## What’s A Deal?

Posted by learningcenter in Learning Center Friday, 20 August 2010 07:33 No Comments

**OKAY, SO WHAT COMPRISES A DEAL? **

As established investors we have developed certain criteria to evaluate whether a property is a deal or not. We use criteria based on our personal experience which involves minimal risk and a good profit margin. We tend to be conservative so that if we run up against extra expenses or unanticipated delays we can usually still can make a profit.

Note that everyone has different profit margins and formulas for real estate investing, but a good rule of thumb that we like to use is called the 70% rule. This rule generally applies to single-family homes.

**THE 70% RULE FOR SINGLE-FAMILY HOMES **

Our goal in general is to purchase property for 70% of its market value. For example, if a home was valued at $100,000 dollars retail, as investors, we would look to purchase the home for $70,000.

This gives us a “safe” margin to play with if there are any unforeseen expenses or delays. Plus, this allows for a nice profit margin. The 70% rule is not always feasible, especially in “hot” markets or the most desirable areas, but it is a goal in most instances and a general rule of thumb to go by. Most established investors won’t even look at a single-family or a small multi-plex deal unless there is a profit margin of at least $20,000 to $30,000 dollars.

Here’s the formula for the** 70% rule for Single-Family Homes**: **MARKET VALUE of home X .70 = Purchase Price**

This is a very basic rule of thumb and of course you will need to figure in expenses (realtor fees, fix up costs, etc) in order to determine the profit margin). You should deduct these additional projected costs from the purchase price to arrive at your offering price.

**DETERMINING MARKET VALUE **

The formula for the 70% rule uses “market value” but how do we determine market value of a property?

Market value is NOT the price you see listed in the paper or the asking price of the owner. That after all, is just someone’s (the owner or realtor) best guess as to what the property will sell for or it is merely an opinion based on non-market factors, such as how much is owed on the property.

The key is finding out what similar properties have actually sold for, not the current for sale price. We determine market value by looking at “comps.” A comp is an actual sale that shows what a real buyer getting a real loan has paid for a property in a specific neighborhood. Comps (short-hand for comparable sales) are basically comparable properties, similar to that which you are evaluating, that have actually sold.

**USING COMPS**

The more recent a real estate comp is, the more valuable it is to us in terms of establishing market value. It is best to evaluate similar properties that have sold within the last 3-6 months.

The comps that are most valuable are the ones closest in proximity to the house you are buying–preferably on the same street or in the same neighborhood. On some houses you will have a plethora of comps and on others you will find very few.

The fewer comps you have for a given property, the riskier the deal—this is because you are less able to determine what your likely profit will be heading into the deal— therefore, you should lower your offer accordingly. Conversely, a high number of comps yields a higher level of confidence in the deal, and may justify a higher offer.

When evaluating comps it’s important to compare apples to apples. We have found that the best indicator of value is the number of bedrooms and baths. If you’re evaluating a 3 bedroom/2 bath home you’ll want to compare it to 3 bedroom/ 2 bath homes.

If you’re evaluating a home that is 1,200 square feet, compare it to another home that is similar in square footage. Note that the number of bedroom and bathrooms would be more accurate than the square footage though. So for example if you were evaluating a house that was 3 bedroom/1 bath and 1,000 square feet and found a comp for a 3 bedroom/2 bath and similar square footage you could assume that the 3 bedroom/ 2 bath has a higher market value than the 3 bedroom/1 bath house even though the square footage is approximately the same.

Another note about square footage: We have found that the percentage of difference in size does NOT relate to a direct percentage in value. In other words, a thousand square foot home is not worth 50% less than a home that is 2,000 square feet on the same street.

For example, let’s say you find five comps and each of them has a square footage of 20% or more than the square footage of the property you are evaluating, even with the same number of bedrooms and baths, you must be careful in your evaluation. You probably need to assume a lower price to account for the lesser size. We generally will deduct 10% or so for up to 20% in lesser size assuming that we have the same number of rooms (bedrooms and baths). You also need to account for things like the age and style of the house, as well as factors such as garages, views, and traffic—these factors can make a world of difference and turn a potential profit into a big loss in a hurry.

