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Buying Foreclosures – Creating Wealth with Foreclosure Investing
This is the second part of an article on real estate & foreclosure investing. The first part can be found here.
Deciding How Much To Offer
This was one of my main areas of concern when I first started to learn about real estate investing. I now have learned that in real estate investing YOU MAKE MONEY WHEN YOU BUY not when you sell. This will give you a margin of safety. So if the market goes down, or you have more costs than you expected you will have an equity cushion in the property to protect you from those fluctuations. It is also why foreclosure investing has so much potential for profit.
In order for me to figure out how much to offer I paid no attention to what the bank was asking. Instead I had to do two things: First, figure out where I wanted to be – meaning that based on the income (rent) that the house could produce, what would be the maximum mortgage amount I can safely get myself into. Second, what my costs are going to be including repairs, utilities, taxes, closing costs etc.
To calculate the first one I figured the house would rent for $1200 - $1300 per month. I determined this by researching market rents for the area, looking at for rent ads in newspaper and calling on for rent properties nearby.
So if I am getting $1250 in rent and I want $200 of monthly cashflow I determine that my mortgage (at a rate of 7.25% - typical for an investment loan) cannot be higher than $127,000.
The way I get to $127,000 is by using a loan calculator which tells me that for that loan amount my monthly payments for principal and interest are $866, then add to that the monthly cost of taxes ($1800/yr = $150/mo) and insurance ($500/yr = $42/mo) add it all up ($866+$150+$42) my monthly payment comes up to $1058. So if the rent I can get is $1200-1300 then I was looking at a monthly cashflow of approximately $150-200 which is the minimum cashflow I was willing to accept.
Calculating costs was a bit more tricky. The main thing here was getting a good estimate of repairs costs. This is a crucial skill set to develop in foreclosure investing in part because you do not know the history of the house and there is no previous ownber there to tell you what has been done or not. The bank that owns the house knows nothing about it or cares either.This is what I did…
I went through the house several times over and made a list of what needs to be repaired and what should be repaired – very different things . [Remember that I wanted to make this house ready to rent not ready to sell, that will affect the amount and level of repairs you make].
Then I put all those in a spreadhseet and based on amount, square footage and required materials I estimated the cost of each one within a range. To come up with a dollar figure for each item I used: my own knowledge of what things cost, internet research (i.e. homedepot.com, etc.), cost estimation tables gathered from my real estate investing classes and a “swag” factor for safety…I was being very conservative. Here is what it looked like :
And holding costs:
Now that I got a well thought out idea of what my costs are going to be I deduct that from the maximum loan amount I got in step one. So $127,000 minus the costs of $12,000 gets me to $115,000. So the maximum I can offer for this house is $115,000-116,000 right?
Not yet…Here is where my financing plan comes in.
How to Pay for It.
Discussing the financing options of real estate & foreclosure investing can take several pages so I will give you what my financing plan was for this particular investment.
From talking to other investors and educating myself I learned the great advantage that it can be to have a line of credit. A couple of months earlier I shopped around, applied and was approved for a line of credit.
Now I wanted to use that line of credit to purchase this investment property, cover the cost of repairs and holding costs and once the house was rented I would do a cash-out refinance loan. Meaning that the bank would give me a loan for up to 75% (maximum allowed for investment properties) of the value of the house. That would give me back the money I put into the house that came from my line of credit. I would then pay off the line of credit and would have it available to use again on another property ;-)
So I needed to make sure that my TOTAL investment into this house was no more than 75% of the value of the house. Or else when I do the re-fi I would not recover all of the money I put into the house.
Going back to my maximum offer calculation above…
Remember how I told you that I thought the max I could offer would be $115,000? I needed to make sure that number meets the 75% requirement. The tricky part of foreclosure investing is figuring out the value of the house, specially in a declining market!
I did this by looking at recent sales of similar houses in the vicinity (I got those from my real estate agent). I also looked at the tax records to see the county’s assesment of the property and finally I consulted with an appraiser. Based on that I concluded that the market value of this house was between $150,000 and $160,000. Therefore 75% of that is $113,000 to $120,000.
As you can probably figure this put me in a tough spot. Because up to $116k would be a fine price to pay in terms of the income potential of the house, it was borderline in being able to make the 75% requirement. So I ended up offering $115,000 – the bank was asking $130,000. They countered back with $120k, I countered at $117k (which in hindsight I think was too high) – they accepted it.
Yes, I know - I went over my maximum offer and here is why:
- I was being very conservative in all my cost calculations so there was a good potential that all my costs were going to be less than I calculated
- I felt confident in the value of the house being closer to $160k rather than $150k
- It was a 4 bedroom house with good feautures, in a good neighborhood and in general good shape. So it would rent quickly, stay occupied for a long time, had good appreciation potential and it would cash flow from day one
- Because of these reasons I was willing to be out of pocket if I had to. Think about it…if this was the stock market, would you be able to buy shares of any company without putting some of your money in first?
Considering that this was my first stab at foreclosure investing I thought this
was acceptable so I went for it. You will have to decide based on your own factors, wether an investment makes sense for you or not.
Soooo...how did my estimates compare to the actual costs? What about the post-rehab pictures?
Yes you guessed it…that will be part 3 of Foreclosure Investing...
Go To Buying Foreclosure Properties part III >>
Reccomended foreclosure investing resources:
 For some very good guidelines on this visit:link
 Another format you can use: link
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