Are you thinking of how to make money in real estate? A real estate investment strategy that would come off is flipping. It is basically a state where the real estate investor buys a property at a discounted price and sells it for a higher profit. Simple as it may seem but it takes a little serious strategic thinking to arrive at a good deal. In today’s episode, we throw a light on the importance of determining if you are in the right price range, the mistakes buy and hold investors make, the effective ways to buy properties at a discount, and more.
Watch the episode here:
Are You In The Right Price Range For Your Real Estate Investing Strategy?
I have a topic of conversation. Are you at the right price range for the real estate investing strategy that you want to employ? Here’s why I want to talk about that. We’ve got a property that’s for sale down at South of Houston. It’s on MLS. When there’s a particular property that we get under contract, sometimes we’ll close on it and we can either flip it or we can say, “Let’s go ahead and wholesale it because if we flip it, we can wholesale it to a buy and hold person and make almost as much in a shorter period of time as flipping it.” A buy and hold investor can oftentimes pay 85% or 90% of what the ARV of the property is minus the costs of repairs. We would make more if we flipped it, but would you rather make $30,000 if you flip it in let’s say three months or would you rather make $25,000 in two weeks if you’re wholesale it? Somebody will say, “$5,000 adds up over time” and it does but it’s still taking up your time, attention, focus, all those things.
You have to then look at how far away is it, if it’s relatively close to where your route is. That particular property is a good 40 minutes away from where our office is. It’s an ideal buy. The ARV on that property is $167,000. That’s a price range that a lot of new investors would like to flip in. When I say it’s not a price range that you should be wanting to flip in, I’m not saying that you can never ever do it. What I’m trying to say is if you are trying to play baseball, your strategy wouldn’t be to hit grand slam home runs all the time. It would be let’s stick to the basics. Let’s have some base hits, some singles, some doubles, make contact with the ball, leg it out so to speak.
A lot of times people are going after that lower price range because they don’t understand. Even the ones that do understand, they will wait an extra three or four months to get a deal to keep it down low. They feel like there’s less risk and they’re trying to play small ball. If they can play small ball, they don’t have to worry about losing. The margins are the margins. You’re not taking any more risk, you’re taking less profit.
Here’s an a-ha moment. In almost every business, there’s a particular margin that the industry will allow you. I don’t know what it is in flower shops. If you try and get above that margin, you better provide some extra customer service or quality of flowers, whatever it is. I’ve got a friend of a friend that owns a large flower shop here in town. I also have another friend that’s owned a flower shop for 40 something years. I’ve talked to them business wise. The margins are pretty good, but there’s a lot of ways like in the food business. When you look at it on a per plate basis, there’s quite a bit of margin in there, but you don’t take into consideration how much food you throw away and waste and all that.
Every particular industry and what you find about capitalism is that anytime that there’s a competitive advantage where you have excess profits for a while, the competition will come in the market place and drive those profits down to where it reaches some level of equilibrium. In the general contracting business, the gross margin you can operate off of is about 20%. That’s before any operational overhead. That’s just your labor and material costs. You can make about a 20% margin on that and then be done.In real estate investing, when you talking about flipping, you should know the 70% rule. Click To Tweet
You see people coming into that sector doing it for less than that, you go, “That’s not true. This guy can do it for 10%.” He can on this job and that job, but he can’t do that long-term. Eventually, he’ll run out of business.
You can say he’s got low overhead or something like that. When you scale, if you’re going to grow, eventually you need to outsource your bookkeeping. Eventually, you need to outsource all these different jobs if you’re going to scale. When you scale it up, the minimum amount of gross margin you need in general contracting business is about 20%. How does that apply to price ranges of real estate? It takes about as much time to flip $167,000 house as it does a $300,000 house. A lot of people in real estate investing, when they’re talking about flipping, they know the 70% rule. It’s 70% minus repairs is oftentimes what you need to be buying a house at. Where does that 70% number come from? It’s oftentimes a lending rule on the hard money side. It’s not a lending rule on conventional financing or anything like that. It’s on the lending side. If you’re looking at 70% minus repairs, keep in mind that if a lender is willing to lend you on a $300,000 house, let’s say $210,000 minus repairs. When I say $300,000, that’s the predicted future value. That’s a term that we created that better describes than what the ARV is.