**ESTIMATING MARKET VALUE **

Okay so let’s say you’ve found 4 or 5 good comps, meaning they are similar in size and/ or rooms and any other important factors listed above. Next, you add up all the sales prices for each of the homes and take an average to determine the market value for the home you are evaluating.

**A good way to determine general values in an area is to ****determine the average price per square foot for existing ****houses with similar age and general features—in this way ****you can account for different sizes and get a better feel for the overall neighborhood values, which is especially ****important when doing fix-up / rehab, adding square footage, or building new units.**

Beginning investors are often afraid they will not accurately assess the market value of a property and thus they feel paralyzed to make an offer. But remember that you never have to estimate the value of a property perfectly. If you build in at least $20,000- $25,000 profit (A MINIMUM!) on a $200,000 single-family house deal, a little wiggle either way will not be fatal.

**OTHER TYPES OF PROPERTY INVESTMENTS**

** **As a successful real estate investor you will not only deal with single-family homes but multiple family dwellings and lots.

Definition of Multifamily property:

More than one dwelling unit is a multi-family or multi- unit property. This is a general term, which could apply to anything from a duplex (two units) to a 1000-unit apartment building. Usually the term “plex” is applied to a single structure with 2-10 individual housing units. The term ”condominium” or condo for short, refers to an individually owned property that is part of a multi-unit property and contains common elements and a homeowners association (HOA).

**DETERMINING THE VALUE OF LOTS **

How do we determine the value of lots? A general rule of thumb for our area is the 25% Rule for Lots:

**THE 25% RULE FOR LOTS**

The 25% rule for lots says that the price of a finished, “ready to build” lot should be 25% of the house value that could be put on that lot.

Again, we determine house values by looking at comps in the area. If all the homes in a neighborhood are worth $100,000 and they are all approximately 1,000 square feet then you would take 25% of the house value ($100,000) and would aim to pay $25,000 for the lot. (Of course this means that you would also most likely build a 1,000 square foot home on that lot as well. You wouldn’t want to put a 2,000 or 3,000 square foot home on the lot if all the surrounding homes were only 1,000 square feet).

**.25 X Value of House put on Lot = Finished Lot Price**

When you are dealing with vacant land or sub-dividable land that is not already platted, or sub-divided, and approved for building, you will need to account for the costs to develop the lots so they are ready for a builder to come in and start breaking ground. Since these costs vary widely depending on the jurisdiction (fees and timelines, etc.), as a general rule of thumb, we simply subtract these total costs from the price we arrived at with the 25% rule explained above.

Be sure to talk to some experienced investors and/or realtors in your area, and adjust these formulas to suit your local marketplace. Sometimes realtors or other so-called investors will tell you that our formulas for great deals are pie-in-the sky dreams that you could never hope to find in this marketplace or that one. Do not get sucked into

the conventional realtor/buyer line of thought that says “it can’t be done” here—finding great deals is no piece of cake, and most realtors and many so-called investors simply do not understand how we can do it. Plus, they’re not actually out there making money at it like we are!

**DETERMINING VALUE FOR MULTIPLE ****FAMILY DWELLINGS**

What about duplexes or multi-plexes? How do you determine the value of these?To begin with, you use the same method as for any other property—getting the best available comps. However, when dealing with rental properties, you have to take into account the value of the rents coming in as this relates to the price of the property. The formula we use for determining the “wholesale” value of rental units for single family and smaller multiple-dwelling units is called the 1% RULE.

**THE 1% RULE FOR SINGLE FAMILY RESIDENCES AND **

**SMALL PLEXES**

Basically, you add up the gross rents from all the units (this is found out by asking a realtor or the seller or by looking up similar rental prices in the area) and get a total rent figure. This number should be 1% of your purchase price.

