Wednesday, January 13, 2010

What Are The Costs Involved When Purchasing An Investment Property?

I am a house flipper in Oklahoma. Of course, you aren't going to have a lot of out of pocket expenses that somebody with a mortgage would, but here is what you can expect:

1. Title insurance and research: $1,100

2. Doc stamps (To file the titlework at courthouse) $250 (give or take)

3. $1,000 for one year insurance policy (It is so expensive, because house is vacant and has higher risk for vandalism) Of course, if you are paying cash for the property, you don't have to get insurance - but it is obviously smart to do so.

4. You do not have to buy this, but it would be nice to buy an appraisal and get a professional opinion on what the after repair value of the home is worth. AFTER REPAIR VALUE is very important, not in it's current condition. The cost of appraisal is $300 dollars.

5. Also, it would be nice to have a home inspector tell you what repairs need to be done in order to make the house go FHA financing. The reason you want to make sure that the home will go FHA is because that is the type of loan 90% of your buyers will have. It is what is known as the "poor man's loan" because it is backed by the government and requires the buyer to have very little to absolutely no money out of pocket. However, the house has to be in pristine condition, according to government regulations. The cost of an FHA inspection can range from $150 to $250 dollars.

6. You also might want to figure how far away you live from the property and how often you plan on making trips to the property. I don't know if you are fixing it yourself, or hiring contractors - but you have to hover over contractors to make sure they are getting the job done. At the very least, you will have additional gas expense. Plus, you may have to rip and run up the road to get contractors supplies (or get them yourself) or sometimes, the contractors will get everything for you - but they will tack on as much as 20% to their invoice for drive time.

This isn't part of your question, but I would create a budget for each phase of your rehab. And also, here is the formula I use to figure out if the house is a good buy to fix and flip (or not)

1. Calculate the After Repair Value (ARV) in the neighborhood (These are top of the line homes featuring granite countertop, new paint, new appliances, completely remodeled, etc.) Write this number down, once you figure out what your remodeled home will be worth on the market.

2. Subtract the amount of repairs the property will need from the after repair value. If you are a former contractor or have a contractor who can give you a bid on the repairs needed, this is the figure you can use. You may also use the figures based on your inspection report.

3. Once you subtract repairs from the after repair value, you will have the homes CURRENT market value (without repairs)

4. I never pay more than 50% of what the homes current market value is.

To give you a visualization, let's say I am buying a home. And the top market value in the area for my home is $100,000. However, the home needs about $20,000 in repairs to get up to that point.

What I would do is take $100,000 and subtract $20,000 in repairs to come up with $80,000 - which is the properties current value.

I would then offer the home owner half of this amount, which is $40,000 dollars.

So, my total investment would be $60,000 dollars to make the home worth $100,000.

Of course, you have to factor in Realtor commissions as well, which are generally 6% of the homes top market value. Also, most buyers do not have cash out of pocket to pay for their closing costs, so most sellers have to foot the bill - especially in this market.

So right away, you can shave 10% profit right off the top of the $100,000 dollar mark for Realtor fees and closing costs.

Also, what I do is intentionally make the property a little bit lower than the other homes in the neighborhood to be competitive price wise. In this example, I would probally list the home at $90,000 dollars to start out with. Then I would factor in $9,000 dollars for Realtor fees and the buyers closing costs. That means I would net $81,000 dollars - or a $21,000 dollars. (But remember, you bought title work, doc stamps to file title work, insurance, the cost of gas driving back and forth to the property and of course, property taxes) So you are looking at about a $10,000 to $15,000 profit

I say "profit" but then there are capital gains taxes. If you reinvest the money into buying more real estate, you will owe 0% taxes until you sell the next property, and claim it as income. But if you take the $10,000 to $15,000 as earned income, depending on your tax braket - you could end up giving Uncle Sam between 20% to 50% of your gross profit. So, I think it is wise to reinvest your earnings into buying more houses. As always, talk to your accountant.

As you can see from this example, it is smarter (in my opinion) to stay within the $150,000 to $300,000 range when flipping homes. The reason being is there is a bigger spread for profits. However, other investors might argue with me - because investors who buy $100,000 properties or lower tend to sell a higher volume than an investor who focuses on the $150,000 to $300,000 range. It's just a business philosophy that I hold, it is not necessarily the common view of most investors.

Call or text Rose @ 405-881-5958

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