We talk extensively about that in our academy. We teach people the difference between ARV and PFV because at the end of the day, that has saved so many people so much money. It’s really important.
We have seen people where that saved them $20,000 to $50,000 on a single deal. There’s another way to break it out. From the lender’s perspective, understand that if they’re willing to lend $210,000, they’re not lending you the $210,000 from the get-go. If it needs, let’s say $60,000 for the repairs, then it’s going to be $210,000 minus the $60,000. At purchase, they’re going to be only at $150,000. Take that $60,000 repairs. Let’s say you complete about $20,000 worth of repair. Now, we’re going to assume that the property is worth at least $170,000. You have to recognize it a little bit like a pawn shop. There’s no risk when a pawn shop lends on an asset because it’s called an asset-based loan. A hard money loan is the exact same thing, it’s an asset-based loan. If they’re in $150,000 and the property is worth $300,000, they’re pretty safe at that. They can probably turn that around. Not only that, they’ve lent you the $210,000 but you haven’t received it yet.
You’re on the hook for the full $210,000 from day one. You’ll never get more in debt than 70% because you’ll be paying the taxes, you’ll be paying the insurance and you’ll be paying the interest as it goes along. What will end up happening is that when you complete that $60,000 worth of repairs, the lender doesn’t care if it’s $300,000, $290,000, $280,000, $270,000, $260,000, because they know it’s worth way more than $210,000. They’ve got a retail ready asset at $210,000 they could turn around and closing costs. If they sold it for $240,000, take $24,000 out. They make a profit, they’ve made interest along the way, they’re good. Does that mean that that’s necessarily the number that you should work with? Maybe and maybe not. Let’s look at that 30% that is on your side. 10% of that you could assign to holding cost. 10% of that you could assign to closing costs, 3% for the buyer’s agent, 3% for the seller’s agent, 2% for what I call the negotiation after the sale.
During the option period, when the inspector comes out, even if you have a fully permitted house, the buyer has an opportunity to renegotiate. They can ask for discounts, ask for extra work being done, a home warranty, all those things. The final 2% is the title insurance, the escrow fees, doc prep fees, attorney fees, all that. I know some investors go, “I’m an agent, I save that 3%.” If you tend to being an agent, then you should be your own agent. You should even budget that 3% because that’s a separate job than being the investor. If you’re going to be your own agent, you should get be paid as an agent as well as being paid as an investor. Otherwise, you’re not making the money that you think you’re making as an investor.
All that to say, then that leaves about 10% for profit. We oftentimes get more than that because we’re buying below 70% minus repairs, that’s how you do that. You execute faster when I’m budgeting my 10% for holding cost so you can shift some numbers there and get 10%, 15%, 20% profit on those deals. Let’s go back to the basics of 10% for profit. We’re talking about the number. There was a particular house in that price range that should have been a buy and hold. I bought a house for $65,000. It was somewhere between $8,000 and $18,000 in rehab, regardless of what it was. We sold it for $119,000, which is great. I think we were in for $73,000 because we only did $8,000. We did paint and we took a Jacuzzi tub out.
You all made a little over $40,000 on it. When is the last time you looked up the value of that house now?
About a year ago, it was $180,000.
Now, it’s probably about $195,000.If you're going to be your own agent, you should get paid as an agent as well as an investor. Click To Tweet
What we realize is although we sold it for $119,000 then, in three years’ time, it grew another $60,000. We’ve had this conversation over and over again with people. In fact, we’ve got a gentleman that we’re in negotiations for him coming on board with us. He bought his first house as a rental seven years ago. He was all in for about $80,000. I was actively involved in fast track. I went out, walked the house with him, helped him make decisions about what to fix and what not to fix. He’s now looking to sell that property because he wants to leverage, take equity out of that and buy two more properties, I believe.
Probably more than that. He’s going to sell it for $180,000.
