How To Analyze A Killer Real Estate Deal

In: Advice By: Brian Armstrong

2 Aug 2007

Today I want to tell you about a real estate deal I’m working on, and how I analyzed it.

First, I set up a saved search on my local MLS website (your city probably has one too). In the search I told it to let me know about all 3 bedroom 2 bath houses that were less than $85,000 and more than 1,888 sq.ft.

Why do that? Because 85,000/1,888 = $45. I was telling it to let me know about every house that was $45 per square foot or less, meaning cheap and usually not in great shape. I wanted to find a foreclosed house that was selling for 60 or 70 cents on the dollar so that I could fix it up.

The saved search notifies you each time a new home fitting that description is listed, and yesterday it sent me list of about five homes.

For each of those five properties, I wanted to answer three questions:

How much could this home sell for if I fixed it up?
How much could I rent it for and would it cash flow?
How much will it cost to fix it up?

To answer these questions, I used a tool called Quest which generated the screen shots below, but if you don’t want to pay for Quest you can also do this type of analysis yourself by manually searching through your MLS and putting the data into Excel.

1. How much could this home sell for if I fixed it up?

This particular house I was looking at had an asking price of $76,000 and was 2181 square feet ($34/sq.ft.). To answer the first question I sought to find comparable homes (“comps”). A good comp is one that has the same number of beds and bath, is about the same size, is in the same neighborhood, was build in about the same year, and was sold in the past 12 months or so. If you can find similar houses that sold recently, you can be fairly confident that your house will sell for about the same price. Other foreclosure properties are not good comps; you want to find homes that are in good shape and represent what yours will eventually look like after its fixed up.

Here are the comps I found which show an estimated value of the property of about $116,000.

All the comps are in the same neighborhood, within + or – 250 sq. ft., built within + or – 8 years, 3 bed 2 bath, and sold in the past 12 months.

This is what initially attracted my attention. With an asking price of $76,000 and a potential sales price of $116,000, there is $40,000 in equity to be earned. If my repairs cost less than $40,000, I can make some money.

2. How much could I rent it for and would it cash flow?

Just like I can find sales comps to see how much a property would sell for, I can find rental comps to see how much it will rent for. Similar search criteria can be used. Here are the 3 rental comps I found:

It looks like it could rent for about $1100 per month. I now have enough information to calculate the potential cash flow (for now I have to assume that the repairs will be about $10,000, but I’ll investigate this further in the next step).

$243/month is the estimate for cash flow. And the deal could get $29,000 in equity. Not bad!

Note that I’m doing a zero down deal here. The lender I’m working with will loan 80% of the after repair value. So if it does get to $116,000 as I hope it will, they will loan me up to 80% * 116,000 = $92,800 to purchase the property and do the repairs.

Doing a zero down deal might not be available to everyone, but even if you needed to put 10% down on the property, the numbers still look pretty good.

3. How much will it cost to fix it up?

With just the information I’ve collected so far, I’d feel comfortable making an offer on this property, even without seeing it in person. It has plenty of equity, and appears to cash flow; this deal probably won’t last long! If I couldn’t schedule any time to see the property for a few days, I’d most likely submit an offer sight unseen to tie up the deal.

Some people freak out about making an offer sight unseen, but I can always back out later by using an “option period”. For about $100 I could get an option to buy the property in the next week which would give me more time to investigate the repair cost, and allow me to back out just in case the repairs were way more than I thought. Making an offer doesn’t mean I have to fully commit to buying it, but I don’t want anyone else to get it first.

However, I was lucky in this case in that i had some free time in the afternoon and the property was fairly close to where I live. I decided to go by and take a look before making the offer.

On the way I called the listing real estate agent to see if someone could be there to show the property or if they’d give me the lock box combination, but it was a no go on such short notice. Luckily, just as I was hoping, the back door was open (this happens surprisingly often on foreclosure properties, the sliding glass doors or locks are often broken). So I was able to sneak inside to take a peak ;)

The kitchen was in decent shape except that the microwave had been torn out.

These pictures don’t due justice, but the carpets and walls were pretty filthy. The occasional busted light fixture highlighted the place.

The yard was generally overgrown and there was some standing water in one corner (perhaps poor drainage or a broken pipe).

Oh yeah, and the AC unit was completely busted (there were literally pieces falling off on the ground). There was also one wall with some exposed 2×4’s that need to be fixed.

