Buying old houses at wholesale price, fixing them up, and then selling them at retail price remains one of the easiest ways to make big profits in real estate. If you are prepared to put in some hard work, property rehabbing remains one of the easiest ways to profit from real estate.
Unfortunately, would be rehabbers can be easily seduced by the promise of fast money. You see it's not simply a case of buying an old house, fixing it and selling it for massive profits. Back in the mid 1990's when I started to fix-up my first investment home, I soon discovered how easily things could go wrong. The following are 8 of the biggest mistakes you can make when fixing up houses. How do I know this to be the case? Yep, you guessed it. I've made them all when starting out.
Big Mistake #1: This is a "Get Rich Quick" Strategy
While adding value to property can rapidly increase your wealth, it is not a miracle cure nor is it a 'get rich quick' scheme. It still requires time, dedication and effort. The results that you ultimately achieve will reflect on your commitment to these three areas.
Big Mistake #2: A Lack of Extensive Research
Many years ago I worked for a paint manufacturer and learn a valuable lesson: Painting is 80 per cent preparation and 20 per cent application. This very same rule applies to buying and rehabbing property. 90 per cent of your time will be spent locating and purchasing the property itself. In this instance, your preparation will be research, viewing, negotiating and more research.
Big Mistake #3: Do All the Work Yourself to Save Money
As rehabbers, we can easily convince ourselves to do the work and save a few dollars. This train of thought is fraught with danger on two levels. Firstly, if the level of workmanship is substandard then this can and will affect your resale price. Experience has taught me one very important lesson: If you're no good at it yourself, pay an expert to do it. The second danger refers to time leverage. It is false economy to save yourself $35 dollars per hour by doing it yourself if you earn $50 per hour.
Big Mistake #4: Insufficient Cash Flow
As with any business venture, cash flow is king. There is no point having a potential $50,000 profit up your sleeve if you can't pay your bills. Unless you have sufficient cash reserves, I highly recommend that you do two or three projects and put the money aside before you rush out and quit your job.
Big Mistake #5: No Exit Strategy
There will be times when, despite your meticulous research and planning, the property doesn't sell. External influences that are beyond your control pop up from time to time. Be prepared for this with an exit strategy and you'll be fine. Firstly, never enter a project if you cannot afford any unforeseen holding costs. Secondly, there is no shame in holding a good property. If the market doesn't agree with you at that particular time, then rent it out for twelve months.
Big Mistake #6: You Pay Too Much When You Buy
You make your profit when you buy. Pure and simple! I will always tell my coaching clients at my workshops that this is the most valuable advice that they will ever receive from me. The added value from the renovation is the icing on the cake. Always research your market well and ensure that the potential selling price is achievable when all costs and profit margins are taken into consideration. Never, ever let yourself be ruled by your emotions when buying. You must always allow for buying, selling and closing costs. Where possible, your purchase price must be sufficiently below market value to at least allow for these costs. Even better, the price should be low enough to allow for closing costs plus rehabbing costs.
The following formula will allow you to assess the real purchase cost of a particular home that you may have in mind. Starting with the final selling price, work backwards and deduct selling costs, profit margin, renovation costs and buying costs. This final figure is how much you should be prepared to pay.
Big Mistake #7: Failure To Understand Your Target Market
How often have you walked into a home and been totally horrified by the décor? Yet this is another common mistake made by renovators. They let their emotions get in the way and decide what is good for them is good for everyone else. There are two principles that I apply when renovating. The first is the K.I.S.S. theory: Keep It Simple Stupid! The second is to focus on the "wow" factor. It is no coincidence that a home sells quicker and for a higher price when it possesses strong buyer appeal. You're here to make money, not win a home decorating award. Give the market what it wants, not what you think it wants!
Big Mistake #8: Spending Too Much on the Rehab
The great temptation of renovating is to do too much. While the "wow" factor is critical, you must keep your emotions out of the equation and strictly adhere to your budget. Nothing goes exactly to plan when renovating, so don't panic if you exceed your budget by small amounts. Allow for a buffer to cover any surprises (usually 10 to 15 per cent). I certainly fell into the 'do too much' trap during my early projects. Always have your costs estimated accurately prior to purchasing a property. Later on I will talk about contract of sale conditions. One such condition is to purchase subject to having a builder inspect the property. This will enable you to discover any unforeseen surprises. I encourage you to renegotiate the price should the inspection uncover any major defects - or better still, walk away.My budget parameters are 10 per cent of the purchase price for houses. This can be stretched to 15 per cent if it means that a great profit can be made. These are personal preferences that have worked for me. They are in no way set in concrete and readers should exercise their own judgment. There is no right or wrong way in this business. The percentages that I allow are in keeping with my primary objective of obtaining the biggest bang for your buck in the shortest possible time and with the minimum amount of money possible.
Conclusion: Understand that things can and do go wrong in this business. Now that you are aware of the pitfalls, you will be better prepared from the outset. All it takes is a little planning and there is no reason why you can't join the thousands of Americans who are quietly making huge fortunes from their Fixer-Upper business.
Real Estate - A Hedge Against Inflation
Depending on which economist you read you may be inclined to believe that the US is headed towards an inflationary economy. The theory is that because the Fed and it's counterparts around the world have been printing money to combat the global recession, inflation is a natural consequence. If you buy into this argument, you may want to consider investing in real estate as a hedge against inflation. With real estate, if you have a low-rate, 30-year, fixed mortgage, your note will become a thing of beauty as prices rise:
- Your property value will rise
- Your rental income will rise
- Your mortgage payment will remain fixed
- You will repay the loan with cheaper dollars
There is plenty of disagreement, of course, among top economists regarding inflation. Some argue that with unemployment figures at a 26 year peak and plenty of idle factory space, rising prices in the near term is not a concern. Real estate investors need to remember however, that a hedge against inflation is just one of the many benefits of investing in real estate. Frequent readers of this newsletter will note that we often discuss the numerous tax advantages to owning real estate including:
- Ability to depreciate real estate hence reducing (or eliminating) your
reportable taxable income from the property
- Ability to write off expenses
- The mortgage interest deduction
- The ability to sell real estate and either avoid and/or defer the payment of capital gains taxes
One thing for certain is that plenty of opportunistic investors are finding value in today's real estate market.
