Real estate investing is a tough business at the best of times. Which means that nowadays, with markets in the shape they’re in, making a handsome profit is a very tricky stunt to pull off indeed. But with a little planning, anything’s possible…
For investors, knowing how to behave when the market is up or down is critical to your success. Obviously when a market is on the rise then sellers have the upper hand. This is the time when you may want to consider taking some of your rental properties or long term equity investments and cashing out on them.
During major real estate booms, it actually becomes fairly common for buyers to make offers HIGHER than the asking price and end up in bidding wars over an investment property in a prime location. Those are the golden days of being a real estate investor.
Today of course, things are not so golden – prices are low, and so far, they are staying low, making it very difficult for investors to realize a profit on any of the homes they buy.
So how to make a profit and survive during a down market or a real estate bubble burst like the one we are experiencing now? Here are a few pointers to make sure you’re on the right track:
First of all, don’t set unrealistic goals or have exorbitant expectations from every deal. If you think you are going to double your initial investment on every real estate transaction you make during a recession then you are going to end up owning either overpriced properties you can’t sell or no properties at all because the profit margin seems too low for you.
Make up a basic spreadsheet for yourself that breaks down each property like this:
- Purchase Price
- Cost to Repair
- Cost to Market Using Realtors
- 3 Months Carrying Costs
- Closing Costs
- Current Fair Market Value
Plug in the numbers based on your educated estimates for each of the fields and see how the deal looks.
Let’s use an example:
- Purchase Price – $100,000
- Cost to Repair – $4,000
- Cost to Market Using Realtors – $6,000.00
- 3 Months Carrying Costs – $4,500
- Closing Costs- $3,500
- Current Fair Market Value – $140,000
So in this example our total expenses to purchase, fix and maintain the property for three months and then sell it would be $118,000. If you are using private money to fund your investment, make sure your estimate for carrying costs includes the interest you are paying on that money. On a property where you are taking the added risk of repairing, holding and reselling it, your realistic goal should be to make a 20% return on your initial investment. Here the initial investment was $100,000 so you would be shooting for a $20,000 net profit when the deal is complete.
Prepare for the Worst
If you sell this property for its fair market value of $140,000, then your total profit on the deal would be $22,000. This is a property you definitely would want to purchase. But here is the secret to making sure you profit on the deal even if your estimates are way off:
Double all of your expenses on the property
In the above case, that would mean our expenses are now $36,000 and our total investment would be $136,000.00. If this number is still lower than what you can sell the property for then you know it’s a solid deal. Because even if ALL of your estimates are off and everything costs twice as much as you anticipated, you will still make a profit on the sale.
This is budgeting for the absolute worst case scenario you can conceive. If your investment still is in the black then you should proceed because there are built in safety factors in this analysis. For example, you know you are never going to pay a 12% real estate commission to market the property ($6,000 doubled).
Get your Priorities Right
Essentially, knowing whether you have a good real estate investment also depends on what your priorities are as an investor. If you are looking for quick cash then flipping properties either to the public or wholesale to another investor is your best choice.
However, if you are looking for long term growth then the rental value of the property may be more valuable in the long run, so you should plan on holding onto the home and renting it out. Finally, always ensure you have plans and exit strategies in place before you buy an investment property, and never change them halfway through the game or you may get burned.