Investment Property Do’s and Don’ts

As the Market is rising again (YAY!), we started thinking about  investment properties. But what do you do? Where do you start?

Despite improvements in the housing market, there are still plenty of foreclosed or bank-owned properties ripe for house flippers—professionals who purchase distressed properties to renovate and resell. According to RealtyTrac.com, an online marketplace of foreclosed properties, investors flipped close to 100,000 homes in the first half of the year, making almost $30,000 per flip, on average. However, experts warn that house flipping isn’t as easy as it looks on TV. Spending too much on repairs or on the property itself means losing money, as does choosing the wrong finishes or general contractor.investment

Here’s a look at the best practices of successful house flippers from U.S. News and World Report, as well as tips on avoiding common pitfalls:

Look for potential. Flippers often invest in properties that don’t appeal to conventional home buyers, since they know how to look beyond an outdated kitchen or moldy basement to spot potential. Chaz Shively, founder of New Alchemy Ventures, a real estate investment company in Denver, says, “If you walk in and it smells like somebody had 30 cats in there, it means there’s opportunities to improve the place.” House flippers typically find deteriorated properties through auctions or relationships with local real estate agents. Areas where new development or redevelopment is heading are where you want to be. The best real estate investment properties are ones that are well located and physically sound but cosmetically challenged and poorly managed.House: before and after
Among residential property options, “Investing for Dummie’s” top recommendations are small apartment buildings and single-family homes. Attached housing makes more sense for investors who don’t want to deal with building maintenance and security issues. Attached-housing prices tend to perform best in developed urban environments.

 

Do the math. Many house flippers focus on single-family homes because they appeal to more potential buyers. Plus, the financing on multifamily homes is more complicated, because mortgage lenders have stricter criteria for those. Either way, comparing the purchase price of the property to the after repair value (ARV) is critical. Flippers only earn a profit when the ARV is higher than the original purchase price plus repair costs, so accurately predicting repair costs and the ARV can make or break a deal.

*Here is a mathematical trick from 123Flip.com that will help you calculate how quickly you can grow your money with a particular investment — it’s called “The Rule of 72″…The Rule of 72 will allow you to determine how long it will take for an investment to double given a specific rate of return. The rule works as follows:rule72

Divide 72 by the rate of return, and the result will be an estimate of the number of years it takes to double your investment.

As an example, let’s say that you are receiving an 8% return by investing in a diversified stock portfolio:calulate

72 / 8 = 9

So, an amount of money invested at 8% will double about every 9 years. Someone who invests $10,000 in 2015 with an 8% return will have $20,000 in 2024, $40,000 in 2033, and $80,000 in 2042.

The Rule of 72 can also be used to determine what rate of return you need to receive to turn a starting investment into an ending investment. For example, let’s say you are 45 years old, and have a goal to retire by 55. You have $500,000 in savings, and know that you need $3,000,000 to retire. So, you need to increase your $500K to $3M in 10 years…what rate of return would you need to accomplish that?

To find out, first figure out how many times your money needs to double to reach your goal. In this case, $500K would need to double two-and-a-half times ($500K to $1M, $1M to $2M, and then a half double from $2M to $3M). Now you know that your investment needs to double 2.5 times in 10 years. This is the same as doubling every 4 years (10 / 2.5).

We know from The Rule of 72 that if we divide 72 by the rate of return, we get the number of years to double an investment. It also works the other way — by dividing 72 by the number of years to double, we can get the rate of return. In this case, we divide 72 by 4, and we get 18. This is the rate of return (18%) that we need to get to double our money every 4 years, and therefore the rate of return needed to turn $500,000 into $3M in 10 years. If our investor can find an investment that returns 18% annually, he will meet his retirement goal.team

