You may have been asked the following question, when do you make money in real estate when you buy or when you sell? Ok, we all know that after you finally sell the property, close on the sale at the title company and deposit the closing check, that is when you see the money from the investment. However, you make the profit when you buy the property. You must first purchase a property at a price that will bring you your desired profits based on your planned exit. Simply put, if you buy wrong you will lose money. Period. Here is the rule that if broken can be a killer to your dreams of ever being a successful real estate investor.
Don’t overpay for a property
If you overpay for a property, there is nothing you will be able to do to make your desired profit from that investment. In my book “How to Fail and Win Big as a Real Estate Investor” I speak about a type of disease that newbie investors have that I call Dealitis. It is defined as the inability to find a deal and then the person buys the 1st overpriced deal that they can get an offer accepted on. It is an unforgiving disease. It takes no prisoners and leaves every infected patient with a smaller wallet. You’ll make your profit when you purchase a property based on what it’s currently worth rather than what it might be worth someday so purchase wisely and stay away from those who have Dealitis. I don’t want you to get infected.
I know we are not fortune tellers and we can not see the future, however we can guesstimate where the market may go. (I don’t know if guesstimate is a real word, but I like saying it.) All of us can figure out where the market is at today and can see what is going on in the world and come up with some type of future price of a property. By looking at where the market is today and studying market trends, you will be able to tilt the scale of profits towards you and earn those big paychecks you heard about when you started your journey into the world of real estate investing.
I have a single family home that was offered to me and it is being marketed at $79,000 with recent comparable sales showing similar nearby homes having been sold between $110,000 and $120,000. This particular home, however, needs about $45,000 worth of work. Therefore, if you pay $79,000 for it and put in $45,000, you’ll have already spent $124,000—and that’s before the closing costs, holding costs, marketing and selling costs, any budget overages, and any other fees that you will be responsible to pay.
In all likelihood, you will be underwater (you’ll owe more than it’s worth) with this property no matter how much work you do to it and how wonderful you make it look. However, if similar homes were valued at $150,000 or more, you would find that you made your profit when you bought the house for $79,000. You would not mind investing the $45,000 into the property because the numbers show you will be in a good position to profit. So, make sure that the purchase price is one that works for you and your business model, not the wholesaler or seller goals. It is our responsibility to make sure that we are being diligent in our analysis of what is a deal and not a deal and make the decision based on numbers, not emotions.
Now the above example is based on profits from rehabbing a property after buying it at a wholesale price and selling it for a retail price. However, there are others who invest for appreciation and they have different numbers with which they make their decisions to purchase a property and those decisions work for their specific exit strategy. That is a big reason why you need to have your exit strategy in mind before you purchase the property and thus make sure that the purchase price fits your exit strategy and is profitable when you buy the property.
Having appreciation is the icing on the cake and it is a wonderful bonus to have on a sale of a property, but buying for appreciation can be a recipe for disaster. If you hold the property long enough and the holding costs are not excessive you can pay more than most and still turn a great profit, not to mention the cashflow that you are able to gain during the time that you are waiting for the property to appreciate. On the other hand I have seen many investors invest hoping for appreciation and when the market corrected they were hit hard and lost a lot of properties that were underwater. Worse is the situation when they can not rent the property for more than their monthly payments are on the property and they are losing money every month on top of not gaining the appreciation.
I strongly believe that unless you are in a position to hold for the long term, an investment does not make sense if you are only investing for appreciation. We are not oil speculators or gamblers at a roulette table and although we could theoretically make a lot of money risking it all on a maybe, I would advice you to be careful and decide wisely. (I have been on the winning and losing sides of investing for appreciation and it is not fun when things don’t go your way, but it is an awesome bonus when you get a big payday.)
So, if you stick to the idea of purchasing a property for cashflow, if that is your model, for profit, if that is your model, or for appreciation, if that is your model, make your purchase decision on the relevant numbers that will work to give you a profit for your designated exit strategy.
Until next time go out and make it happen….