Posted by Ed Garcia on August 18, 2003 at 10:19:09:
Kevin,
I went back into my archives and found that I gave this answer to another Kevin. In addition to this answer, I suggest that you read all of the articles in the How-To Articles and read as much of the Main News Group as you can. Here is what I told the other Kevin.
I?m sorry to say that, I?ve answered this question so many times. I now save my answer to reprint it when the question comes up again.
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 compted 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.
GAME PLAN.
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.
$20,000
-$ 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.
(5) Financing.
How am I going to take my deal down? An 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.
Ed Garcia