Common Questions Series: #2 How Do You Know Which Houses to Buy??? (For Flips)
With so many different houses out there it creates opportunities for investors to choose a variety of strategies in which properties they will or will not pursue. For us, we have come up with basic criteria that works for us (I’ll share that criteria with you here in a minute). Before we even get into that though, keep in mind that everyone has different criteria depending on what they are most comfortable with, so before even searching for properties I would recommend sitting down and figuring out what your specific criteria is going to be. This will help you streamline which homes you spend most of your time looking at and will help you quickly filter out properties that wouldn’t work for you.
While we do have our specific criteria for homes, we mostly use these things as guidelines, knowing that each of these different elements could influence the end sale price for better or worse. Just being aware of what factors go into the value of the home has helped us tremendously. So here we go, these are some things we look for when buying a property.
One of the biggest risks in real estate is that market conditions can always fluctuate, but we’ve found one way to mitigate that risk is to stay closer to where the businesses are. Doing this will ensure there will almost always be buyers ready to buy your flips, and if worse goes to worst and no one can buy your home, you can always go to a backup strategy of renting out the home instead (when markets crash, rental demand typically goes up). Doing this will usually cover at least your expenses until the market goes up again and you can sell.
We like to be in cities where there are at 2-3 Fortune 500 companies. These companies typically have hundreds or thousands of employees which means if the market tanks, these companies likely aren’t going anywhere and you’ll still have customers to sell to. Other factors we look for to help in this regard are to look for cities with population over 200,000 people, and a history of growing population trends over the last few years. No one can predict the future, but there are certainly ways to hedge your risk by understanding your market before jumping in. Again, smaller cities and rural areas aren’t bad, we actually have property in these smaller areas too, but just remember to compensate for that risk and be aware of how market fluctuations can impact your resale or rental values.
Example: One of the areas we invest in is in St. Paul, Minnesota (granted we used to live there so it made it easier). This has been a good market for us because there is a population of about 300,000 (a lot more people if you include the surrounding Twin Cities population). Right near there are the headquarters of 3M, Target, and General Mills plus a large university. These are all solid companies that have helped the area not only grow, but also give us a sense of security in case of a downturn.
It’s All About the Numbers
If you have talked to us about real estate, you more than likely have heard us say “It’s all about the numbers.” Falling in love and getting emotionally invested in a property is so easy to do, so one of the things we are most strict on is keeping to our numbers. No matter how good a property looks, if it doesn’t fit our numbers criteria with enough safety buffer, we don’t pull the trigger. This not protects not only us, but our investors as well. They know we have criteria we stick to when buying properties which helps give them peace of mind knowing we are selective in the deals we pursue and only pull the trigger when the numbers make sense. So how exactly do we calculate these numbers?
For us, it’s simple. We estimate the After Repair Value, which is what we believe we can sell the house for after the work is complete. We do this by looking at sold comparables in the neighborhood -ask your realtor to help with this, they are the masters at helping you estimate this number (or you can search for sold comparables on Zillow as well to see what similar homes have sold for in the area). We then will take 70% of that number (which gives us a 30% safety buffer), and then we’ll subtract the estimated repair amount from that. This tells us what our offer price would be on a particular property. Here’s the formula:
Purchase Price = After Repair Value *.70 – Rehab Costs
So let’s look at an example. Let’s say we find a property where we think we can sell for $200,000 once the rehab is done. We estimate that it’s going to need $50,000 in repairs so all we do is take $200,000 * .70, which gives us $140,000. We will then subtract $50,000 from that number to get to $90,000. This tells us our top purchase price would be $90k and that’s the number we shoot for when we make an offer.
The hard part about sticking to this formula is that it’s very difficult finding properties with this kind of buffer. In the example above, the home would probably be listed at $175,000 and tell us it has “Great equity potential.” Don’t be fooled by this because that’s where you get in trouble. Especially in today’s market we are seeing people purchase properties at 80% 0r even 90% of ARV which makes it challenging to compete. The key for us is to remember it’s a process and not to get discouraged. We probably look at over 100 deals before actually getting an offer accepted based off the numbers that will work, so we definitely have our work cut out for us here.
We typically key in on homes with at least 3 bedrooms. Our usual target market for the homes we buy is first time home buyers. Typically this segment of people are in their mid 20’s- 30s and either have started a small family or will be starting a family soon. One bedroom homes are definitely too small for this type of buyer. We have found that usually a family with one child will look for a 3 bedroom home so they have a master bedroom, child’s room, and then space for either an office, craft room, or storage space. We try to stay strict to our 3 bedroom rule for flips, meaning if we find a 2 bedroom home, we try every way we can to get creative and turn it into 3 rooms.
We’ll keep this one simple. Garages help sell homes and will definitely add value to a home. People search specifically for homes with a garage so if you can strike gold on a house with a garage, either connected or separate, that will help your resale value. There are some areas that are exceptions where it’s normal for houses to have no garage, but all of the houses we have bought so far are in areas that have snow so garages are a must.
Now we are known amongst friends and family for being willing to live or work in areas that seem a little sketchy to most people (hey, the numbers made sense in these areas so why not??). With that said, we actually do have a standard and want to be able to walk safely down the street still. Hopefully you understand your neighborhood and market well enough to know where is safe and where to stay away from. Just like every other criteria, we need something measurable so we do have a way to ensure we’re not in a “war zone.” For us, we run all of our properties through Trulia’s crime map to get a general feel for what the crime is like in an area. We will buy properties in green or yellow areas, but are very leery about buying in the red zones as those definitely have more crime. Just type the address in Trulia and start playing with their interactive map. It tells you how many crimes occurred in the area, what block they happened on, and the nature of the crime (i.e. we avoid shootings!).
Trulia Crime Map
Houses on busy roads are less desired by the general public. The more lanes a road has the more you can expect it to impact your home’s value and days on market. Single lane roads are typically fine, but we try to stay away from streets with 4 or more lanes (2 lanes on each side). This will cause homes to sit longer on the market, which means you will need to account for higher holding costs.
We enjoy analyzing properties because everything is basically a puzzle that you are trying to put together to ensure your investment is going to be safe. You hear the saying “measure twice, cut once” which we follow in real estate as well, because once you close on a property, it’s yours and you get all the baggage that comes with it. Just take the time to know what you’re getting into, how you will account for the various risk factors, and make an offer based off what your analysis tells you. Trust your calculations and hold true to what you know works and everything should be A-OK!