Real Estate Investment Strategies: Rehabbing
Rehabbing, or fix and flip, is another popular method employed by real estate investors. This can be a very profitable way to spend your investment dollar, but does require a hands-on investor and a considerable amount of work.
The concept behind Rehabbing is simple. Find and purchase a property under market value, fix it up, and sell it for a profit. While extremely lucrative if done correctly, Rehabbing can be very challenging when you consider all of the details involved. You must first of course find the property, effectively manage the repair schedule, and sell the property after completion all while keeping a close eye on your budget and not having the benefit of rental income to offset costs.
Locating Property
The first natural step to rehabbing distressed properties is of course finding the right property. You can always search for properties yourself but real estate agents constantly search for properties and have many tools at their disposal that you will not have access to. Combined with the fact that it does not cost you anything to use them since their commission is paid by the seller, many rehabbers have several agents on their team who constantly send them potential properties.
If you do decide to use an agent to find your properties, know that several multiple listing services, or MLS, will label properties as "fixer uppers" to help you distinguish them from the pack. It is also a good idea to have your agent search for homes by price per square foot. If you find a property priced at $110/sq. ft. in a neighborhood with most homes priced over $150/sq. ft. then this property might be worth pursuing. Also, keep your eyes open for homes with an unfinished basement, because by finishing this space you can nearly double the livable sq. footage and add a considerable amount of equity.
Before you take the time to actually visit a potential property, have your agent give you a CMA or comparative market analysis. This report is designed to help compare properties to one another, and can be a very useful tool when looking for rehabs. A CMA will further help you to accurately asses what your homes value will be after the makeover. Also be sure to ask what he/she would sell your home for if it were in pristine condition. As real estate agents list and sell homes on a daily basis, they are very familiar with how to price a home to sell. If you do not have at least a 20% margin under market value, move on to the next property.
Costs
To understand why you need at least 20% equity in the property, you need to evaluate the costs involved. If you are lucky, you will only have carpet and paint to pay for, but there are often times other repairs required before you are ready to sell. If you will be finishing a basement for example, plan on $15,000+ in expenses although this will make your returns much larger. You will then need to anticipate the costs associated with selling the home. If you do not plan to sell the home yourself and are not a Realtor in the state in which you purchased the property, you will need to pay the listing agents commission. For this expense, plan on 6% of the sales price. Finally, you will need to pay the sellers side of the closing costs.
In addition, you must consider that the normal escrow period is typically 30 days, and it's highly unlikely that your previous owners will move out immediately, so can count on making at least a few mortgage payments before you re-sell.
Controlling Your Costs
This means that to break even you will need to get the home around 15% below market value. There are, however, some ways to control these costs but it is wise to always plan for the worst and expect the best. For example, you can remove your largest expense by selling the property yourself with some simple marketing. Many tactics used by real estate agents, such as placing an ad in the paper, putting a sign in the yard, and exposing the property to other agents are simple, cost effective and easy. Be sure to plan on including a buyer's agent commission of 3% into your costs so as to not eliminate anyone represented by an agent from your potential buyer pool.
Depending on how the market is, it can be easier said than done to sell a home, so sometimes it is best to leave things in the hands of a professional agent. This is just one tactic, used by savvy investors to keep their costs down. Another approach is to do many of the necessary repairs yourself. By fixing the home on your own, you only need to account for the expenses relating to the materials, which can save you thousands in labor. If you are not the do-it-yourself type, you can even bring in a partner who is more familiar with the construction side of things to assist you. Many investors choose this route, because having a partner allows them to do several homes simultaneously.
Also, since you will probably be making some monthly mortgage payments, many investors will use interest only loans to help keep this cost in check. You see, interest only loans allow you to only make payments toward the interest portion of your loan, and cost considerably less than conventional mortgages. The only disadvantage being that you are not paying down the principle loan amount, but its insignificant because you are not planning to keep the property for long anyway.
Conclusion
While extremely challenging and often times quite complicated, rehabbing a distressed property can produce excellent returns for the determined investor. Keep in mind the key to finding success in rehabs, is locating the right property and being creative in finding ways to cut costs.