by Jeff Adams
More and more people are giving up the daily grind and aspiring to venture into the lucrative real estate market. It seems that even in a struggling economy, there is money to be made in the housing industry. Investing in real estate rehab or fixer-upper projects offers pretty much anyone the opportunity to make a substantial profit within a relatively short term. By definition, a fixer-upper is a real estate property that requires some maintenance, redecoration, reconstruction, or redesign. Doing so raises the property’s potential value and ensures a return on the initial investment.
Before tackling such a business venture, there are several elements to consider. First and foremost, an investor needs to decide on the best strategy for locating bargains with the most potential for profit. Real estate owned properties (REOs), foreclosures, auctions, or for sale by owners (FSBOs) are all options to consider. Also, working with a local area real estate agent offers much insight into the current market.
The type of financing that will be incorporated will also be a key component within this overall strategy. There are several ways to acquire financing for an investment. The sellers of the property, banks, government programs, investors, or private mortgage companies can provide funding. Also, one has to decide if partners will be involved in the transaction, who will actually be doing the rehabilitation work on the property, and whether or not the property will be listed with real estate agents.
Creating a business plan is the next course of action. This allows an investor to choose the proper alternatives that cater to each individual situation. It outlines specific objectives and also highlights both the risks and rewards of the investment. A business plan also offers a perspective and pinpoints the strengths and weaknesses of the potential purchase.
Once the business plan is in place, an investor can begin his/her journey to investment by finding target properties. A target property would generally be a single-family home in need of repair that is located in a decent neighborhood. Lower to mid-priced homes in areas which first time home buyers wish to live in are great target properties.
Looks do matter. The best looking homes are not necessarily the best options for profit. Houses that require only cosmetic repair are typically marketed nearer to their maximum retail value. Comparatively, houses that are structurally sound but need some work are ideal. They are priced cheaper and when coupled with value added rehabilitation, they become assets, which in turn offer a profit. Houses that offer causes for concern such as severe foundation settling, soil instability, plumbing problems, electrical system overhauls, extensive roof damage, or obsolete floor plans are not desirable investments.
Determining a purchase price is the next step in process. Having a realistic idea of what you are getting into is key. This price is contingent on a variety of factors. The maximum retail value of the property after repairs and renovation have been completed, comparable purchases in the neighborhood, real estate appraisers or agents familiar with the local markets all play a role.
A property’s purchase price can be determined by assessing the maximum retail value of the property and subtracting purchase costs (loans, brokerage fees, closing costs), rehab costs (repairs and improvements), holding costs (interest expenses for loans, utilities, taxes accrued between the purchase and the sale of the property), sales costs, the contingency factor (any unforeseen or unanticipated expenses), and profit (the amount netted after expenses). This formula decides the maximum purchase price for the property.
After the purchase price has been established, a funding plan needs to be implemented. One can either work with private mortgage lenders or receive financing from the seller or a combination of both. An investor needs to identify potential sources of income and decide if he/she will supplement what is needed through personal savings, with other investors, or joint venture partners.
One popular choice is a renovation loan through a home equity line of credit or a mortgage. This type of loan can generally be borrowed against ninety percent of the equity the homeowner will have when the house is completed. The interest rate on a home equity loan is about the same as a mortgage but only about one hundred thousand dollars of this is tax deductible. An even better way to procure financing is with a renovation loan paired with a first mortgage. Loans can be borrowed against the house’s value after the rehabilitation and renovation work has been completed and the interest is tax deductible up to one million dollars. Almost all lenders, the Fannie Mae’s HomeStyle program, and Freddie Mac’s Home Work! product offer this type of financing.
When financing has been established, it is time to find a real estate agent in order to proceed. The expertise they offer is invaluable and they are knowledgeable of properties that are or soon will be available, price ranges, financing options, neighborhood characteristics, title issues, seller negotiations, and purchase offer submittals. In addition, they have access to multiple listing systems (MLS). These Local Association of Realtor databases are useful tools to have in the market. Considering that only about fifteen percent of the properties in the market are for sale by owner and REOs can only be accessed through an agent, working with a real estate agent is crucial.
After the initial investment has been made and the property has been purchased, a rehabilitation strategy is implemented. The ultimate goal is to enhance the marketability of the property. All structural, mechanical, and electrical systems need to be repaired in compliance with the Federal Housing Association (FHA) construction standards. High quality work by professionals is necessary to ensure the best possible renovation. Curb appeal, kitchens, and bathrooms should be paid particular attention. Monitoring the project, tracking expenditures and maintaining records, and also photo documentation of progression are essential.
Over improving a property does not necessarily offer a greater profit, but rather hinders the sale of the house. Renovations should be comparable to other homes in the area. To receive the maximum resale value of the property, rehabilitation and remodeling investments should not increase the retail value of the house by more than ten to fifteen percent above the median sale price of other homes in the local area.
When it is time to sell, a powerful marketing strategy is necessary. Finding a top selling real estate agent is imperative for maximum market exposure. The listing agreement should include monetary incentives that stress the urgency factor of the sale and protections that define liabilities for all parties involved. Keeping in close contact with the agent enables the seller to monitor the progress of the marketing plan. Buyers can also be attracted with seller financing options.
Buying, fixing, and selling a house is a huge undertaking that offers an investor a potential for a good profit within a relatively short amount of time. It involves a lot of hard work and a large time commitment. For those willing to put forth the effort and often times the elbow grease required, it is definitely an investment worth making.