Savvy investors have strictly followed the philosophy of “You make money when you buy the property!”

The improvements are just part of the blocking and tackling.

With high competition for properties in attractive areas, it will take hard work and many offers to land the property that has a high probability of generating attractive profits or building immediate substantial equity that enhances cash flow!

To efficiently process a larger volume of opportunities you will need to systematize your approach.

The first step is to use a spreadsheet or piece of paper to create a template of the formula for success.  When investing in rehab projects, it is best to work backwards to solve for the “Maximum Purchase Price” for each property.

Step 1 – You identify a property.  It is presented by a realtor, referred to you or you drive by it.  First thing you must do is set a market value expectation for the property.  What are homes with similar amenities, (bedrooms, baths, garage, square footage, etc.) selling for in the area.   Most accurate estimate of value will be to get at least four sales comparables that are within one-half of one mile and have sold within the past six months.  If you have trouble finding these types of sales comparables, so will an appraiser when you go to sell the property or refinance it.   This might be a reason to lower your LTV% (loan to value) target.  Add up the purchase prices of those properties and calculate the average.  This will be your estimated market value or what you think you could sell the property for in the present.

Step 2 – Determine scope of work that will be required for entire project.   It is recommended that you get three estimates for the work.  This will help you identify the full list of improvements needed and provide additional ideas from the contractors.  The more detail the better for each improvement item and quote.  This will be deemed the improvement amount.

Step 3 – Set a target maximum loan to value (“LTV”) which builds in the inverse of the amount of gross profit that will be in the transaction.  65% to 70% LTVs are safe targets for most areas and will provide flexibility for unforeseen issues, longer sales times, realtor fees and seller concessions.

We are now ready to set up our template as follows:

Multiplied by Maximum LTV
Less Improvement Amount
Equals Maximum Purchase Price

Numeric Example:
123 Elm Street – Asking Price $69,000
Sales Comparable 1         $105,000
Sales Comparable 2         $90,000
Sales Comparable 3         $110,000
Sales Comparable 4         $95,000
Market Value                    $100,000 ($105,000 + $90,000 + $110,000 +95,000 = $400,000/4)
Maximum LTV                   70%
LTV Discount Amount    $70,000 ($100,000 * 70%)
Less Improvements        $20,000
Maximum Offer Price    $50,000 ($70,000 – $20,000)

To be successful you need:

1.)    To be disciplined on following the formula and bidding based on results.  Do not fall in love with a house or let your ego make you want to win the bid!  This is an investment and business transaction.  Emotions will cost you money!

2.)    Establish a relationship with a realtor who is willing to provide the sales comparables and submit numerous offers.  Their assistance is invaluable.  You can reward them be being loyal and giving them your listings.  Alternatively, you could also get your realtor license.

3.)    Build a stable of contractors that are reliable and responsive.  Asking them to walk through numerous properties to provide bids will give you a better idea of how they will operate.

4.)    Make sure you understand deed restrictions.  Some sellers, like HUD, will limit the amount of debt you can put on the property.  This could eliminate your ability to obtain loans for the repairs.

5.)    Remember, larger proportion of improvements means higher risk due to potential surprises, (the more moving parts the more parts that could be broken), and longer renovation period.  During construction these projects are non-earning assets.  Meaning, you are not collecting any rent and you are not pocketing the profit from the sale.  The longer the renovation period, the more that can go wrong.  Think break in, storm damage, fires, bursting pipes and vandalism.

This approach and formula works for rehab projects that are being sold and for projects that are held for rentals.  When sold, the real estate investor collects their profits at closing.  When kept as a rental, the real estate investor collects cash flow over time and has a larger built in equity position which typically lowers borrowing costs and enhances the cash flow.