He’s in for $80,000. Imagine if you bought ten properties now and in seven years you generate $100,000 per house in equity. It’s $1 million in seven years passively. That’s not counting the depreciation. That’s not counting the equity pay down because he didn’t owe the $80,000. I think he owes $74,000 or something like that. You get equity to pay down, you get depreciation, you get appreciation and you get the cashflow. Back to flipping, know your right price range. If you’re looking at 10% as a margin, if you flip a $300,000 house, you’re making $30,000. If you increase that to 15%, you’re making $45,000.
That can happen from getting down a little quicker. Days on the market, it could sell faster and less holding cost. Very often times, if you’re buying these things right and you’re not lying to yourself, the numbers don’t lie. A lot of times I see folks who want to convince themselves the best-case scenario so they can get the deal. What happens is when you have a best-case scenario on the front end, you have typically the worst-case scenario on the back end. If you buy that thing right and you’re conservative with your numbers, when you get to the back end, a lot of times you’re going to sell it for even higher than you expected because the market’s risen while you’ve had it. That’s where you get those home runs, those grand slams. You’re not shooting for the grand slam, you’re shooting for a base hit, but grand slams happen.
If you do this enough times, you’re going to hit a grand slam.
If you’re going out only looking for grand slams, you’re not going to get any base hits.
If you’re doing $165,000 ARV like this house down in South of Houston, you’re talking about $16,500 for that same amount of work. This particular house, the person that we bought it from, they were planning on doing a lot of the repairs themselves. They had gone out and bought almost all of the materials. They never could get the labor part going and sold the property with the materials. To retail this property for a flip, you’d probably have to spend more money than if you were going to rehab it for a buy and hold. There are two reasons why you have to know the right numbers in terms of what are the numbers for buy and hold?
What are the numbers for flipping and then how does the wholesaling fit within all of that? I just want to cover that. If you’re flipping, it makes more sense to not compete with people that can buy business design and do a better job than you. You and I went to a property. We went to a hardware store and it was one of the old school type hardware. This place, when we bought what we bought, they hand wrote out the ticket. It was an old school hardware and lumber yard. I’ve bought tons of stuff. I bought over $1 million worth of materials from Home Depot. You walk into Home Depot, the level of experience is different. The guy that helped us knew where everything in the store was.
He knew about different types of screws, links, treads. That was just one small area of probably his expertise. You’re not going to find that from the guy on aisle nine at Home Depot. He might be able to show you where the batteries are, that’s about as far as it goes.
They probably operated a different margin on their materials than a Home Depot does, because they’re not running the same volume. What you have to recognize is that you could as a buy fix and flipper compete within that same space than a buy and hold investor is going to do. We know that flippers are buying at 70% minus repairs and we know that it works. It’s different if you’re full-time real estate versus if you’re passively real estate. We have members in our group that want to buy ten, fifteen and twenty. In one case, 30 houses. When you’re trying to deploy that much capital, you’re trying to look to put 30 houses worth of capital to work. You’re not going to be able to hit a grand slam on every single one of those and you don’t need to. It’s the reason why Warren Buffett can’t play in this space very effectively as he wants to put $1 billion to work.When you have a best-case scenario on the front end, you have typically worst-case scenario on the back end. Click To Tweet
That’s good news for us because it keeps those guys who have a lower cost of capital than almost any of us from competing in that space. I believe in Houston Texas, the price range that you need to be in inconsistently is above where the buy and hold guys want to operate. You have to look at where the buy and hold guys are operating. Most good buy and hold guys that are doing it consistently are from about $70,000 on the low end. If you get much below about $70,000, you understand that the two key ways that you make money in buy and hold is one appreciation and the other is cashflow. The one that builds more wealth is the appreciation. If you’re getting 7% appreciation, you’re leveraging it five to one. In other words, you’re putting 20% down on a house and you’re getting the other 80% from a mortgage lender.
You’re getting a 35% rate of return on your money.
That’s for a real wealth building. When you are compounding 35% year after year, that’s how you make $100,000 in seven years on one house. It’s not from the cashflow, it’s from that portion. It makes sense for people that are deploying capital like that. We give an example on our website where you can buy a house for $150,000, fully retail and ready to move in. If you’re below $70,000 what I would say is, if you’re buying a house that’s retail-ready at $70,000, I would argue that in the last several years, it was still $70,000. There are neighborhoods that don’t show much appreciation.
They have it in twenty or 30 years and probably won’t in another twenty to 30 years.
