Your Most Important Asset

Most real estate investors are quick to answer the question, “What is your most important asset?” with the response “Real estate holdings.”  Others will mention cash reserves.  Working for an organization that caters to only rehab investors, and having completed thousands of deals, we can tell investors that the answer is their credit score!

Mortgage lenders, banks, utility companies, prospective employers, insurance companies, trade creditors, and more use credit scores.  A credit score can have a lasting impact on your ability to grow your real estate business in addition to other aspects of your personal and business endeavors.  Your credit score is your most valuable asset.  It must be protected and nurtured or it will cost you money and opportunities.

Access to Loans

A credit score can make the difference between being able to obtain a loan and getting denied. Even if your score only drops several points, it can result in higher interest rates.  As far as lenders are concerned, lower credit scores equate with higher chances of delinquency, which translates into a higher risk premium on your loans or flat denial of your application. Delinquency is defined as any default, bankruptcy, non-payment or 30-days past due payment.

According to myFICO, a website dedicated to FICO Scores, the following are the delinquency rates for different categories of FICO Scores. A FICO Score is used to establish mortgage rates, car loans, and credit card terms. A FICO Score is devised based on credit history, and helps lenders appraise credit risk.

Assume for a moment that you are the lender and it is your money being lent.

Armed with the “Delinquency Rate” chart, to who would you lend? The answer is obviously that person with the higher credit score meaning lower probability of delinquency.  Who would you give the “best” rate to and who would get the “highest” rate?

Insurance Premiums

Yes, insurance companies use credit scores to determine if they will even provide insurance to a client, the types of coverages that they will make available, and the cost.  Insurance companies have thousands of historical data points and statistical evidence that shows a correlation with “Bad or Lower” credit scores and the probability that an insurance claim will be filed.  The insurance companies take the logical approach that if the probability of a claim being filed is high, then coverage will be denied or reduced and premiums will be raised.   This can occur even after you have an established relationship with a provider if your score drops.

Trade Creditors

Suppliers of building products and many utility companies use the credit score as the primary tool in evaluating whether they will extend credit and how much.   The alternative is to require cash payments or deposits for those products and services.

Building and growing a real estate business can be challenging and requires the management of many variables.   Managing the most important or valuable asset, the credit score, is something that you have control over.  Taking the necessary steps to preserve and increase the score will result in significant savings that can be reinvested in the business and provide access to premium loan and insurance products.

“You make your money when you buy the property!”

It took me several years to truly understand what “You make your money when you buy the property” meant.  After seeing my first real estate investor client successfully complete over 100 projects and make money on all of them, and hearing a similar mantra from other top notch investors, I began to understand.

There are basically five “variables” in the rehab real estate profit equation.

  • Purchase Price – What you pay for the property
  • Improvement Costs – What it costs to bring the property back to market condition
  • Soft Costs – Closing Fees, Loan Fees, Interest, Insurance, Taxes, Realtor Fees
  • Sales Price – What the property sells for

And it all equals…

  • Profit – What you put in your pocket once the property sells

The successful investors start with a target Profit figure and work backwards.   A Profit target can be a minimum dollar amount or a percentage.  In either case, they make sure there is wiggle room for unexpected negative changes in any of the other expense variables.  The percentage or dollar amount target can be influenced by factors like the investor’s experience, appetite for risk, neighborhood, and size of project or amount of improvements required.   It may take longer to find the right project that meets or exceeds your target, but that is much better than the alternative of cutting it too close and making little or no money or possibly taking a loss.

Since you do not know what the Sales Price will exactly be, the best way to estimate is to determine the market value of similar homes.  Sales Comparables or a “Subject To Appraisal” can provide this data.

Title Companies, Realtors, Insurance Agents, Lenders, and Auditor Sites can provide the information you need to determine a Soft Costs total.  Remember, that several of these Soft Cost items are impacted by the passing of time.  Taxes, Insurance and interest expense grow the longer the property is in your hands.   Use Days On Market (DOM) data to help you calculate those figures and it is not a bad idea to add a couple months to the average.

Improvement Costs can be obtained by getting 2 – 3 estimates for all the improvements required.  Additionally, walking the project with different contractors typically provides great ideas and different perspectives on what needs to be done and how.  If in doubt, spend the money for a professional inspector. 

We now have all of the required variables to calculate our maximum Purchase Price.

                Sales Price – Profit Target – Soft Costs – Improvements = Maximum Purchase Price.  

Now the negotiations begin.   The negative aspect of this approach is that it takes work, time and in most cases many offers. However, the positive is that you have dramatically increased your probability of a profitable project by “Making your money when you buy it!”