Cash Flow Business Tip of the Week- What’s A Good Deal in Real Estate?

real estate concept with US dollars and mini house, shallow dofAll good deals in the complex business of purchasing real estate depend on knowing the fair market value of the property you wish to buy. A “good deal” is defined as being able to buy a property for a certain price and being able to resell that property the same day for a profit. Below are several examples of how this can be accomplished.

In the following examples, it is assumed that you have done your homework and know what the property is worth. In the real world, there are many apparent “good deals.” Be wary; many smart sellers can take advantage of buyers who want to be “creative.” Sellers can price the building with what may only appear to be very good terms. Many of these sellers fully intend to foreclose on the unwary. Be careful…clever buying techniques without a good knowledge of your market can lead to disaster.

If the figures seem confusing, try drawing a chart or write out the numbers. It is important to understand these calculations, as this kind of thinking is the key to creative and profitable investing. Here are some examples of “good deals.”

1. No or Low Down Payment: Nothing down is a buzzword in the real estate arena. These deals are popular and can be profitable because of “leverage.” Leverage means investing the least possible amount of your cash. In this way you earn the maximum percentage return on your money. So, we look for properties that are priced at least 15% below “fair market value.”

Example: If you can purchase a $100,000 home for 25% cash down, or $25,000, and you can later sell the home for $110,000 you will have made a profit of $10,000. That amount divided by your investment of $25,000 would give you a return of 40%. But, if you could purchase the same $100,000 home for 5% down or $5,000, then your return would be 200% ($10,000 divided by $5,000 = 200%.) That is the magic of leverage, and that is why low or no down real estate purchases are important to the investor.

2. Seller Carry Back: If the seller will carry back 25% or more of the purchase price in the form of a note with no balloon payment, at below market interest rates, then this can usually be considered a “good deal.” Similarly, if you can take over the seller’s low interest loan with no qualifying and with no escalation of payments or interest, this would qualify as a good deal.

3. Below Market Purchase Price: Clearly, if a seller is distressed and must sell, or if the seller is unaware of the fair market value of his or her property, or if the seller is unable to manage his property, she may sell to the buyer who can solve her problem. Many people make a lot of money seeking out the distressed seller, often called a “don’t wanter.”

Example: People who may be selling under distressed conditions include couples going through a divorce, probate sales, foreclosure sales, people who place desperate type ads, people who cannot manage an income property, out of town owners, owners who are retiring. There are as many reasons for distressed sales or forced sales as there are don’t wanters.

4. Clauses: When the seller will accept subordination clauses or substitution of collateral clauses, then you have the makings of a good deal. Properties that can be lease-optioned and then sold on a contract for deed have a potential for making a lot of profit. This clever technique will be explored in future tips.

5. Turn Around Deals: (Also called Flips or “Buy-Wrap-Sell”): You can fix up or just re-sell a property with the same $ down you made but with higher monthly payments. Or, the property can be bought “subject to” existing loans, you then resell on a wrap around mortgage with the same down payment and the same price, but with a higher interest rate. These are good deals because they can be quickly resold at a profit.

Example: Buy a cosmetically ugly property with good assumable financing for $75,000, $5,000 cash down and payments of $348.93 per month ($65,000. 5%, 30 years.) Resell for $90,000, $5,000 cash down, $717.28 per month ($85,000, 6%, 15 years.) Profit: $368.35 per month and you don’t have to manage the property.

6. Fixer Uppers or Junkers: Potentially the most profitable investment in real estate. In this case we get the seller to deed the property to you, with you giving him some non-cash security, such as a note with no payments for one year. You then fix up the property, finance at the new increased value and pay off the seller. The seller then gives you back your note. Or you can then sell at a higher price and keep the profit.

Example: You locate a junker six-unit property that an owner is unable to manage. The purchase price is $105,000 based on an income of $1,250 per month or an average rent of $208 per month per unit. Seller agrees to sell to you if you pay all cash one year from now. Seller however, wants a note on some other property of yours for $105,000, 5% interest only, first payment due 12 months from now. Note: This second property does not have to be worth $105,000, it is merely a convenience to insure that you will pay the purchase price on the six units as agreed in one year. You then do what you have to do to raise the rents on the property to $295 per month within one year. Raising the rents will raise the price of the property from $105,000 to $148,680. You then can refinance for 75% of that value or $111,510. Profit: At that point you have a few thousand dollars in profit, depending on refinancing costs and $37,170 in equity, with very little of your own money involved.

7. Notes to Get Cash for Buying: You may have a good deal if you can “over finance” a property, and then use the extra money to increase the value. You first “create” a note for the down payment, or even the entire purchase price, secured by something other than the property being purchase. This could include a car, house, rental unit or whatever. The important thing to remember is to make the security for the note something other than the property being purchased. If you are creating a note for just the down payment, make your offer “cash plus a note” secured by the other collateral. Be sure the cash part is less than what can be borrowed against the property.

Example: $100,000 property with $80,000 new first mortgages possible. You might offer $70,000 cash and a note for $30,000 secured by the other collateral. This totals $100,000. You then finance the purchase for $80,000 giving $70,000 to the seller and keeping $10,000 for yourself. Since this is borrowed money, it also becomes tax-free. You now owe $80,000 to a bank on the first note on the purchase property and $30,000 secured by a mortgage on “the something else.” You owe a total of $110,000. Clearly, the property being purchased provides enough income to make both mortgage payments. Or you must be prepared to make the higher payment yourself.

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