If you’re going by the house that’s $45,000 or $50,000, it’s probably been $45,000 or $50,000 for the last ten years.
What I found is on the wholesale side of things, that’s typically where a lot of your owner finance guys want to play it. Somebody that’s buying a $70,000 house, they’re not going to be able to get funding for something that low.
That’s almost all-cash buyers because it’s hard to get a mortgage on a $40,000, it’s nearly impossible. When I say a $40,000, I don’t mean a purchase price of $40,000. What I meant was that’s the predicted future value. It’s worth $40,000 when it’s all fixed up. Those are neighborhoods that I call not safe at night. I’d say that most buy and hold investors are operating from about a $70,000 ARV all the way up to about $175,000 ARV. Here’s one of the mistakes that I see people make. I see buy and hold investors that want to go out and buy $250,000 or $300,000 ARV houses and turn those into rentals. Although that may be good from an appreciation standpoint, it doesn’t cashflow. For $300,000 of money, I’d rather have $250,000 house rather than one $300,000 house, because I’m going to get cashflow on those $250,000.
It’s even scarier. There are people that are buying these $300,000 houses for cash. It reduces your rate of return from 45% to 47% down to about 15% to 17%. You could deploy that same amount of capital into ten different houses and increase your appreciation year-over-year.
If I go buy a $300,000 house in cash, then it’s going to rent for about $2,200 a month. What’s going to happen is that I’m going to pay taxes and insurance. I won’t pay principal and interest, but I’ll also pay a management fee and there will be some miscellaneous and other expenditures. I’d recommend property management because if you’re buying a house for $300,000, you’re creating capital at a pace that you should do something else right with your time, other than management. Management only costs about $100 a month and sometimes even cheaper. You’ve got those expenses. If it’s renting for $2,100 or $2,200 a month between taxes, insurance, HOA, management fees, and miscellaneous expenses, you’re going to make about $1,800 a month.
I know someone who knows someone that saved up about $1 million. He wanted to deploy it into buy and hold real estate. He wanted to go out and buy four $250,000 houses. When you start running the math that you’re going to run about 3% of the home value on taxes in a year. On a $250,000 house, that’s about $7,500 a year in taxes. Let’s call that about $600 a month. On a $250,000 house, it’s going to rent for $2,100. If you paid cash for the house, you’re going to have 3% in taxes. You’re going to have insurance. On a $250,000 house, I’d say 1% in insurance. That’s $2,500, let’s call it $200 a month. You’re going to have $100 a month in property management and let’s throw in an extra $50 a month in miscellaneous expenses. On a $2,100 a month rent, you’ve got $950 a month in expenses.If you're going out only looking for grand slams, you're not going to have any base hits. Click To Tweet
That means that you’ve got $1,150 a month in cashflow. That’s $13,800 a year in cashflow on a $250,000 investment. That’s about 5.5% cash-on-cash return. Let’s assume that that property is going to go up 10% a year in value. Now you’re making about 15.5%. What that means is that $300,000 house can become $330,000 and then $360,000. I’m overestimating in those numbers but that gives you about 15.5% rate of return between cashflow and appreciation. You’re outperforming the S&P 500 by about 50% because it’s gotten 10% long term. You’re doing 50% better than that. You’re still doing worse than Warren Buffett.
He was about 19% and some change, a little less than 20% over a long period of time. He’s done okay. If we’re trying to shoot for Buffett’s numbers, how do we do that? One way is if you had $1 million to invest, you’d be better off buying 33 $150,000 houses. I’d be putting $30,000 per house. That would give me $990,000 going into that number. At $3,300 and $990,000, I’ve got 33 times $150,000 a house, I’d have almost $5 million worth of real estate. Imagine that $5 million of real estate is going up 7%. That means it’s appreciating $350,000 in a year. That’s 35% on your millions. That’s taking a more conservative approach on a $150,000 appreciation. I was at 10% on a $250,000 house. I’m at 7% on $150,000 house. That’s the difference. If I want to invest $1 million, now I’m making $350,000 on $1 million, but then let’s talk about cashflow also. My rents are going to be closer to $1,500 which is way less than the $2,100 I’d be getting for the $250,000.
