Re:You have to empty your cup to taste my drink - Posted by Ed Garcia
Posted by Ed Garcia on July 19, 2002 at 12:38:10:
The more that I’ve seen your post, the more that I realize that you’re not a Real-estate investor.
Yes, you’re a home owner, and have made money on your home in San Diego, but you’re not an RE investor or you wouldn’t have asked the questions that you have because you would have already know the answers.
When I mentioned Campo California, there were other towns that I really had in mind but I couldn’t think of the names and Campo was one of the towns that I remembered.
But it makes no difference because you see Alan, it’s not important to fall in love with the town or any RE investment, it’s number crunching, and only important that I as an investor feel that they I can make money with it.
It’s a matter of PERCEPTION.
Let me tell you a story,
Two-shoe salesman from competing companies in the early 1900’s were told they were going to the continent of Africa to open up a new market for their respective companies. They were to go with a few samples, and while there drumming up business, a steamer would be dispatched with an entire inventory to deliver on the orders.
The first salesman got off the plane, looked around and immediately telegraphed this company.
“Turn back the shipment! There is NO market here. NOBODY wears shoes!”
The second salesman got off the plane and looked around and immediately telegraphed his office.
"Double the shipment immediately! TONS of potential business here! NOBODY WEARS SHOES!!!
Allen, your hypothetical example is not a good one because you have given it terms and conditions in front that will not work or I wouldn’t do as an investor.
Allen, life has no guarantees, so even when I buy to hold I keep in mind that something may come up and I may have to sell tomorrow, so I can’t buy with just cash flow in mind and I would never consider brake even, because break even will eventually become negative. Something will always come up or go wrong in a deal “Murphy’s Law”.
So I’m going to share with you what I tell a Newbie and by the way the deal that I’ve penciled to buy to sell should also pencil as a hold property with positive cash flow.
Alan, before you read what I’m giving you don’t forget perception. If you tell a Realtor that you want to purchase some property at 60 to 70 cents on the dollar, they will tell you that, that’s not realistic. You see you have to look at the mentality of that Realtor. Day in and day out they’re dealing in RETAIL SALES, so therefore, they can’t comprehend do a deal at WHOLESALE. They’re product of their environment, and that’s why they’re not investors.
Here is what I tell a Newbie who is starting out.
First, is to evaluate how much time you are going to be able to commit to Real-estate? If your approach is hit and miss, so will be your result.
Second: Go to the street. It is the best teacher. Rather than talk about doing deals, reading in the library, getting courses, JUST DO IT.
You’ll find in the long run, the street is the best teacher. Not only that by getting out an doing it, you’ll learn your MARKET, meet people to build a NETWORK, learn the demographics as well as the geographics of your area, and of course you would have over come the biggest obstacle in getting started, PROCRASTINATION.
We need to do what we call, penciling out a deal. When doing that, we ask ourselves a battery of questions necessary in structuring a deal.
I’m going to give you 5 steps to get you started.
(1) How much do we want to make?
So many times I hear someone act as if they are afraid of loosing a deal because of the profit they put into it. Forget about it. I’d rather be sorry about the deal I did not make, rather than the one I did. The profit is what protects you in a deal.
Don’t be afraid to make it.
When doing a deal I want to make at least 30% and believe me when I tell you, when I structure a deal with 30% in it, I never get it. Some how the profit always dissipates, even after I thought I figured it to the penny.
Would I do a deal with less profit? Yes but I would do it as a flip, lease option, or as a leveraged deal with positive cash flow.
(2) Determine the Value of the Property.
The next thing I must do is determine what the property is worth. The obvious thing to do, is comp it. Don’t let the seller or real-estate broker tell you what it is worth. Get it comped yourself.
(3) Deferred maintenance.
Usually I figure my profit after taking off the deferred maintenance otherwise it distorts my profit. So it must be figured in the beginning to determine your profit.
(4) Game plan.
What do I want to do with the property? Do I want to fix it and sell it? Do I want to keep it long term or short term? When I buy a property, I have a plan for it.
And usually I buy it with that plan in mind. This part is so important , I’m going to go into more detail by giving you an example.
Remember, you make your money on the buy.
Each deal speaks for it’s self. For example, if I bought a house for Lets say $50,000 and had to put $10,000 into it for fix up. I’m in this deal $60,000. Now what would that house have to be worth in order for me to feel comfortable to buy it, and debt service it on my line of credit.
$70,000 ? No I don’t think so. I have no room in this deal for error. What if after a month or two I don’t sell it ? Now remember, we can play the what if game all day. I can create a fast Sale for the purpose of this posting to make myself look good, but that’s Not the answer. So remember we have to always be careful with hypothetical questions and answers. The profit structure on this deal is not good enough for me to do the deal.
$80,000 ? Were getting better, but No. I have to keep in mind that things can go wrong with my deal. What if I sell it after 2 months, and then the sale falls through after being under contract for 45 days because of financing.
Now I have had the property for 31/2 months, and have to put it back on the market again. Also what if the market changes or slows down ? Even though I show on paper that I have a $20,000 profit, that’s not so. For the fun of it, lets take this so call $20,000 profit and structure a Game Plan around it.
(1.) I plug in 6 month worth of debt service on my deal. I’m in the deal $60,000. Interest, depending on the interest of your credit line, Let say for the benefit of our example is 9.5%. Our payments would Then be $475 per month. 475X 6 = $2850.
(2.) What ever the market value you come up with, always cut it 5%. Because
realistically, the potential buyer is going to want you to Discount your price. Now if you don’t have to, great. But lets face It. If you were trying to sell it for $80,000 and someone offered You $ 76,000, you know you wouldn’t want to wait for another Buyer. You would still be debt servicing the deal. With you luck, You wait another month or two and the next buyer would make The same offer. Terry Vaughan will tell you, that the first 10% of a deal is water. I agree with Terry, but for the purpose of this
deal we’ll just keep it at 5%. So lets take off another $4000.
(3.) I always plug in a realtor. Now I know that there are a lot of Geniuses out there that don’t need them. They are so great that they can sell the property themselves. Great, you plug in a Realtor. 76,000 X .06 = $4,560.
Lets recap. A sale of $80,000, gives us on paper a $20,000 profit.
-$ 2,850 Debt service
-$4,000 5% Discount
-$4,560 6% Sales commission.
Potential Profit $8,590.
As you can see the profit dissipates quickly. And personally I don’t think it’s enough to take the risk your taking with your line.
How about $90,000 ? Now all of a sudden the deal can make sense. We have between a $17,500 and $18,000 profit.
Lets look at our LTV (loan to value). 60,000 divided by 90,000 = 67% LTV.
So you see the deal speaks for it’s self, but the structuring of a deal with a Game Plan is what will let you know if you should do the deal.
How am I going to take my deal down? Am I going to create a seller carry back, and use a lender to give some money to the seller? Will the seller carry back the whole deal? Will I have to buy it with a combination of down payment and financing? Or will I pay cash and then refinance it later, getting all of my money back.
These are just a few basic fundamentals of doing a deal. I hope this is some help to you.