Strategies for buying investment properties don’t vary much across different types of properties or real estate markets, for that matter. Basically paying the least amount you can to insure a nice profit when you sell or refinance is the key. Here are some basic investor buying formulas that work every where and a new twist that your real estate agent or title company can help you with.
While making money in real estate isn't easy, it can be done if you pay the right price for the property and get a low interest rate on your loan - that way you can see positive cash flow when you rent out the property. But let's see what other investors use as their real estate buying formulas:
1. Determine the best use and highest market value of the property in excellent condition. This research can be done by your real estate agent (comparable Market Analysis) or by your expert knowledge (experience) in the marketplace (you should know your market inside-out and not by guessing)
2. Estimate cost of repairs use contractor estimates (you should have a team of experienced contractors) that you can trust and depend on. Your experience will help you quickly estimate ball park numbers on most any project.
3. Calculate the carrying costs of the property. Purchase costs, taxes, insurance, Title, attorney, appraisal, utilities, financing (points, interest), selling costs (commissions), advertising (for tenants or to sell), overhead expenses and may be some miscellaneous costs not listed. On a quick paint and replace carpet the work may take 2 weeks but you should plan on 2 to 3 months holding time. Larger projects may take a month or two to complete you may want to consider 4 to 6 months carrying costs.
4. What’s your profit do you want to make 10% to 20% on the deal not a bad profit but 10% on a $35,000 deal is only $3,500 for two months work and headaches. You may want to consider paying yourself a minimum $20,000 to $25,000 per deal this can guarantee a good profit at the end of every transaction.
5. Offer price is the highest market value less repairs, carrying costs and profit. This is the most you will pay for the property you want to start somewhere lower, some where a lot lower, an offer somewhere lower like your agent will be ashamed to present your offer.
6. A new twist to the formula, there are a tremendous amount of bank owned properties on the market today and there be more tomorrow. When a bank takes over a property they list it for sale with a real estate broker who prices it at the market value it usually sells somewhat less than that. But what did the bank actually pay for the property or what was the mortgage balance when they took it over. Many times what the bank has in the property is much less than the listed price.
123 Main St - highest market value $250,000, brokers listing price $240,000, bank costs through foreclosure $165,000. In this example the property needs only minor cosmetic work and can be turned over quickly so you offer $210,000 and will make a nice $25,000 profit. But what about the other $45,000?
729 New St – highest market value $195,000, brokers listing price $190,000, bank costs through foreclosure $102,000. This is another property with minor repairs; you offer $98,000 and close at $102,000 (depending on the marketplace you may close a little higher). Using our normal formula we would have offered $140,000 to close at $145,000 a difference in your pocket of +$43,000.
To the bankers it's a numbers game they are building a backlog of properties to move so you may have some good opportunities in your area. Work with your real estate agent or title company do a little more research into what all parties have in the property and you may make some bonus money on top of your planned profit.
In-laws are a great way to offset your mortgage payment and you will be able to write off the depreciation of the unit and the appliances in the unit. Plus, when and if you sell the home, you can include the cash flow from this unit in the price. But you need to be aware of zoning laws for your city and neighborhood, specifically for an in-law unit or an addition.
However, if you have an in-law unit, you will have what is probably the most negative aspect: someone living in your residence. But if the house is structured with a separate entrance, kitchen, and bathroom, you'll still have the freedom and privacy of your home.
If not, you might want a friend or relative to live in the in-law, which will make the conditions much more pleasurable. Conflicts can always arise but with some borders between your living spaces, things should go smoothly.
Similarly, with a duplex, your neighbor can conceivably pay for your home, but you are again in closer quarters with your tenant. But if you're starting out and are young, these are not bad options. Look for a duplex that makes separate living very easy, and comes with good parking and a separate stairway for the upper unit.
The other option is renting out your second home or vacation unit. Again, you run the risk of having the tenant in the unit when you might want to use it. But the IRS gives you two weeks of tax free rental income each year for second home landlords, which could be worth the intrusion. I know someone who has a large house near Lake Tahoe where the rooms have been split up and he rents the unit out to snow boarders and skiers. The house even has closets that function as lockers. There are ways to generate cash flow, reduce your taxes, and get into the investment property game. Sometimes, the key is to be creative.
Think about ways you can satisfy a demand, whether it’s in a ski area or near the beach, or maybe it’s an apartment in Arizona just near the spring training practices for Major League Baseball. Each spring you'll have a waiting list for baseball enthusiasts looking for a place to stay.
TIP: Don’t Sell Income-Generating Property. When you sell it you have to pay taxes and you lose the cash flow. Consider that you can still refinance and then pull out equity, or use equity to buy another property. And, don't forget about the 1031 exchange. Give up that cash flow only if you know there’s a downturn coming in the market or perhaps new rent control for the apartment you own. Or maybe there’s huge growth and demand in the area you own property, and you can make a substantial gain by selling. Take these factors into consideration before you make that decision.