I get this question on REO Rockstars calls a lot so let me share a bit of free insight on why REO agents and investors buying bank owned homes have their hopes of a golden finish blow out violently, like a speed skater who's shoved into the boards, trying to squeeze out Apollo Ohno on the last turn before the finish line! Grab a pen and paper and take some notes my friend. This stuff is not for the fainthearted but it doesn't take 4 years of torturous training either-just a tiny little bit if focus. You can manage that can't you? 😉 ...Every day my office receives offers from these "would be" investors. Seems like everyone has taken some class, "learned from a friend", or just plain walks blindly into the "investor" game. Now not to be critical of REAL investors here. We do business with PLENTY of super smart guys who make a very good living at this. But how do they do it? Well, it begins with the basics of knowing HOW to structure a deal that just makes sense. Contrary to what the "wanna be" guys seem to think, a great deal involves a heck of a lot more than looking at a few comps and speculating on a flip price. Bluntly, It is not the HOUSE that matters. It's the PLAN. Smart investors, the guys who actually make a career out of this (and no, I'm not talking about some of these TV goofballs who make me cringe as they buy termite infested, water logged, structurally defunct houses and end up rebuilding from the foundation up-HACKS!), break the numbers down to the last penny, including the financing factors. First, they have to consider "where" they are going to get the non-occupant financing and more importantly "how" they are going to convince the hard money guy to fork over a chunk of change to finance the project. It is a grave mistake that many investors make, to simply contract on a deal as "all-cash", thinking that hard money lenders hand over cash to anyone on blind faith, simply because they charge high fees and top level interest rates on short term loans-WRONG! In my experience, these guys are the best of the best when it comes to analyzing a deal and it's potential for being a bust. I see many not so savvy investors defaulting on deals because they got caught up in their own wild-eyed optimism and ultimately shot down by a wise lender and I am MORE than happy...perhaps I should say DELIGHTED to scoop their fat earnest money deposit and hand it over to my clients. Vicious...maybe. Deserved...You Bet! (Hey, I take pride in teaching people how to learn from their own ignorance in not "knowing everything about what you are doing" (thank you Mr. Trump for that tidbit of advice)...in the end I have probably SAVED them from themselves by making them think twice before blowing their money on the next "not so well thought out" mind deal"...on that note: YOU'RE WELCOME!)There are a few very specific things that a hard money lender will look at in determining whether a deal is solid enough to lend on. I have cited an example of a bad deal from a well respected hard money lender, Wade Munday of Peachstone Capital, here in Atlanta. Incidentally, he's one of the best. If you need a solid guy, call Wade.
Here's Wade's take on this one:
A real estate investor submitted the following hard money loan deal for consideration:
* Residential single family house, 3 bedroom, 2 bathroom, built in 2003, bank owned foreclosure (REO)
* After repaired value (ARV) = $65,000
* Estimated repairs = $5,000
* The real estate investor intends to offer $40,000
I don’t have to run the numbers to tell that this deal is too thin and that the real estate investor should offer a lot less on this REO property.
A quick check of the recent comparable sales (comps) in the MLS indicated that his estimated ARV (future market value) of $65,000 was a valid number. There are houses currently listed for sale in the $110k-$120k range, but the only properties that have sold in the past 6 months were foreclosures which brings the ARV down.
I assumed that it would take the real estate investor 6 months to turn the property around from the time he purchased the property, completed the renovations, found a buyer, and got the deal closed.
Estimated Sales Price
Loan Origination Fee
Closing Costs (buy)
Holding Costs (interest $42k @ 15%, $525 month x 6 m)
Holding Costs (taxes @ $1,700/yr, $142/m x 6 m)
Holding Costs (utilities, maintenance, yard, $50/m x 6 m)
RE Commission (sell, est 6%)
Closing Costs (sell, est)
Total Purchase, Rehab, Holding, Selling Costs
Estimated Net Profit
That’s a pretty skinny deal. The RE investor has no margin for error here and it’s a lot of time, money, and effort for very little profit and a lot of risk. Could the investor sell the house for more than $65k? Maybe, but in the absence of any recent comparable sales to justify a higher sales price, you can’t basis your analysis on the hope that you’ll get a higher sales price. Could the house sell in less than 6 months? Sure, but the average days on market (DOM) in the area is about 70 days, add in 2 to 4 weeks for the rehab, and 30 to 60 days for the buyer to get financing and you are at 4-5 months from start to finish.
The only way for this deal to make sense, is for the real estate investor to acquire the property at a much lower price. As the saying goes, “you make your money when you buy, you get paid when you sell”.
Well, I think Wade covers all the big points extremely well here. Hey, you're getting' it straight from the horses mouth so to speak! This is NOT brain surgery here. It's about applying simple common sense decision making and putting a game plan in place. Simple formula. Winners will get it. Loser won't. When you look at this guy above, I immediately think to myself "one big plumbing leak and this guy's finished". Then what happens? He defaults on the loan and Wade is stuck with it! Like I said, guys like Wade weren't born yesterday. If you're gonna buy foreclosures or sell foreclosures to investors and hope to be a true REO Rockstar, you REALLY need to be on your game. And if you're just plain bad at math...One word: C A L C U L A T O R.