When you are beginning your real estate investing career, it is extremely important that you not rush through the process of purchasing a property. Unfortunately, all too often as I travel through the southeast United States to invest or speak on industry panels, I come across investors who make mistakes such as underestimating repair costs, overestimating the after-repair market value of the property and not accounting for cost overruns.
I feel it is extremely important to become familiar with these common beginner issues, in order to avoid them.
In most cases, these mistakes stem from the investors simply lacking a solid investment plan.
Planning is the foundation of success in any business, and especially in real estate investing, where timing is absolutely essential. On average, the amount of time between an offer being accepted and a property officially switching ownership is roughly three to four weeks. In a hot market, this timeline can decrease to as little as a week.
An intelligent investor will utilize this time to create a detailed renovation plan and devise a solid market strategy, depending on whether the ultimate goal is to flip the property for a quick profit or to rent it out and enjoy the fruits of positive cash flow, passive equity growth, amortization and inflation.
After taking ownership of the property, do not waste a single day. The minute the keys switch hands, you should be in a position to begin renovation work. That requires preplanning: ordering dumpsters to be on site, making sure all the necessary materials are acquired, obtaining any required city or state permits for the planned work, etc.
Take care also to ensure your calculations are accurate. In any endeavor where money is on the line, numbers rule. It is essential to conduct a proper, detailed inspection, preferably accompanied by a professional contractor.
Too many newbies make the mistake of building a team without vetting the right contractors and thereby underestimate repair costs, and they are later forced to subtract tens of thousands of dollars from their profits just to complete the project—assuming that the property sells at the projected market value.
And that brings us to another all-too-common beginner mistake: overestimating the value of the property. For example, let’s say you purchase a property for $100,000 and estimate that after repair costs, which will run up to approximately $25,000, the property will sell for $175,000. Under that scenario, your projected gross profit margin is $50,000. However, if your projected sales price falls short of the actual sales price—which usually happens due to inadequate research—that profit can quickly diminish, or even disappear altogether.
As real estate investors, we are speculators. And in order to play the game, we must become proficient at all aspects, including valuing the current, as-is value of the property and the value of the finished product. One wrong move here, and you will lose your shirt.
The excitement of closing the very first deal leads many investors to rush through the process of acquiring the property. Planning tends to be bypassed, renovation costs tend to be underestimated, and the projected final sales price, after renovations, can be and usually is overestimated by optimistic and hopeful new investors or by wholesalers and real estate agents looking to make the most of an opportunity.
Being able to detect these mistakes before they manifest themselves will simultaneously save you and make you a lot of money.
Here’s a quick rule-of-thumb that I use when looking at single-family flips:
If the timeframe for the entire deal from close to close is less than six months and I have confidence in my team to get the job done, then my Maximum Purchase Price = (70-75% * FMV) – Cost of Repairs. Otherwise, my Maximum Purchase Price = (60-65% * FMV) – Cost of Repairs. For all new construction deals, my Maximum Purchase Price = (18-22% * FMV) – Cost of Construction.
Does this mean I sometimes may miss out on opportunities? Yes. But I am OK with that. There is a lot more to talk about here, even if you are a seasoned investor, and I am happy to share my insight. If you have questions, feel free to get in touch with me.