5 Basic Fundamentals of a Real Estate Investment

Here is what I tell beginners…

First, evaluate how much time you can commit to real estate investing. If your approach is “hit or miss,” your results will be too.

Second, go to the street. It is the best teacher. Rather than talking about doing deals, reading in the library, getting more courses, JUST DO IT.

In the long run, you’ll find that the street is the best teacher. Not only that, but by getting out an doing it, you’ll learn your market, meet people to build a network, learn the demographics and geography of your area, and of course you will have overcome the biggest obstacle in getting started–procrastination.

You need to do what we call “penciling out a deal.” When doing that, we ask ourselves a battery of questions necessary in structuring an investment. I’m going to give you five steps to get you started.

How much do you want to make?

So many times I hear someone act as if they are afraid of loosing a deal because they need to make a low-price offer. Forget about it. I’d rather be sorry about the investment I did not make, than the one I did. The profit is what protects you in a deal. Don’t be afraid to make it.

When doing a deal I want to make at least 30% and believe me when I tell you, when I structure a deal with 30% in it, I never get it. Somehow the profit always dissipates, even after I thought I figured it to the penny.

Would I do a deal with less profit? Yes, but I would do it as a flip, a lease option, or as a leveraged deal with positive cash flow.

Determine the value of the property

The next thing you must do is determine what the property is worth. The obvious thing to do is get comparable sales for it. Don’t let the seller or real estate broker tell you what it is worth. Get the comps yourself.

Deferred maintenance

Usually I figure my profit after taking off the deferred maintenance, otherwise it distorts my profit. So it must be figured in the beginning to determine your profit.

Game plan

What do I want to do with the property? Do I want to fix it and sell it? Do I want to keep it long term or short term? When I buy a property, I have a plan for it. And usually I buy it with that plan in mind.

This part is so important. I’m going to go into more detail by giving you an example. Remember, you make your money on the buy.

Example:

Each deal speaks for itself. For example, if I bought a house for $50,000 and had to put $10,000 into it for fix up, I’m in this deal $60,000. Now what would that house have to be worth in order for me to feel comfortable to buy it and debt service it on my line of credit?

$70,000? No I don’t think so. I would have no room in this deal for error. What if after a month or two, I don’t sell it? Now remember, we can play the “What if…” game all day. I can create a fast sale for the purpose of this article to make myself look good, but that’s not the answer. We have to be careful with hypothetical questions and answers.

The profit structure on this investment is not good enough for me to do the deal.

$80,000? We’re getting better, but no. I have to keep in mind that things can go wrong with my deal. What if I sell it after two months, and then the sale falls through because of financing after being under contract for 45 days. Now I have had the property for 3 1/2 months and have to put it back on the market again.

Also, what if the market changes or slows down?

Even though I show on paper that I have a $20,000 profit, that’s not so. For the fun of it, lets take this so-called “paper” profit of $20,000 and structure a Game Plan around it.

(1) I plug in six months of debt service on my deal. I’m in the deal $60,000. Interest, let’s say for the benefit of our example, is 9.5%. Our payments would then be $475 per month. 475 X 6 = $2,850.

(2) Whatever market value you come up with, always cut it by 5% to 10%. Realistically, the potential buyer is going to want you to discount your price. Now if you don’t have to, great. But lets face it: If you were trying to sell it for $80,000, and someone offered You $76,000, you know you wouldn’t want to wait for another buyer.

You would still be debt servicing the deal. With your luck, you wait another month or two and the next buyer would make the same offer. Terry Vaughan will tell you, that the first 10% of a deal is air. I agree with Terry, but for the purpose of this deal, we’ll just keep it at 5%. So, let’s take off another $4,000.

(3) I always plug in a Realtor. Now I know that there are a lot of geniuses out there who don’t need them. They are so great that they can sell the property themselves. Great, you plug in a Realtor. 76,000 X .06 = $4,560.

Lets recap. A sale of $80,000, gives us on paper a $20,000 profit.

As you can see the profit disappears quickly. Personally, I don’t think $8,500 is enough profit to take the risk.

How about $90,000? Now all of a sudden the deal can make sense. We have between a $17,500 and $18,000 profit.

Lets look at our LTV (loan to value). $60,000 divided by $90,000 = 67% LTV.

So you see, the investment speaks for itself, but the structuring of a deal with a Game Plan is what will let you know if you should do the deal.

Financing

How am I going to take my deal down? Am I going to create a seller carry-back, and use a lender to give some money to the seller? Will the seller carry back the whole deal? Will I have to buy it with a combination of down payment and financing? Or will I pay cash and refinance it later, getting all of my money back?

These are just a few basic fundamentals of a solid real estate investment. I hope this is some help to you.