How to Evaluate a Real Estate Investment Deal

Business concept isolated on whiteThe number one priority of any real estate business is finding great deals. Yes, it is important to build your buyer’s list so that you can sell the properties you buy quickly. But you won’t stay in business long without deals to sell to your buyer’s list.We speak with many investors that are looking to buy real estate investment properties. Some are seasoned pros and some are new to real estate.

When you get to down to it, evaluating a real estate investment deal is really a simple process. No matter what your exit strategy is (wholesale, buy and hold or fix and flip), it is vital to buy your investment properties right. Let’s take a look at the process of evaluating a real estate investment deal.

Evaluate a Single Family Home

Let’s look at the main elements to consider when evaluating a real estate investment deal.

  • Cost of repairs to bring the condition of the house up to neighborhood standards or slightly above
  • The after repair value, or ARV of the property, after it is fixed up
  • If you are going to buy and hold (whether as a rental or a rent to own), you will need to the costs associated with this exit strategy. Considerations include the mortgage payment, property insurance and taxes just to name a few.

These are the three main items to consider, though there are others that need to garner your consideration as well (realtor fees, if you are selling retail, utility costs, etc).

Buy and Hold – Rental and Rent to Own

What if you want to buy your properties to hold as a rental? Or even rent to own? There are a couple of other factors that you will want to consider when evaluating a real estate investment deal. The primary concern… will it cash flow?

In order to determine this, you will need to know what the mortgage payment will be on the potential purchase. You will want to speak with a mortgage broker to determine this payment. Or, maybe you use a private money lender. Just plug the rate and term from your private lender into a simple amortization calculator to determine your monthly payment.

Next, you will want to determine what the property will rent for on a monthly basis. You can get this research a number of ways. You can do a search on craigslist.org for comparable properties. You can take a look at Zillow.com and use their Rent Zestimate. You could also speak with a realtor to get an idea.

Subtract the estimated monthly rent and the monthly debt service and the property to determine if the property will cash flow. You will also want to subtract other expenses like property taxes, insurance and reserves for future repairs.

Cost of Repairs

One of the most important skills that you should become good at is estimating repairs. If you don’t want to take the time to learn the process, then make sure that you get a good contractor as a member of your team. Nothing will torpedo a deal more quickly than incorrectly estimating repairs costs. Getting a couple of estimates would be even better.

After Repair Market Value (ARV)

The easiest way to get the after repaired value of the house is to have a realtor pull sold properties the are comparable to the property you are considering. The variables that you use when having your realtor pull comparable sold properties are VERY important.

The value of a sold comparable property is tied directly to its relevancy to the subject property. The sold comparable properties should be within a half a mile of the subject property, but no more than a mile. There may be times, such as rural properties, where this may not be possible. The age of the sold comparable properties should be within the last 90-180 days, if possible. Due to the volatility of the current market, any older may not be an accurate reflection of the homes current value. You will also want to use comparable properties that are +/- 20% of the size of the subject property.

Finally, you will want to compare apples to apples. Don’t use properties that sold as bank owned or as a short sale as comparable properties. These properties are “distressed” properties that often sell for an average of 25%-30% of the normal retail values.

Failure to consider these variables when pulling your sold comparable properties will keep you from being a successful real estate investor. Make your offers too low because you are using bank owned and short sale properties as your comps and you will never get an offer accepted.

Calculating Your Offer Price

The age old formula, developed by Ron Legrand, is as follows:

ARV – Repairs X 70% = Maximum Allowable Offer (MAO)

This is a little bit of a generalization. If your exit strategy is to buy and hold and the property cash flows well, you may be more willing to stray (go higher) from the 70% multiplier. However, if you are a wholesaler, you will want to purchase below the 70% multiplier. As a wholesaler, you make your money from the spread between your offer price and the MAO. A good rule of thumb is to be between 60% and 65% if you are wholesaler.

Making an Offer

From here, just make the offer.

Just remember, the rule of thumb in real estate is to never over pay for a property. That’s why you want your deal evaluation process to be so strict. Always keep your emotions out of it.

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