Overall, these pictures make it look better than it really was, but still…the damage was cosmetic. New carpet, paint, microwave, AC, and repairing that one wall…and this place was going to look great. I think painting the garage door white would improve the curb appeal as well.

My repair estimate of $10,000 was probably about right. Maybe $15,000 if things got worse. I could call in a contractor for a free estimate, but based on other estimates I’ve gotten on similar properties I feel pretty good about the repair cost.

So I went ahead and made the offer. Cash flowing $200 per month, and pulling $29,000 out of this deal after it was fixed up would feel pretty good. If my offer is accepted I’ll call in an inspector before committing to buy.

Stay tuned for future updates!

This post is part of a series on Killer Real Estate Deals

Haha…i grew up in California, so I know the feeling Tyler. This house is in Houston, TX. It’s cheap for a few reasons. (1) property taxes in Texas are high so prices are lower (2) it’s not in a great neighborhood, but not the worst either, (3) it’s a bank owned foreclosure and is in need of repairs. Houston is a good area to invest right now from what I’m told!

Terra Andersen

August 2nd, 2007 at 8:22 pm

Great find Brian! I’m in California… so $76,000 is a normal down payment! It looks like a great find though! I’ve been getting my hands dirty with Real Estate Investing as well, and can attest that even in a bad market like this one… there is definitely still money to be made! Congrats on the offer, and good luck with it all!

Flat Fee Realty Louisville

August 2nd, 2007 at 11:38 pm

Wow, you’re a genius! I never would have noticed that you could do that. Thanks so much, I am very interested in flipping houses. And, $76,000 is a steal!

Terra Andersen

August 3rd, 2007 at 4:50 pm

I just had to add this to Fridays links.. *=) http://www.betterforbusiness.com/2007/08/03/friday-link-love-entrepreneurs-on-a-mission/

It's Me

August 29th, 2007 at 5:44 am

I couldn’t help but notice that you didn’t include maintenance expenses, reserves, or vacancy costs (your rental comparables took 40 to 114 days to rent).

And I wouldn’t give your comparable sales much credence. Every one sold close to asking price, even the one that was on the market for over six months. This wasn’t unusual when values were increasing, but in the current slowing market, nominal sales prices are often artificially raised in order to obtain 100% financing. A large percentage of speculative properties with high LTV’s is a sure sign of unstable neighborhood values.

Over the last ten years, it was hard to lose money in real estate. Mistakes were quickly covered by skyrocketing values. Today’s market is a whole different game.

Brian Armstrong

August 29th, 2007 at 1:53 pm

I’ll be structuring the lease so that tenant pays all maintenance, and I plan to rent it below market so it will move fast (< two weeks, maybe before rehab is done). Finally, I’m not trying to sell it in this market. While home prices fall rents go up, so I’ll rent, maybe in a few years if things change I’ll sell instead of rent. Money can be made either way.

That being said, you could be right…you never know what might happen. I’m closing on this house Sep. 7th and will post a follow up perhaps after rehab is done and it’s rented.

It's Me

August 29th, 2007 at 3:25 pm

You’re walking a fine line but if you watch the pennies and the days you should be ok. There even a chance to get it rented over the next week and have the repairs done as the new tenants are moving in.

Don’t forget to knock on the neighbors’ doors. Someone probably has a friend who’s looking for a place to rent. Good luck – I’ll be interested in watching your progress.

Ben

September 5th, 2007 at 6:16 am

Great and simple way to show and explain to people on flipping or buying properties as an investor. I should be telling you shhhhh…don’t be telling everyone! LOL! ; )

Salank

September 9th, 2007 at 4:35 pm

Are you still able to do cash out refinancing now with the subprime market situation?

Brian Armstrong

September 10th, 2007 at 5:26 pm

I’m not planning to do a refi on this property, but to answer your question yes it is still possible. Thanks!
Brian

Helen Yu

September 20th, 2007 at 8:51 pm

I have been in the lending business since the early ’90’s. There are a few inaccuracies with the scenario you have posed:

1) Lenders across the board will calculate the maximum loan-to-vlaue on the LOWER of the actual purchase price OR the appraisal value. No lender will loan 80% of the projected value after reapirs which by your estimation is $92,800 loan amount = $16,800 more than the actual cost of the property.

