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Last Updated: May 14th, 2012 - 22:24:01 |
Profit Potential of the Rehab Business
The real estate rehab business is essentially a manufacturing operation. A raw product is purchased wholesale and is transformed into a final retail product. Like all manufacturing businesses, profits are based on margin, or the difference between cost and sales price.
Your minimum net profit or margin should be no less than $10,000 on any rehab project. I want to emphasize that this is the minimum profit that you should accept. In evaluating a potential deal, if you can’t see at least $10,000 net profit, move on to another deal. It’s just not worth your time and effort to get involved for anything less.
But as you become more adept at finding bargin properties and negotiating better deals, your profit margins will increase. And at some point, you will expand your operations into more expensive properties. Higher-priced properties carry more risk because of supply-and-demand factors, but the profit margins increase dramatically. A $50,000 profit on a $250,000 house is not at all unusual and the amount of time and effort is basically the same.
The other factor is how many projects you complete. On a part-time basis, you could comfortably do two to three houses in a year, with little impact on your current lifestyle. Anything above about six houses a year and you’re getting into a full-time operation; however, I know of some people who are doing as many as 50 to 60 houses a year. Obviously, this level of activity requires several people to manage the operation.
Advanced Techniques for Finding Bargains
Without a doubt, finding and acquiring bargain properties is the most important aspect of a real estate rehab business. You’re not in business unless you can develop a continuous stream of houses on which you can make offers. And you’re not managing your business property if you’re not spending about 80 percent of your time on the acquisition process.
Why such a heavy time commitment on the acquisition process? Because it takes that much time to find and buy properties at wholesale prices.
It would be nice if you could just call up your real estate agent and say, George, I’d like to buy a house today at wholesale – what do you have? Unfortunately, it just doesn’t work that way. It takes a lot of time and hard work to consistently purchase properties that meet our major investment criterion – that will make you money.
Getting Rich by Driving Around
One of the most important and valuable activities you can undertake as a real estate entrepreneur is to get out and drive around the neighborhoods in your community. It is the only way to observe characteristics and determine trends. How else are you going to find out where the marginal areas are, which neighborhoods are improving, and which ones are going downhill? But beyond these important tasks, getting out and about affords you with the opportunity to sot fixer-upper properties.
Your job at this point is to jot down the street address of every candidate. You might even want to take photographs. It doesn’t matter if the house is vacant, boarded up, or full of life – you’re trying to build a database of potential candidates that might meet your investment criteria. You know the clues you’re looking for – curled up roof shingles, chipped and faded paint, cracked stucco, broken windows, cowboy landscaping (weeds and dirt), abandoned cars, cars on blocks in front yard, and so forth. Obviously, you can’t see the inside of the house, but these external clues at least indicate poor maintenance. If I’m in a new area, I like to park the car and walk around the streets. Not only can you see the houses better, it gives you a chance to talk to any of the neighbors who might be outside. I just tell them I’m looking for a house in the area, maybe one that needs a little work, and ask them if they know of any houses like that. Be simple, straightforward, and honest. Because you are a stranger, you usually don’t get a lot of information, but sometimes you do. It’s worth the effort.
By the way, while you’re out driving, don’t hesitate to stop in on any FSBOs that look interesting and be sure to make a note of any listed property that looks like it might have potential. Not all handyman specials are identified as such in the MLS.
Preforeclosure Market
Buying a house from sellers in default on their loans can be a very lucrative transaction. The sellers don’t have the money to make house payments and are usually three or four months behind in payments. They know they are about to lose their house and totally destroy their credit for many years to come. Sellers in this situation are typically very motivated. If you can solve their problem by bringing the loan current and out of default, and give them some additional money to move out and get relocated, you can often buy a house at a substantial discount.
The preforeclosure market, although highly competitive, can be exceedingly profitable. You can participate in this market with relatively small amounts of cash and can quickly reap huge rewards. Some people who specialize in this area do so without any cash – they find the deals and quickly pass them on to another investor for a nice finder’s fee. Success requires a tremendous amount of time and energy, intimate knowledge of market values, a clear understanding of the local foreclosure procedures, and the ability to act very quickly. But most of all, you have to be knowledgeable and skilled in solving a number of potentially sticky problems:
- Meet face to face with a distressed seller and negotiate a sales price.
