There’s a Method to Determining Where and Why to Buy Single-Fmaily Houses
I recently met an investor of single-family properties who made this statement when I asked him where and why he buys houses:
“I am very specific about the single-family homes that I invest in. I only buy three-bedroom, two-bath properties built between 1985 and 2001. And they must be located north of Main Street between Elm Street and Washington Drive, and not one block further south from Sixth Street. I will not buy anywhere else.”
He was very serious and implied that his approach was quite prudent for him.
“It’s close to where I live, and I know the area pretty well,” he explained.
“So you are holding these as rentals?” I asked.
He looked at me with a quizzical look and said, “No, I’m flipping them!”
“Must be a hot area. I bet you’ve bought a lot of houses there!” I said.
“Well, just two. In the last two years,” he said.
Over the past 20 years of buying single-family houses, I have heard similar explanations on dozens of occasions. Most of the reasons why these single-family real estate investors go after what they buy have nothing to do with market performance and investment fundamentals. It’s generally what’s most comfortable and convenient for the investor at the moment.
Do you know anyone who would apply this personal basis for investing in the stock market? Not someone who realistically expected to be profitable, that’s for sure! But for some reason, when it comes to real estate, people tend to get emotionally involved and find reasons to buy houses that only make sense to them. Many times (and I’ve seen this WAY too much) people just flat fall in love with a house, or a neighborhood, and not for the reasons that make solid investment sense.
Real estate investing is no different from any other form of investing. Targets (acquisitions) should be considered based on the fundamentals of the product and market performance.
Take it a step further and separate yourself from the emotional attachment you may have with real estate. Try to think of houses as if they were widgets. Imagine you are in a business and those widgets are your inventory. In order to make money and maximize your profits with your widgets, you must buy the widgets wholesale—a price lower than that for which you intend to sell them at retail. This must include room for expenses and a reasonable profit for you.
But you can’t invest in just any widget. The best widgets are in high demand and can be rotated out of your inventory as quickly as possible. Otherwise, you’re losing money in holding costs—every single day.
You should approach your real estate investing plan with the same steadfast commitment as in the widget scenario. When looking at any house you are considering renovating and reselling, or holding as a rental, remember the following:
No. 1: Leave your emotions at home and forget the episode of the HGTV show you watched last night. Remain practical and DON’T fall in love with the house.
No. 2: Smartly consider the neighborhood and the area around the house you are reviewing. Real Estate 101 = Location! What’s going on around this house? Is the area improving, stagnating or declining? Can you get a sense for what the house and the neighborhood will look like in 10 years?
No. 3: Is the neighborhood predominately owner-occupant, or rental? Is there consistent pride of ownership on the majority, if not ALL of the other houses?
No. 4: What is the average DOM (Days on Market) for houses similar to this one? Have there been excessive discounted sales such as foreclosures, REOs or as-is? Only use comparable sales data for houses that are similar in age, structure and configuration to the house (subject) that you are considering AND that were sold in repaired or upgraded condition OR needed no work when they were sold. You can usually find this information in the listing descriptions.
No. 5: When considering repairs and upgrades, don’t fall into the trap of “over-renovating” with items like granite and stainless steel if it doesn’t make sense and there is no precedent for this. Conversely, if the bulk of the houses in the area were sold, for example, as “newly renovated with modern improvements and updates” and consistently described as having “granite countertops and stainless steel appliances,” then you need to account for these upgrades in the repair estimate for your project.
No. 6: Avoid rural and outlier houses. Buy your widgets—I mean houses—where there are abundant and similar type structures and the demand is plentiful and can be demonstrated.
Now that we have some house (product) specific fundamentals, let’s talk about supply and demand. We need to know the high mark of supply and demand in our market. This is our “bull’s-eye.”
In my world, we define the bull’s-eye as 70 percent to 90 percent of the median sales price in a typical metro market.
How can you find the bull’s-eye in your market? It can be quite a project, but you can test the 70 percent to 90 percent rule by doing the following, with data that is readily available from Zillow:
No. 1: Write down the number of houses that sold between $0 and $25,000 in the past 90 days.
No. 2: Then, write down the number of houses that sold between $25,000 and $50,000 in the past 90 days.
No. 3: Then, write down the number of houses that sold between $50,000 and $75,000 in the past 90 days.
No. 4: And, so on …
As you work this exercise, you will begin to see that the number of units (houses) sold begins to increase. At some point, the number of units sold will begin to get smaller and smaller. You can use a line graph to chart this. Take the group where the most units sold in the last 90 days and write down that price range.
Next, determine the median sales price for the market you are researching. Let’s say the median sales price in the market you are researching is $175,000. Write that down. (The website www.zillow.com/home-values is a good source for finding median sales prices.)
Take the average sales price of the group where the most units sold. For example, if the group where the most units sold is $125,000 to $150,000, then the average would be $137,500.
Now, divide the average by the median sales price. In the example we are using, $137,500 divided by $175,000 equals 78 percent. So the bull’s-eye is 78 percent of the median sales price.
In almost every stable market across the country, you will find that between 70 percent and 90 percent of the current median sales price is where we see the most activity and is where to buy single-family houses for the shortest hold times and maximum profits.
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