In my previous article I did an overview of real estate investing fundamentals. With this article I’m beginning a series on the most popular investing strategies and taking a look at the underlying fundamentals that are essential for success.
Quick Cash – (a.k.a. flipping, wholesaling, quick turn) – The primary strategy behind using a property to generate “fast cash”, involves the “buy low, sell higher” concept. The idea is to buy as low as possible then sell as quickly as possible to another investor for a cash profit.
Prior to the housing market crash, a gross profit of about $20,000 was our standard minimum target. We used a team of 4 key people to manage raising money, viewing leads and writing offers, rehab management and coordination of closings.
Things happen that add to costs, so a $20K gross allows for some cushion in the event of unforeseen expenses. (like say, unpaid property taxes of $3000) It’s not unusual to have issues that are unpredictable when working in older neighborhoods.
In order to make “quick cash” turning houses as fast as possible, you must locate a property and buy it based on a formula such as this:
After Repair Value (ARV) X .50% minus (repair + buying selling and holding costs) minus (desired profit) = MAO
(Maximum Allowable Offer)
Here is an example of this formula in action:
$100,000 ARV X 50% – ($12,000 + $6000) – $10,000 = $22,000 Maximum Allowable Offer.
This formula allows you to determine the value of the property after any repairs or renovations, leave a nice profit on the table for your buyer, then allow for costs incurred to buy it, hold it or resell it, and your own desired gross profit of $10,000. Subtracting 50% from the ARV basically insures that there will be plenty of money on the table for your buyer so that you can sell the deal quickly. I call this strategy “wholesaling” because you are selling to a middle man at a discounted price so that they too can resell or rent for a profit.
If all goes according to plan, you’ll pocket $10,000. In our example your objective is to buy for $22,000, then quickly resell for $32,000 or more. And if you are allowed to assign your purchase contract to another buyer prior to closing, you can make your $10K profit in a matter of days, once you’ve gotten a property under contract.
Finding leads is the key to success, as you are looking for the cheapest possible deals out of all the properties for sale in your market. In terms of fundamentals that support this strategy, the primary ones are location, moderate condition with some significant but affordable repairs and lots of equity.
When you examine the formula above, we are talking about an 80% spread between MAO and ARV. Traditionally the target has been older houses which tended to need lots of repairs and were old enough to be paid for or nearly paid for, so they had lots of equity. After the housing melt-down, it became possible for the first time ever to find deeply discounted properties in newer neighborhoods. Prior to 2008 this was rare.
Once you find a discounted property and have it under a purchase contract, or under an option to buy, you want to assign or transfer your contract to another buyer prior to having to close on the property. If you cannot close using your own funds, it’s preferable to use an “option to buy” to tie up the property while you search for another buyer. Once you find a buyer who will buy your contract from you at an agreed upon price, you can assign your contract to them and collect your profit from them in return. (note: though foreclosures and bank owned houses may be cheap, the seller probably won’t allow you to assign a contract. Usually you’ll need funds to close if buying from banks, then resell to your buyer.
This is the one true method for making cash from real estate investing without having to have any cash or credit of your own. When someone says “earn money with real estate quickly and easily without cash or credit”, the “quick turn” or “wholesaling” strategy is usually what they are talking about.
During the housing boom I was involved with successful operations that did more than 200 transactions per year and generated millions of dollars in profits. It is easy to make money with this strategy when prices are rising steadily. But quick turn virtually collapsed as a strategy during the last two years of the housing boom, because the cost of purchasing properties had gone too high too fast.
Along came another fundamental – supply and demand – that changed everything. During the boom years the easy money resulted in demand initially exceeding supply. But by 2007 over-building and rampant speculation gave us too much supply while sky-high prices made properties unaffordable.
This was a dangerous combination of fundamentals and as a result the market began to collapse. Real estate investors starting seeing a dramatic increase in foreclosures before owner occupants did, but the problems snowballed and finally reached a tipping point which began to jeopardize the banks that were invested in the failing mortgages. Despite the best efforts of the FED, the U.S. Treasury, the NAHB and the National Association of Realtors who all tried desperately to deny that the crisis existed, the fundamentals had their way and the crash ensued.
The quick flip strategy has seen a dramatic revival thanks to 7 million foreclosures since 2008. The market is still over supplied in some areas, as the “boom” markets still have many more properties for sale than there are end-user buyers. The problem of over-supply has resulted in a crash in property values, which are down some 35% from their peak highs. Until the over-supply has worked through the system and we have more real demand from owner occupant buyers, property prices will remain well below the boom years. Low prices is a good thing as it is the only way to clear out the backlog of inventory.
Buying property using the wholesaling / quick turn formula shown above is a good strategy in most any market. It always pays to get the best possible deal on a property no matter where the fundamentals are headed. The fundamentals always dictate your choice of strategy. The fundamentals will either support your strategy, or they will undermine it and leave you wondering what happened. It is vitally important to consider the market fundamentals when you plan to invest in real estate as a business or for retirement income.
Donna S. Robinson is a real estate investor, author, market analyst and investing coach in Atlanta, GA. Follow her on twitter at donnaconsults. Her website is www.RealtyBizConsulting.com