Real Estate

Evaluation of a real estate investment agreement

We speak to many investors who are looking to purchase real estate investment properties. Some are seasoned professionals and some are new to real estate.

The number one priority of any real estate business is finding a good deal. Yes, it is important to build your buyers list so that you can sell the properties you buy quickly. But you won’t stay in business long without offers to sell to your buyer list.

When you get to the bottom of it, evaluating a real estate investment deal is really a simple process. No matter what your exit strategy is—wholesale, buy and hold, or fix and trade—purchasing your investment property right is critical. Let’s take a look at the process of evaluating a real estate investment deal.

How to Evaluate a Single Family Home

Let’s look at the main elements to consider when evaluating a real estate investment deal.

  • Cost of repairs to bring the home in condition to or slightly above neighborhood standards
  • The after repair value, or ARV of the property, after it is repaired
  • If you’re going to buy and hold (either as a lease or rent-to-own), you’ll need the costs associated with this exit strategy. Considerations include your mortgage payment, homeowners insurance, and taxes, just to name a few.

These are the three main items to consider, although there are others to consider as well (real estate agent fees, if you’re doing retail, utility costs, etc.).

Cost of repairs

One of the most important skills to get good at is estimating repairs. If you don’t want to take the time to learn the process, make sure you get a good contractor as a member of your team. Nothing will ruin a deal faster than incorrectly estimating repair costs. Getting a couple of estimates would be even better.

After Repair Market Value (ARV)

The easiest way to get home value after repair is to ask a real estate agent to sell properties that are comparable to the property you are considering. The variables you use when having your real estate agent get comparable sold properties are VERY important.

The value of a comparable property sold is directly related to its relevance to the property in question. Comparable properties sold must be within one-half mile of the subject property, but not more than one mile. There may be times, such as rural properties, where this is not possible. The age of comparable properties sold should be within the last 90-180 days, if possible. Due to the volatility of the current market, any antique may not be an accurate reflection of current home values. You will also want to use comparable properties that are +/- 20% of the size of the property in question.

Finally, you will want to compare apples to apples. Do not use properties that were sold as bank property or as a short sale as comparable properties. These properties are “distressed” properties that often sell for an average of 25% to 30% of normal retail values.

If you don’t consider these variables when checking out your sold comparable properties, you won’t be able to be a successful real estate investor. Make your offers too low because you are using bank and short sale property as your offsets and you will never get an accepted offer.

Buy and Hold: Rent and Rent to Own

What if you want to buy your properties to keep them for rent? Or even rent with option to buy? There are a couple of other factors you’ll want to consider when evaluating a real estate investment deal. The main concern… will it be cash flow?

To determine this, you’ll need to know what the mortgage payment will be on the potential purchase. You will need to speak with a mortgage broker to determine this payment. Or maybe you use a private money lender. Simply enter your private lender’s rate and term into a simple amortization calculator to determine your monthly payment.

Next, you’ll want to determine how much the property will rent on a monthly basis. You can obtain this research in several ways. You can search craigslist.org for comparable properties. You can take a look at Zillow.com and use your Rent Zestimate. You can also talk to a real estate agent to get an idea.

Subtract the estimated monthly rent and the monthly debt service and the property to determine if the property will have cash flow. You’ll also want to subtract other expenses like property taxes, insurance, and reserves for future repairs.

Calculation of your offer price

The old formula, developed by Ron Legrand, is as follows:

ARV – Repairs X 70% = Maximum Allowable Offer (MAO)

This is a bit of a generalization. If your exit strategy is buy and hold and the cash on the property is flowing well, you may be more willing to deviate (go higher) from the 70% multiplier. However, if you are a wholesaler, you will want to buy below the 70% multiplier. As a wholesaler, you make money from the spread between the offer price and the MAO. A good rule of thumb is to be between 60% and 65% if you are a wholesaler.

Doing and Giving

From here, just make the offer.

Just remember, the general rule of thumb in real estate is never to overpay for a property. That’s why you want your bid evaluation process to be so strict. Always keep your emotions out of this.

I hope this tutorial helps put a few more bucks in your pocket the next time you’re considering a real estate investment deal.