It’s a question that the real estate investor asks himself often…
“What’s the best way to make money out this property?”
Sometimes, the answer is easy…
The property might be a duplex in need of a bit of a scrub and some paint…
Or a PPR on two blocks of land that can easily be subdivided.
Or, you’ve got an opportunity to paint your investment picture on a piece of raw land where a new highway into town has just been approved…
Those kinds of deals are great when you find them…
The direction you want to go in is more or less pretty clear.
Then, there are those other opportunities…
You know there’s some good profit to be made in a property…
But you’re just not too sure about which direction makes the most sense from a risk and reward point of view.
The thing of it is…
You’re just as likely, if not more, to be involved in one these types of deals as you are of walking into of the more easy deals I just talked about…
This is where you got use your brain to analyze the situation.
Fortunately, there are few steps you can take to make that process a lot easier…
Mind you, there is still risk involved…
But there’s risk in crossing the street, isn’t there?
The point is to minimize the risk so that you have the best chance at success.
That means identifying the relevant factors in the profit equation…
Making your calculations…
And arriving at the right answer BEFORE you put your money on the table.
What’s the mean market value?
First of all you need to know the market in your area of investment…
What is the mean market value for the type of property you’re considering renovating?
What’s the spread between the mean market value and purchase price of the property?
Remember that you shouldn’t expect to sell the finished property more than about 10 per cent above the mean market value.
Any price above the 10 per cent margin over the mean market is just wishful thinking…
And don’t think that just because you’ve seen another similar property that sold for 20 per cent over the mean market value, that yours will, too.
You don’t know the circumstances behind the sale…
It could be a sale from one individual to another business partner, or any number of different scenarios.
Stay with the right numbers and you will reduce your risk.
Know your reno costs
With that in mind, what will the reno costs be?
Know that your reno costs will likely run higher than you’d expect or like…
That’s just the way renos go (see some recent reno posts on hiring a project manager).
Still, reno costs shouldn’t be more than 5-10 per cent of the purchase price…
And 10 per cent is really pushing it unless you’re getting a fantastic deal on the property.
Also, be clear about what exactly your reno project will be…
And what it will realistically get you in terms of real market value.
For example, is your location better than others on the market?
Or is it in a worse area?
Do a rough reverse feasibility study
Once you know the purchase price, the mean market price and the reno costs (plus about a 10 per cent cushion), you will then need to make your analysis…
It will be a rough, reverse feasibility study based upon the total reno costs, mean market value and purchase price…
You will then know if there’s a profit to be made in the property and how much it might be.
Will it be perfect?
Of course not…
But it will give you a ballpark figure to work from.
Reno or Demo?
But what if that figure doesn’t add up to a nice profit?
That can easily happen if the reno costs are way out of line…
Which can take you right out of the deal.
Now, you all know that the purchase price is where you make your profit…
But if the reno eats it all up, you might be better off with a demo project.
Say, for instance, reno costs on a three bedroom, two bathroom property with foundation damage and a bad termite problem eat up all your profit in the deal…
It’s almost a demo already, isn’t it?
That may help you drive the price lower…
“Look” you say to the seller, “I’ve got to demo the entire property and then rebuild it.”
That’s a powerful point in the negotiations.
Chunk Deal or Cash Cow?
Now suppose you have decided to demo the property and start over…
But you also add another bedroom or two and bath to it…
The costs may well be quite similar, but now it’s a different property.
Maybe the costs of the demo and rebuild eat up your profit just like the reno was going to…
But the deal has been transformed by the demo…
Now the property has become a Cash Cow rather than the Chunk Deal you thought it was.
You don’t want to be surprised by this…
If you’ve done your analysis properly, you will have seen it coming…
The reno or demo costs involved and your budget will drive this decision.
It’s an odd but very useful combination of flexibility and firmness…
You need to remain flexible on the options possible in a deal…
But you must also remain firm to your budget.
The costs, including price, mean market value and reno/demo expenses, will tell you whether you have a deal or not…
And what kind of deal it really is.