I want to start with the most important thing in real estate investment business and that is to buy a good property.
For understanding what I meant by a good property, I would like to introduce some terminologies:
1. After Repair Value or ARV
This tells you the worth of a property after it has been rehabbed.
2. Highest Best Use or HBU
This term is basically used for commercial properties, which means that what’s the highest to best use of that particular property.
HBU is also used for residential properties, where after evaluating a property; you can decide what would be the highest to best use of your money.
For example, after evaluating a property you decide that you can only spend $25,000 on repairs instead of $40,000 as you’ve thought because the total worth of the property after repairs would only be $150,000 max, which is going to be the highest to best use of that property.
But to sell the house, it is important that you should realize few things. If the house has something, which is missing like a driveway, then you will have to build a driveway because other houses in the neighborhood have a driveway.
But if you would like to have an edge over others, then you might need to do something extra like modernizing the kitchen by putting granite countertops or nice cabinets or you can do some extra work in bathrooms.
It is advisable to look around in the neighborhood at the active and sold homes and see what are the basic features in these homes.
You will definitely need to have all these features and if you want to have an edge over the others, then you can do something extra but don’t overdo it. This may help you to get competitive prices or not but it would always be better to have something extra.
3. Adjusted after repair value or AARV
AARV is the value, which you will get after subtracting the cost of repairs from the worth of a property after it has been rehabbed.
For example, if the property is worth of $150,000 after it has been repaired and the repair cost was $20,000, then AARV will be $130,000.
The question, which arises here, is the loan amount i.e. how much loan you can get on a property like this from hard money lenders.
For that, you will have to do some calculations. Your AARV is $130,000 and above that you have different other costs like real estate agent fees, closing fee, title fees etc. This will cost you around 10%.
Then you will have interest fees for hard money loans and a little bit of flush funds. This could be another 10%.
Finally, you will have to keep a profit margin for yourself, which could be 10%.
All of this becomes 30% and you will have to deduct that out of your AARV value i.e. $130,000. This will give you $91,000. So, this is what you are going to get from hard money lenders if you are looking to invest in a single family house situated in a typical neighborhood.
But if there is a private money lender, who is going to lend you more than 70% of AARV because if they will lend you that much amount of money, then there would be no space for both of you to make any profit.
That is why, it is better to make a decision about the worth of a property after it has been repaired and that will give you the highest to best value of that particular property, which is the most important thing.
But if you will become emotionally attached to the property and spend a lot of money on repairs without doing the calculations, then you can never make money on that property.
To make sure that your calculation is right, you should look at the lowest sold and active comparables within that particular neighborhood and make your ultimate decision on that rather than falling in love with the property.
If you will keep in mind only the highest comparables, then you will definitely be going to make a mistake because if someone has made a profit of $50,000 on their property, doesn’t mean that you will also make the same amount of money in your deal.
These kinds of profits are made once in a blue moon but not everyone could be that lucky. So, you need to send independent evaluators from the similar neighborhood to evaluate the property and make a bid, based upon their reports.