You’re getting cashflow about $300 a house. That’s $10,000 a month in cashflow.
I’m going to get $9,900 times twelve. I’m going to get $118,800 versus before I was going to get $13,800 times four. I’m going to get a lot more in terms of cashflow. If I take $118,800 and divide that by $1 million, I’m at 11.8%.
Add that to the 35% from before, that’s 46.8% on your $1 million.
Do you realize that if you’re putting your money, it’s not about deploying the million? We could talk about what if the market dips. We could play all the “what if” scenarios but what I would say is you’ve got enough equity always. Even if I had to sacrifice that $300 a month per house, I could always lower the rent from $1,500 to $1,400 to $1,300. It’s not going to fall. $1,200 a month for a place to live, three-bedroom, two baths, two-car garage, it’s not going to happen. We’re probably off on the numbers. We’re probably being overly conservative on the appreciation because $150,000 house is well below replacement costs. It’s well below the median home price. That’s not even equity capture. We teach people how to buy properties at a discount. What it’s saying to wrap it back at the beginning, is if you’re trying to flip properties in the price range where buy and hold investors are operating, you’re going to get killed.
Can you get a deal every now and then? Yes, you can. Can you do it over the long haul? Are there other strategies? Yes, there are. I talked to somebody and they say what they like to do is buy a house that’s semi-livable. You get the bathroom work in and you get the bed and then now you do a lot of the work yourself and you move into the house. Keep in mind that when you’re looking at “Do I want to build my business strategy around this price range?” For every single property, if you’ve got a nearly retail ready house as an investor, turn away and walk away.
We don’t bring any value to that transaction. In order to buy anything at a discount price, you have to bring value to that transaction.
As long as you’re living life in a relationship building way where it’s a win-win scenario. If you’re looking to have a win-lose scenario, then you can probably make one or two of those works.
It’s not the right way to do things. I see people all the time trying to push these deals off on investor groups and things like that. It’s like no repairs needed. Why do you have it under contract? Obviously, there’s a miscommunication somewhere between you and the seller or you’re not being completely honest about what you’re doing. There’s no reason that you should have brought anything to the table for that deal.It's important to know exactly what it is that you're trying to do to be able to focus in the right area. Click To Tweet
For every single property that’s available, if you’re competing against a retail owner occupant, in other words it looks like, “All it needs is some very minor updating.” That’s going to typically be bought by somebody who wants to live in the house. They can always pay 95% or even full retail and bragged all their neighbors about what a great deal they got. Then you’ve got the buy and hold guy. Honestly, I’d argue that they can buy at 90% or 95% of retail even all the way up. If you’re not happy with 46%, 47% on $1 million, that’s full retail. That wasn’t buying at any discount. That’s buying $150,000 house that’s move-in ready. You’re putting 20% down and financing the other 80%.
The next highest after the retail owner occupant is the buy and hold guy, then next after that is the flipper. You’ve got wholesaler depending if the wholesaler is going to sell to the buy and hold guy. What that means is that below $70,000, that’s where I see a lot of the seller finance guys top rate. Between $70,000 and about $175,000 is the sweet spot for where the buy and hold guys like to operate. You’ve got to get north of $175,000. I think $200,000 to whatever your comfort level is going up, that’s where the flippers need to operate. If you do not understand that, then you definitely need to come to our Wealth Through Real Estate Academy weekend. I’ve covered a lot in an hour. I know it’s not a whole lot of fun to cover the math.
Doing the math on here doesn’t always work. We try to keep it simple enough that you can follow along.
Here’s where we’re going to make a difference in people’s lives. If you’ve got a 401(k) that’s got $300,000 or $400,000, if you can do it at all, it’s going to take about twenty years to have that get to $1 million. What if you could take that $300,000 or $400,000 and have it become $1 million in less than seven years? If you’re 53, 54, 55 years old and you’ve got $300,000 or $400,000 in your 401(k) and you’re like, “I’ve got ten years to make it to $1 million,” statistics say that you cannot get there.
