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The Basics of Real Estate Investing

If you are thinking about getting into real estate investing, here are a few tips to help you get started.  It’s seems so many people are charging large sums of money for dubious “methods” of getting rich.  Real estate investing is as much of an art as it is a science.  The best approach is to use your wits and a little common sense.  A few pointers don’t hurt.  So take it for what it is; free advice from someone who has made some money and learned a few things.

I specialize in short term renovation flips for single family residential properties less than $200,000.  That is to say I find distressed houses that are selling for low prices, renovate them and sell them at market price (or maybe a little above, hopefully)  My time frame is usually about 1 month for renovation and then they are back on the market.  It is not necessarily the best method, but it is simple and moderately conservative if done correctly.

The thing about this approach is that it doesn’t involve risky speculation or long term forecasting and operates on the sound principles of supply and demand.  We all know the mantra “buy low, sell high”.  (If it was only that easy.)  Simply put it is:

            ($Distressed + $Upfit - $Market) / #Time = $Profit

Where:
$Distressed is the price you pay for a property
$Upfit is the money you spend making it nice (And other miscellaneous buying and selling costs)
$Market is what you sell it for
#Time is how long it takes to renovate and sell it
$Profit is what you make

Ok, this is a little oversimplified, but the general concept is sound. The variables are known.  You control the purchase price by what you pay.  The values associated with up-fitting, time to sell and market prices can be calculated for THIS exact moment.  Tomorrow is a little less certain and next week even less so.  That is where the element of risk lies.  As time increases, so does uncertainty.  Your risk increases and your profit will dwindle. 

How do we use this knowledge?  Look at each of the variables individually.

  • Distressed – Buy Cheap.  Duh.  Opportunities happen if you look for them.  (Ergo, Look for them)
  • Upfit – Control costs. Use competitive bids for labor.  Don’t overspend to create the Taj Mahal.  People are looking for good solid value for their money.  Also, have a renovation plan.  Know what you going to do before you do it. 
  • Market – Have a good idea of the selling price of your property before you sign anything.  Don’t be overly optimistic.
  • Time – Time is desirability.  Desirability is price and marketing.  Make a nice product and people will buy it, if the price is right and they know it exists.  Use a good agent and don’t overestimate the market or get greedy.  Tweaking a house with a few extra nice touches can help immensely.  Don’t discount the power of curb appeal.

It sounds simple, but the devil is in the details.    The parts are all there and have been known for a long time.  You can play with other strategies, but they tend to follow this same formula.  Perhaps you can omit the up-fitting if you find a really good buy that no one else or only a select few knew about (Wholesaling, Pre-foreclosure).  How about stretching the time out a bit (Speculating)?  What if you spend a lot of money on the up-fit and sell way above current market price (Boutiquing)?  All are valid approaches depending on your level of acceptable risk.  But starting out, play it safe until you get a feel for things.

Here are a few more details to help you apply your newfound knowledge of everything with a roof.

Know Your Property - Before you bid, look the property over fully.  Have renovation costs handy.  Factor in every thing that you can in a reasonable amount of time.  Is there a stove missing?  That’s obvious.  Someone damaged the wall?  Write it down.  Soon enough you will be able to estimate things quickly.  Many investors advocate buying at auction.  In my opinion, this risky the first time as you rarely get a chance to see the property before you buy it.  As we say in the south, you’re buying a “Pig in a Poke”.  Start with properties you can see.  HUD foreclosures and bank owned properties are ideal ways to get started.  Ask a real estate agent that specializes in investors or do your own legwork.

Know Your Market – Conduct your own Competitive Market Analysis.  Forget Zillow.com.  In my experience, it’s wrong about 60% of the time in my area.  Find properties that have recently sold and use them as a basis for determining the selling price for a potential flip.  Don’t be afraid to go a competitor’s open house.  That’s why they offer free cookies. ;)  Average the prices and square footage to figure the Average $/Sq Ft.  Try to compare properties that would be close to the look and feel of your renovated property.  Garages and covered parking need to be accounted for as these can significantly change an estimate. Factor in up-fits such as new appliances, granite countertops, custom trim, etc.  Finally, you need to determine the average time to sale to create financial projections. Creating a solid CMA takes a lot of work. Don’t skimp here.

Know Your Area - Work in local areas that you are very familiar with and close to.  I know Uncle Bob said the big money was to be made in Topsail Beach, NC but you live in Atlanta, GA.  There are two problems.  First, it’s hard to manage a job that you can’t get to quickly.  What if there is an emergency?  Second, you aren’t as familiar with the political/economic climate and might not detect the market changing until it’s too late.  Start close and when you become a pro, then you can expand your empire.

Let’s stop here.  The three previous items are in my opinion the single most important factors in being a successful investor.  Don’t be lazy or take shortcuts.  If you rely on others for this information, you will likely get burned at some point in the future.  Knowledge is what makes an investor.  Relying on tips and guarantees are how a lot of people get hurt.  By the way, if someone offers you a guarantee or a sure thing, ask yourself “If it’s guaranteed money, why aren’t they doing it themselves?” 

Let’s continue…

Start Small – VERY SMALL.  Replacing a foundation on your first time out is a recipe for disaster.  Keep it simple.  Paint, carpet, maybe a little spackle here and there.  Learn how to run a project and schedule subcontractors.  When that gets easier, take on more challenges.  

Be Ready to Act Quick – Paralysis of analysis has no place in real estate investing.  Plum properties get snatched by your competitors that have experience in making quick decisions.  I’ve had it happen before I got home from my first look.  Create a set of criteria for purchase and when you meet them, ACT!

Have Reasonable Profit Expectations – Making $100,000 on a $50,000 property will not happen without someone doing jail time.  Figure a percentage profit that is reasonable considering the amount of time you will spend.  Expect to make less the first time out.  You are paying a bit for the schooling.   Learn from your mistakes.

Have the Title Searched (and Insured) - We have a weird system for recording titles in the U.S. that is unlike most other countries.  Clerical errors can happen that allow expensive liens to show up on your bright and shiny new property after you buy it.  Title searches reduce the risk of that.  And insurance makes the problem someone else’s.  Money well spent.

Get an Inspection - Nothing can ruin your day more than finding out that that beautiful hardwood in your new house is covering a rotted floor. I speak from experience on this one.  Let a professional crawl all over your potential purchase and provide you with a summary of the problems.  Always make your purchase contract contingent on the result of this report.

There are no great revelations in real estate investing.  However, there are those with expensive seminars that would beg to differ.  Armed with a little knowledge you can fair better that a lot of the graduates of those programs.  Do your homework and have reasonable expectations and you should be able to manage a reasonable profit, maybe even an exceptional one.

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