with a certain percentage allotted for contingency expenses based on the investor’s comfort level regarding the property.
Anticipating the Risks
Distressed properties are generally old or neglected homes and they carry a number of risks to the investors. Knowing what to look for and being prepared for what could be unearthed through inspections and research will make a huge difference. Old properties are notorious for costly issues such as structural problems, mold, asbestos and septic issues. They could also carry unresolved burdens such as problems with the title or the bank, or certain issues that may involve the neighborhood or the zone. Knowing what to do and being prepared to handle these issues will help investors minimize the risks and optimize their profits.
Learning the Ropes
The real estate market is very fluid. To survive in this very competitive industry, serious investors should keep educating themselves and obtain as much information as they can. This is not to say that beginners stand no chance at making a profit on rehabbing distressed properties. However, beginners who want to succeed on fix-and-flip deals should be able to have a clear view of how this niche works. New investors should build their own network, find reliable partners who are willing to work with them, and learn from others who have been successful in the business. They should also learn to adapt and even change their strategy when and if necessary.
Having An Exit Strategy
New investors often have a clear idea about what they want but this idea is limited to a general perspective. Problems occur when (not just “if”) things do not happen as they anticipated. To avoid costly mistakes, investors should prepare a workable exit strategy that will allow them to make the best out of a less-than-ideal situation. They should, for example, have a clear idea about how long they will hold the property and what they could do in case the house does not sell for the amount they want.
They should also look into their finances and consider how long they could hold out before they throw in the towel. Each investor is different and the situations they find themselves in may be unique. To maximize their chances of succeeding in this market, investors must have a clear understanding about their goals, capabilities and limitations.