Real estate investment gurus often say real estate investors make money when they buy. We hear that said a hundred different ways, but it all comes down to the simple strategy: buy low, sell high. We could hope that market conditions improve during our time of ownership so that we can sell the property in the future for more than we paid for it, but hoping is gambling. As investors, we rely on skill and strategy to achieve acceptable profit margins. So, how do real estate investors make money when they buy? They look at more than the price of the property and focus on the detailed costs of ownership and operation and ways to improve the revenue stream. In those details lurk opportunities to buy lower than market value and by doing so make money when they buy.
Here are four general strategies that can help real estate investors make money when they buy any potential acquisition.
Don’t Inherit Expenses. Require the seller to correct all problems identified in property inspection reports prior to close of escrow. Some reports, e.g. termite, segregate mandatory repairs (Section 1) from optional repairs (Section 2). Require that ALL repairs be completed, including optional items that could become more expensive to fix over time. Also require proof that all outstanding debts against the property are paid through the transfer date, including utilities, trash collection, lawn care service and repair contractors.
Discount Seller’s Assumptions. Don’t assume a property will continue to operate at the profit level disclosed in the seller’s financial disclosures or pro forma operating statement (forecast). Sellers typically base their asking price on the property’s earnings, but as we often hear in the investment world – past performance is no guarantee of future earnings. Base purchase offers on your evaluation of market conditions and financial potential of the property, not the seller’s.
Create Your Own Cost And Revenue Model. Unless the seller has management practices and vendors already in place that are better than yours, replace them with your own. Replace the $200 per week pool service contractor now servicing the property with a $150 per week contractor who produces identical results. Same with lawn care, pest control and other providers of recurring services. Conduct a Market Rent Analysis (MRA) to determine if current rents are truly below market, as many sellers often advertise. Tip: Beware of sellers that advertise tremendous up-side potential on rents. If rents are really low, the owner would have raised them. Perhaps if they did raise rents, they’d have a vacancy problem as tenants seek affordable housing elsewhere. That problem could become the buyer’s if rents are raised after purchase.
Evaluate Possibilities. Most investment properties have the potential to increase cash flow and market value with simple cosmetic or functional changes. For example, adding storage space to multifamily properties can either justify higher rents or create an additional revenue stream if storage rental is optional. Adding a security gate to single family or multifamily properties can increase rental value. These improvements could be paid for in less than a year from improved rents.
Most real estate sale negotiations eventually boil down to the purchase price. If the investor has identified opportunities to cut costs and/or raise revenue, settling on a sale price that helps them make money at the time of purchase becomes a simpler task.
Have questions about how real estate investors make money when they buy or other real estate investing issues? Drop me a line!