These days, it seems the discount pricing is simply unbelievable. It’s mind boggling that houses are available for under $10,000. With any buy, comes risk and you know the old saying, “cheap can be expensive.” The experienced buyers know exactly what they are buying and what they plan on doing with them after acquisition. Simply put, you need to know what your exit strategy well be before you stroke that check.
Lets look at a typical example of a purchase and what the possible exit strategies will be.
Arizona SHF for $12,000
You just bought SFH (single family house) a $60,000 house in Mesa, AZ for $12,000 with a quit claim deed. The property needs about $10,000 in renovations and there is $2,700 in outstanding taxes due. After closing costs, you are into it for about $25,000. That’s about 41% of ARV (after repair value). Not too shabby. What are you going to do with it.
1. Buy and flip it for a few thousand dollars more to another investor.
2. Renovate it, then retail it for 80% of FMV.
3. Renovate it and rent it for cash flow.
4. Sell with a contract for deed.
All are plausible exit strategies but which work best for you?
BUY AND FLIP
You bought the house for $12,000. You then locate an experienced realtor in the local market and have her do a CMA (competitive market analysis). She determines that the ARV price would be around $60,000. She recommends a price of $15,000 you can sell quickly for cash. You agree and she places it on the MLS. If the realtor is good, she will also have a rolodex of cash investors she can call. After a week, you get an offer for full price with an investor who will also pay the $2,700 back taxes. You take the deal.
Let’s break it down:
$12,000 – your purchase price
$360 – closing costs when you bought it
$450 – closing costs when you sold it
$900 – 6% realtor’s commission
$15,000 – your selling price
$1,290 – Profit
Is this a good deal? It depends. What is your time worth? What is your cash flow situation? Maybe you have a full time job and this is your side hobby. Most buyers will put in perhaps 3 hrs of their time in this type of deal. That’s $430 per hour. Your in. Your out, Nice and clean. No worries. Now if you can do four per month at 12-15 hrs total for an average profit of $1,500, that’s $72,000 per year additional income.
RENOVATE AND RETAIL
This strategy works wll only if the property needs light rehab (carpet, paint and yard cleanup) and costs under $5,000 in renovations. You complete the necessary work and use the same realtor to list the house for $48,000 (80% of $60,000).
After six months, you have a buyer who is approved for a mortgage of $45,000 and you agree to sell.
Let’s break it down:
$12,000 – your purchase price
$360 – closing costs when you bought it
$2,700 – taxes you must pay
$5,000 – renovation costs
$1,350 – closing costs when you sold it
$2,700 – 6% realtor’s commission
$45,000 – your selling price
$20,890 – Profit
Is this a good deal? The profit is better than the buy and flip but let’s look at the unknowns. There is considerable risk with this deal. You have to wait around for a retail buyer who hopefully can get a mortgage. There are inspection periods, negotiations, and concessions. What if during inspection, there are problems like termites or a bad septic tank? What do you do? Bank may or may not approve the mortgage or you might have to pay out of pocket or give money back at closing.
You are putting a lot of hours in to this transaction but for some, the advantages may outweigh the risks. After all, six of these deals in a year nets you $125,000 so you mitigate your risks by having your own formula for buying and renovating and it works well for you.
RENOVATE AND RENT
Once you fix the property, you rent it out for $800 per month cash flow.
Let’s break it down:
$12,000 – your purchase price
$360 – closing costs when you bought it
$2,700 – taxes you must pay
$5,000 – renovation costs
$4,200 – yearly taxes and insurance
$24,260 – total yearly costs
$9,600 – rental income
After one year, you can sell it to your tenant for $48,000 and while they are working on obtaining their mortgage, you are still getting rental income. Or, you can sell it to another party.
$24,260 – total yearly costs
$9,600 – rental income
$14,660 – adjusted net costs
$45,000 – sales price
$1,350 – closing costs
$2,700 – 6% realtor’s commission
$26,290 – Profit
Is this a good deal? Not really. You have made about $5,400 more then renovating and retailing it. However, what if you kept it as a rental and refinanced it. You refinance just enough to pay you back all your expenses. However, your new mortgage, taxes and insurance may exceed your monthly rental income so make sure you refinance at a monthly payment that is less than your rental income. You may pull out some of your costs but not all. This is the least desirable exit strategy for me.
CONTRACT FOR DEED
You sell the property to your buyer and hold the note, essentially making you the bank. You have your buyer put $500 down and make $500 per month payments. A 30 yr amortization schedule would show a $52,500 note value. You just created money!
Let’s break it down:
$12,000 – your purchase price
$360 – closing costs when you bought it
$2,700 – taxes you must pay
$15,060 – total costs
Is this a good deal? Absolutely! Why? You have just created equity of $32,440 ($52,500 – $20,060). You don’t have to rehab the property because you are giving your buyer such a great deal, that they will do it themselves. You have no closing costs. Your buyer is responsible for paying the taxes and insurance or you can have them escrow it with you. You have no responsibility for maintaining the property whatsoever.
After a year, you have enough seasoning to sell the note for around 70% of the value ($36,750) which would net you $21,690 (I would not propose you do this). The best scenario is your buyer refinances after a year. Your note of $52,500 is paid to you netting you $37,440 (after your total costs). Now, that is a sweet deal.
If you ask me which ones I would recommend, it is obvious; the buy and flip and the contract for deed strategies are by far, the best way to go.
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