What are Good Deals in Real Estate?
All 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. I have had experience with all of these methods of purchasing properties.
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.” However, tricky sellers can take advantage of buyers who want to be “creative” and use lease options, or buy with low or no money down. 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 below 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 again becoming 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 its “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 might 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 her 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 put “desperate” ads in the newspaper (“must sell”, “leaving town”, “owner will carry”, etc.). Many people cannot manage an income property are ready to sell. Others include out of town owners and owners who are retiring. There are as many reasons for distressed 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.
5). Turn Around Deals: (Also called Flips, “Buy-Wrap-Sell”): You can fix up or just re-sell a property with the same down but with higher monthly payments. Or, the property can be bought “subject to” existing loans, but you can then resell on a wrap, with the same down payment, and 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 $570.42 per month ($65,000. 10%, 30 years.) Resell for $90,000, $6,000 cash down, $864.03 per month ($84,000, 12%, 30 years.) Profit: $293.61 per month and you don’t have to manage the property.
6). Fixer Uppers or Junkers: These may, potentially, be the most lucrative investments in Real Estate. In this case you get the seller to deed the property to you, and you give 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. You will have earned a cash profit on the difference between what you paid for the property and what you sold it for.
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, 10% 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 Fixing Up a Property (Over-Financing): You may have a good deal if you can “over finance” a property, and than use the extra money to increase the value of property with landscaping, painting, etc. 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 anything else of value that you own. 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.
The object in each of these examples is to purchase the property, and have cash to fix it up. You will surprised at the profit potential in an income property with a ‘”burned out owner” and run down building in a working class neighborhood.
Example #1: (Over-financing a $100,000 property with $110,000 in loans.) Seller has a run down duplex she wants to sell for $100,000 with $80,000 new first mortgage 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 fixing up the property and increasing its value. 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 purchase must provide enough income to make both mortgage payments. Or you must be prepared to make the higher payment yourself.
With the $10,000 you make cosmetic improvements and increase the price of the property to $125,000.
PROFIT: Sell for $125,000. Payoff the $80,000 bank loan, and the seller’s $30,000 down payment. You have an approximate profit of $15,000 less selling costs.
Example #2: (Extreme Over-financing a $100,000 property with $150,000 in loans.) Seller has duplex, that is in extremely bad condition. It needs extensive rehabilitation, but has a potential sale price of $180,000. Seller wants $100,000 for her RUN DOWN property with a $30,000 cash down payment. She agrees to carry back a note for the balance of purchase price of $70,000. You make the offer as follows: $100,000 purchase price, $30,000 down and seller to carry back a note for $70,000 secured by a “blanket” second trust deed on the property AND your home.
This allows you to obtain a new first of $80,000 on the duplex. From the $80,000 you give $30,000 to the seller and keep $50,000 with which to fix up the property. There is a first note of $80,000 held by the bank and a second note of $70,000 held by the seller and $50,000 cash to you for fix up.
In short, you have an $80,000 bank loan, and $70,000 seller carry back loan secured by another property you own. You have $150,000 in loans but have purchased the property with no down payment.. From the $80,000 bank loan, the proceeds of which went to the seller, she keeps her $30,000 down payment, and gives you back $50,000. You point out to her that you will use the money to fix up the property to increase its value. This makes her $70,000 loan more secure as the building rises in value.
Profit: Your net price is $100,000 for the property. With judicious fix up with your $50,000 you increase the price of the property significantly to $180,000 or more. You then sell the property for $180,000, pay off the $150,000 in loans, and have made $30,000 and have invested none of your own money.
Example #3: A house is for sale for $100,000. You offer $70,000 cash and a note for $30,000 secured by something else you own. Included in the offer is a clause stipulating that you, the buyer, are making the offer subject to new financing. It is important to be sure the ‘cash offer’ to the seller is less than what you can obtain via new financing. Your offer is subject to your obtaining a new loan of $80,000. $70,000 is given to the seller and you retain about $10,000 for buying the property. You now owe the lender $80,000 and $30,000 secured by another property. The seller nets $70,000 cash and a $30,000 note. You have $10,000 cash.
Profit: You fix up the property, improve the management, and increase the income such the property will now will sell for $135,000. You sell and pay off the $110,000 in loans and have a $20,000 profit less selling costs.