Assemble a team of experts. Successful flippers know their strengths and aren’t afraid to tap other experts, especially technical workers like plumbers and electricians. Experts recommend having the sewer line checked by a professional before purchasing a property, as sewer issues can be costly to fix, and soliciting multiple bids and references from contractors to help ensure the job runs smoothly. Always take references from contractors and after you call the references, research that contractor online for any reviews or pictures of previous work.  Building relationships with local real estate agents can also be useful for finding properties and getting accurate ARVs. And have your real estate team in place before you begin SHo & Sarah floatingyour serious property searching. Line up a real estate agent (of course you should use Snyder & Pritchard Homes), loan officer, tax advisor, lawyer, and so on early because the real estate investor with the best resources can identify the properties to ignore and those worthy of careful consideration. Move quickly — the speed at which you can close a transaction is an advantage in any type of market.

Design for buyers, not yourself. Selecting cabinets and paint colors for a flip is different from decorating your own house. The design elements need to appeal to a broad group of potential buyers. “We try to be conservative in our color selections,” says LaCava. “We try to keep it basic like an antique white. When we go to a little higher-end home, we go with features like when you close a drawer, it won’t slam, and nicer crown molding on the cabinets.” Installing features that buyers in the area want, like a wall-mounted TV, higher-quality cabinets, or a built-in wine cooler, can make a property stand out and sell more quickly.

We talked about how to be successful, now lets talk about the mistakes Investopedia claims you should avoid.

1. Not Enough Money
Dabbling in real estate is an expensive proposition. The first expense is the property acquisition cost. While low/no money down financing claims abound, finding these deals from a legitimate vendor is easier said than done. Also, if you’re financing the acquisition, that means you’re paying interest. Although the interest on borrowed money is tax deductible, it is not a 100% deduction. Every dollar spent on interest adds to the amount you will need to earn on the sale just to break even.money

2. Not Enough Time
Renovating and flipping houses is a time consuming business venture. It could take months to find the right property. It will take more time to renovate it once you buy it. Before you can sell it, you’ll need to schedule inspections to make sure the property complies with applicable building codes. If it doesn’t, you need to spend more time and money to bring it up to par. Next, you’ll need to invest time to sell the property. If you show it to prospective buyers yourself, you’ll spend plenty of time commuting to and from the property and meeting with potential buyers.flip

3. Not Enough Skills or knowledge
Professional builders and skilled professionals, such as carpenters and plumbers, often flip houses as a sideline to their regular jobs. They have the knowledge, skills and experience to find and fix a house. Some of them also have union jobs that provide unemployment checks all winter long while they work on their side projects. To be successful, you need to be able to pick the right property, in the right location, at the right price. In a neighborhood of $100,000 homes, do you really expect to buy at $60,000 and sell at $200,000? The market is far too efficient for that to occur on a frequent basis. Even if you get the deal of a lifetime, you need to know which renovations to make and which to skip. You also need to understand the applicable tax laws and know when to cut your losses and get out before your project becomes a money pit.house invest

4. Not Enough Patience
Professionals take their time and wait for the right property. Novices rush out and hire the first contractor that makes a bid to address work they can’t do themselves. Professionals either do the work themselves, or rely on a network of pre-arranged, reliable contractors. Novices expect to rush through the process, slap on a coat of paint and earn a fortune. Professionals understand that buying and selling houses takes time and that the profit margins are sometimes slim.

Bottom Line

Before you get involved in flipping houses, do your research. Like any other business venture, flipping requires time, money, patience, skill, and it will definitely wind up being more difficult than you imagined. Do the research, build a team, and be prepared for anything! Good luck!!

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***Investor activity varies by investor, region and property types. Auction.com, the largest online real estate marketplace, recently released survey data collected from investors bidding on properties across the country, which confirmed that buying property to hold and rent is currently favored over flipping nationwide. However, investor intent varies considerably between online and offline investors, regions, and property prices. money1Next week we will talk about buying investment properties for the purpose of renting. 

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Shoshana Snyder

Shoshana Snyder

shoshana@snyderpritchardhomes.com
203.321.3502

Sarah Pritchard

Sarah Pritchard

sarah@snyderpritchardhomes.com
203.414.5571

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