What if you’re ten years younger than that at the same place? Can you get to $1 million? Do you know what they get you per month? That’s less than $5,000 a month. To get $5,000 a month, you got to be at about 1.7%. Shooting for $1 million, where’s your ceiling? That’s not a great goal. Doing it the way we do at 45%, 47% or even 35%, if you’re doing appreciation only, when you compound that out over two, five, ten, fifteen years, that’s life-changing. When you truly grasp the concept of that compounded, it’s a different story. We’ve been talking about making sure that you’re in the right price range for your business strategy. I think a lot of times people get a little mixed up because they’re not quite sure about what their strategies should be. It’s one thing to be operating in the wrong price range. It’s another thing to not even know what your strategy is to even figure out what price range you should be in.
Here at Houston House Buyers, we do fix and flip, we do buy and hold, we do wholesaling. That wasn’t the case in the beginning. A lot of times when people are first getting started, they’re trying to do everything. All three of those are separate business models. While they can be synergistic and things like that and work together in the beginning, not focusing on one is a downfall for a lot of folks. It’s important to know exactly what it is that you’re trying to do to be able to focus in the right area. For us, wholesaling was a byproduct of the business that we’re doing already. A lot of people want to get into flipping and wholesaling and buy and hold all at the same time in the beginning and not have a strategy.
We had that property in Copperfield for example. We can share numbers. There was a property we had in Copperfield. It’s north on Highway 6 and south of 290. We knew that we probably had a $300,000 or maybe at $325,000 ARV. It didn’t make sense to change the flow too much. It could have been opening up the kitchen a little bit. That’s a $5,000 to $7,500 expense, whether you do it or you don’t. If you spent that $7,500, you’d probably get closer to $325,000 maybe even hit $340,000. You’re probably going to have $100,000 to $110,000 rehab. We knew that $110,000 rehab is about four months. For $110,000 we were budgeting new siding. Not a new roof, but new foundation, new plumbing, new HVAC, all of those things. We look at, “Let’s put it out on the market and see what we can get for it.” We got $141,000, but we bought it for $35,000. We could have killed it if we flipped it. We could have made a little bit more money. There’s enough meat on that bone. We can wholesale it quickly and get cashflow coming in.
It’s $106 in a couple of weeks. Maybe we hit $130 or $140.
It’s like, “Do you want $106 now or do you want $130 in five months?” It’s that $24,000 Delta or $30,000 Delta which $30,000 on a $300,000 house, that’s 10%. That’s right on the money. If they execute better on the holding time and all that, it’s there. Could they execute well and make $50,000, $55,000, $60,000? Absolutely, they can.
It’s a win-win for everybody.
It’s not like we flipped the good deals and we wholesale the bad deal.
You cannot get that all the time. People will say, “I see your deals coming out. Can you send me some of the good deals that you all don’t send out?” Either we flip them or are we keep them as a buy and hold or we wholesale them.
That’s a grand slam home run. We have acquisition guys that are absolutely tense on the acquisition side. If you’re going to do what we do on that, we’ll teach you how to sell if you want to learn how to sell. If you’ve never sold anything before and you don’t have the personality to be a salesperson if you don’t have the confidence to be able to look somebody in the eye and make them that offer. Our acquisition guy said, “As soon as they took the $35,000, people are like, ‘How do you buy a $300,000 house for $35,000?’” If you want to learn that, come to our Wealth Through Real Estate Academy and we will teach that because it’s doable. That’s a grand slam home run.
Do we count on that? No. Do we get one or two of those a year? Yes, we do. Do we get a hundred of those a year? No, we don’t. Do we do about 100 deals a year? Yes, but we don’t do 100 of those kinds of deals a year. We have a realistic expectation because we want to build our business model on being scalable and duplicatable. When’s the next time that somebody can come and learn more about this? The easy way to do it, the freeway to do it, come to our Wealth Through Real Estate workshop. All you’ve got to do is go over to RightPathRealEstate.com or send an email to Support@RightPathRealEstate.com. It’s easier to go to RightPathRealEstate.com. Click on the events tab on the upper left-hand corner and register for the event.
If you’ve been to that already or you want to jump right into the meat of this thing and get signed up, our next academy is going to be the 23rd and 24th of March. You can sign up for the membership right directly online. You don’t have to contact us if you don’t want to. You’re more than welcome to talk to me at Support@RightPathRealEstate.com.