The real estate inventory is low in the DC area, and any real estate investment opportunity is bound to attract multiple investors’ attention. It’s not unusual for a distressed home to receive twenty or more offers. How do you keep your competitive nature in check and remain level-headed when faced with such intense competition? How do you resist that rush (or high) that real estate investors derive from being that winning offer? How do you make sure that the need for instant gratification does not cloud your judgment? The answer is in unbiased financial analysis, disciple, and perseverance.
Let’s start with an unbiased financial analysis. A year or so ago I’ve talked to a frustrated real estate investor who kept losing properties to higher offers. He called us to solicit our professional advice. As a top hard money lender in Washington, DC, perhaps we can share an insight into how his competition can pay so high and still make money on that flip?
A simple answer is that there are no hidden trick or secret strategy on how to make money on an overpriced property. An experienced investor with his own crew might be able to save on rehab costs, but those saving are rarely enough to make a big difference. The truth of the matter is that the unreasonably high offers come not from experienced rehabbers but those who are new to the real estate business. They are the wishful-thinkers eager to start on their first project. They are also the ones willing to bend their financial analysis to “create their own reality.”
“The unreasonably high offers come not from experienced rehabbers but those who are new to the real estate business.”
The most common way to “create your own reality” is by inflating the home’s after-repair value. I’ve recently worked with a new investor who got pre-approved for a specific scenario. We’ve discussed the maximum purchase price, the approximate rehab budget, and the potential ARV. Interestingly, the ARV that this investor initially came up with was the same as mine. However, during the bidding process, she has changed her mind and offered significantly more. She also increased her estimate of the future value of the property by more than $100K. Though there was no single property within a .5 mile radius that came even close to that price, she needed that fictional ARV to justify her higher offer.
Needless to say, real-life doesn’t follow such logic. We’ve written many articles about how to determine the ARV correctly. The bottom line is that it’s based on the prices of similar homes sold in the vicinity of your subject property. Your ability to increase its value much beyond the highest sold property in the neighborhood is finite. You might get a slight boost from appreciation or even set the neighborhood price record, but it’s almost impossible to raise the neighborhood prices beyond a certain point single-handedly.
Another common way to “massage” the numbers is to reduce your rehab budget. If you are a first-time rehabber with no tested crew, chances are you will be paying closer to the retail prices. If you are an experienced flipper providing your crew with a consistent income source, you might get a decent labor discount. However, reducing your renovation costs to make the numbers work will not serve you well. If the other homes in the neighborhood have beautifully finished kitchens, you cannot use builder-grade materials and expect to compete against them. If you decide to reduce the construction budget by not finishing that basement, don’t forget to reduce your after-repair value accordingly.
So how do you resist the temptation to chase that instant gratification of putting properties under contract – regardless of their prices?
Cast a wide net.
Do not fixate on a single property. By putting all your eggs in one basket, you run into the risk of getting emotionally involved. Emotions are not a real estate investor’s friends. Do not fixate on one transaction no matter how profitable it appears. Remember, many real estate agents will purposefully create a feeding frenzy by listing a property at a very low price. It attracts wide attention and with it – more offers.
Our most successful borrowers are always making offers. When they are in the property-hunting stage, it’s not unusual for them to request multiple proof-of-funds letters each week. They have the discipline to know that getting the right property at the right price is a process and is not a sudden stroke of luck. So make it a habit to make offers on multiple properties at the same time. Cast a wide net. The majority of opportunities will get away, but you are looking for just a couple of gems here and there to make it a great year. You can also check out our blog on creating a robust real estate investing business plan for ideas on how to keep focused during this stage.
Rely on a trusted analytical tool to make the right decision.
Make sure you have the right tools at your fingertips to quickly determine the profitability of each transaction. One of such tools can be a hard money calculator. The right hard money calculator is a great reality checker because it forces you to consider all costs associated with the transaction. It should also allow you to run a number of what-if scenarios to determine your maximum offer.
Be realistic about your goals.
Some new-ish real estate investors aim for certain amount of profit or a specific ROI – many of them too ambitious for today’s market. A profit of $15K might not sound too exciting but if you can book it quickly by flipping a low-priced home with a cosmetic rehab budget, it might be worth your while. In contrast, $15,000 might be way too low to compensate you for the risk and effort redoing a Washington, DC townhouse from top to bottom. A modest but certain profit might be worth your while if your capital AND time investment are also kept in check.
Resist the temptation to massage the numbers.
As we’ve discussed, it’s tempting to give in to wishful thinking and look at the most optimistic scenarios. This wishful thinking usually goes like this: “If I can keep my rehab budget to the minimum, and sell the property in three months for the highest price in the neighborhood, I can squeeze some profits.” In such a scenario, you need to align three stars: minimum budget, minimum holding time for your hard money loan, and the maximum sale price. If this is the only way you can make a profit, then let’s face it: you are about to bite more than you can chew.