For example, say a duplex is selling for $100,000. You would find out what the two rental incomes are and they should be 1% of $100,000 which is $1,000. So each unit should be bringing in $500.00 a month. (500 X 2)

Another Example: If you saw a purchase price of $200,000 for a duplex, as an investor you would want to make sure that the rent for each unit was $1,000. (1% of $200,000 is $2,000. $2,000 divided by two units = $1,000)

**Gross Rents = .01 X Purchase Price**

**NOTE:** These formulas aren’t set in stone because each property, lot or duplex is unique as local markets vary widely. This formula is also designed to provide for cash- flow rentals with zero-down financing in today’s interest rate climate, which can also change rapidly.

These are mere guidelines that have worked for our personal investing standards. These formulas are based on minimal risk and a good profit and can be adapted for use in any circumstance.

In fact, the main point of this section is not to give you a cookie-cutter formula that will work in all occasions, but rather to demonstrate that you can and should develop your own simple rules of thumb so that you will begin to know right away when you catch a whiff of a good deal. Remember, often it is those who are able to move the most quickly who get the best deals. As with any business endeavor, real estate investing is full of competition ¼ just make sure you’re not competing with those who are willing to pay too much or make emotional investing decisions. For the successful investor, it is all in the numbers¼

**MORE SPECIFICS ABOUT DETERMINING VALUE**

There are many little nuances you will encounter while analyzing a deal. You may encounter a situation where you would need to divide a lot and you don’t know how to evaluate what that would take, or, you may need to figure out fix up costs but you may be unsure of how to calculate them.

We have included some general situations that are often encountered as a beginning real estate investor. (Note: these prices are evaluations of our specific market in the Portland, OR/ Vancouver, WA area. Be sure to determine the pricing for your area).

**BUILDING COSTS: **

In our area it averages about $60.00 a square foot to build a basic sticks and bricks spec house, and about $90.00 to $150.00 per square foot to build a nicer house.

Again, these figures are for our area at the time of this publication (2005). Check with a developer in your area to determine costs.

Once again, our point here is to encourage you to develop your own simple rules of thumb that you can use in your own marketplace to evaluate properties and deals quickly and confidently, so that you don’t waste time chasing down rabbit holes leading to nowhere—this will allow you to focus more energy on the promising properties and beat out the competition with speed and efficiency.

**OTHER FEES: **

You’ll always want to deduct the other fees that come along with a successful deal.

You’ll always want to deduct realtor fees (we generally use 5% in our market), holding costs (including taxes, insurance, and the principal and interest due on the money you are using to do the deal), closing costs (we usually use 2%), and any other cost associated with the given project that you can think of.

**Realtor fees** are typically 5-6%. One way to get out of this fee when selling a finished home, is to sell the property as a FSBO when you are done with the fix. Another option would be to find a realtor who you can create a long term relationship with and contract a lower rate, many times around 4%.

**Closing Costs** are all the costs associated with the deal. Title company insurance, appraisals, and various governmentally regulated documents all add up. Escrow fees are usually split between the seller and buyer. Allowing about 2% of the property value for these costs should usually cover your part.

**DIVIDING LOTS: **

One more word on dividing lots: Profit. Dividing lots can be very profitable, because the extra land associated with a house or plex is often an overlooked or undervalued portion of the overall property value. If you can learn to automatically seek out and

determine the potential for dividing a lot or two, or building extra units, you may just find a very profitable deal where others have passed. You will want to take the time to learn the basics of doing lot-line adjustments, partitions, plats, and subdivisions in your area. A good place to start is by taking an experienced builder, surveyor or land-use attorney out to lunch. Then go and spend some time at your local city or county planning department. When you are really serious about learning, offer to do the legwork for someone who is going through the process or considering it. The best way to learn is by doing!

We mentioned earlier that being able to sniff out a deal takes practice. It involves making calculations, knowing market values and subtracting associated costs. Please take some time to go through the “**Is this a Deal**?” sheet in Appendix D to work out some of the calculations. Then start doing this on properties you find in papers, in the neighborhood, etc.

Okay, so now we know what a deal is and how to determine whether or not a specific property is a deal or not. Now let’s move on to FINDING DEALS!

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