- Get the seller to sign a sales contract.
- Get loan balances from the lenders.
- Research other encumbrances or liens to get clear title.
- Overcome the ever-present “due on sale” clause.
- Get the seller to move out of the house.
These are the typical problems that must be solved in almost every preforeclosure deal. To be sure, there are solutions to all of these issues. If you’re in the rehab business, this market is probably not where you want to focus your efforts, at least initially. As you become more experienced and knowledgeable, this is a great place to find exceptional deals, but you have to be able to devote the time and effort.
Putting Together Your Own Dream Team
You cannot operate your rehab business in a vacuum. Your success, to some extent, will depend on your ability to assemble a good-quality team of advisers. These people could include all of the following: real estate agent, attorney, accountant, appraiser, mortgage broker, home inspector, handyman, and general contractor. Each of these people has specialized knowledge that you need to effectively operate your business. Select your advisers carefully, because bad advice from any one of them could significantly affect the profitability of your venture.
Operating to Maximize Profits
Once you’re up and running, maximizing your profits is the name of the game. And it’s an ongoing continuous process of improvement. How can I do this better and more efficiently? What it really boils down to is control. The more control you exert over every aspect of your business, the more profitable it will become. This requires you to pay close attention to all of the details so that nothing slips through the cracks. It also means that you consistently replicate the things that work.
Speed is one of the secrets of success in the rehab business. Speed in buying, speed in rehabbing, and speed in selling are all very important. Speed in the buying process is worthy of special mention. When you’re out in the marketplace looking for bargains, you must be prepared to act quickly in making your offers. If you dillydally around, someone else is going to scoop it up while you’re still day dreaming! Be prepared at all times to make offers if the right opportunity presents itself.
Building Your Business and Investing Your Profits
Good businesses, ones that endure, are built on word of mouth, otherwise known as referrals. The best endorsement any product or service you can get is from a satisfied customer or vendor. Treat people fairly and the returns to you will be compounded exponentially.
This is particularly true with buyers of the properties. Try to include a home warranty package – either a commercial one that you have purchased or guarantee the house yourself for a reasonable period of time. And if something goes wrong, get it fixed immediately. People will remember you and tell their friends, neighbors, and relatives – all potential future clients. This is how you build a strong future for your business.
As things get rolling along, your profits will start rolling in, more money than you probably thought possible. This isn’t a get-rich-quick scheme – you will work your butt off for the money. But it will come and you will deserve it! The question is, what will you do with your new-found wealth?
As soon as you can, you need to start investing your money so that it will grow. There are many ways to do this. Certainly, you could buy and rehab more houses. But how big do you want your operation to get? I would suggest you consider real estate – related investments that are less hands-on in nature. Specifically, I think investing some of your profits in mortgages or “paper” is one of the best alternatives out there.
You can become lender to another rehab operator or a homeowner. You are in on the deal as its inception and through your private mortgage broker, and know all the details about the property and the people involved.
This is a big advantage compared with just buying “discounted paper” through a note broker who did not originate the loan and may know little about the players or the property. My observation of people who routinely invest in discounted paper is that they focus too much on yield with insufficient attention paid to the property or the people involved.
Most private mortgages are funded in the 12 percent to 18 percent range, with additional profit potential if the borrower defaults. You mean a private lender can actually make more money if the borrower defaults and the lender forecloses on the property? On those rare occasions when foreclosure does happen, the private lender has the opportunity to make a bundle. If you’re the lender and foreclose on a 50 percent LTV loan, you have the chance to sell the house at full value and make a 100 percent profit! You may have some attorney expenses for the foreclosure, but these are minor amounts compared to the profits.
This is why some investors make private loans, in hopes that a foreclosure situation will occur. Indeed, some private lenders like to specialize in loans on property headed for foreclosure. It’s just another opportunity for a huge profit center upon reselling the house.
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