2) 100% financing (based on purchase price of $76,000) is only available on a full income documentation owner occupied primary residence, not a non-owner occupied investment property.

3) 12 months ownership and value seasoning is required on any cashout transaction and with the current lending crisis, loan-to-value will be very, very low, particularly if the property is an investment, not owner occ.

Brian Armstrong

September 21st, 2007 at 1:14 am

Helen please know that I don’t mean any disrespect by this, but that is simply not true. I know because I’ve just done it: 80% of the after repair value, stated income, refinancing in 30 days. I think this type of loan is pretty rare right now but I’ve seen similar programs designed for investors from a few companies so they are not impossible to find. Keep in mind that it is hard money during the 30 day rehab period, then refinacing into something permanent. It’s not a cash out refi.

Helen Yu

September 21st, 2007 at 1:46 am

Fannie/Freddie and FHA actually have full doc versions of this loan which is essentially a small construction to perm loan funded in one step, but they would require full income documentation with strict debt to income and general contractor qualifications… This would be a much safer approach, but very arduous to qualify. I wish you lots of luck in your investment endeavors. The risk in the current declining R.E. market is that by the time an investor has completed the rehab 30 to 60 days later to pursue a refiance out of the hard money purchase loan, the property value as predicted by the initial appraisal may no longer be substantiated with new more current comparable sales and one may end up unable to refinance out of that hard money loan because the loan to new comparable value may now exceed the pevious 80%. An investor could find themselves stuck carrying the property at the 12-15% hard money rate and suddenly the negative cash flow can drive it into foreclosure in a very short time. Also need to consider that in light of the recent global lending crisis, lenders now have ever tightening requirements on ownership title/value seasoning. Property value will be calculated based on purchase price + documentable cost of improvements and the maximum loan-to-value to refinance will be calculated from that, not an inflated new appraisal when qualifying for your refinance. May be doable if you have 10-20% to bring in, not necessarily a $0 down deal in this market. Best of luck to you in this tough market.

Brian Armstrong

September 21st, 2007 at 2:02 am

Hi Helen, thank you for the comments…I will post a follow up once it is rehabbed and rented. Hopefully it works out as planned!

Helen Yu

September 21st, 2007 at 3:34 am

Rental market is strong since 100% stated income financing is gone and fewer buyers can qualify to purchase. The bigger challenge will be getting it refinanced out of the hard money loan to which you have committed for the purchase money. You could find yourself having to maintian that high interest private money loan for as long as 6 months to a year before a lender will grant a new conventional loan based on new appraisal value (and for new appraisal value to be high enough to absorb the $92,800 you borrowed initially.) Hopefully, it all works out, but as previous poster said, up to now rampant appreciation and lenient lending guidelines have mitigated a lot of the potential risks in real estate speculation, but those days are gone and the exposure can be high.

Helen Yu

September 21st, 2007 at 1:32 pm

Just checked Fannie Mae guidelines (they are really the only entity buying loans right now), they will allow new appraisal value for LTV calculation, but unless your Debt-To-Income ratio can qualify with full income documentation (complete tax returns or W2’s and paystubs if wage earner) a “stated income” loan will require minimum 720 fico score to go to 90% LTV and will require Mortgage Insurance if LTV exceeds 80%. “Stated” income doc type will also require cash reserves (seasoned in your account for > 60 days) in the amount of 4 X monthly income as stated or 6 months of PITI overhead, whichever is higher. Assuming you “state” $5,000 monthly income for the loan to fit into your debt-to-income ratio, you will have to document $20,000 in seasoned cash reserves. I hope you can fit these guidelines. Good luck!

Brian Armstrong

October 30th, 2007 at 11:47 pm

For those waiting to see how this deal turned out, please check out my follow up post. Thanks!
http://www.startbreakingfree.com/200/

JaimeG

January 16th, 2009 at 1:07 pm

Real estate investing is where the big money is. I consider it even more stable than investing in the stock market. Seriously if you are thinking about it..do it. To get started I can recommend reading “The Pizza Delivery Millionaire” by Rick Vazquez. Mr. Vazquez truly simplifies the strategies that will lead you to success and to becoming financially free. The best part is he talks about how anyone, no matter what background can become successful… real estate is not only for the rich!

Brian Armstrong

January 16th, 2009 at 3:51 pm

Yep WAY more stable than stock market. Thanks Jaime!

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How To Analyze A Killer Real Estate Deal

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