Inner Circle Lesson: Are You Making This Huge Evaluation Error?
Several times in the past few months, I’ve found myself explaining to Inner Circle members that the reason they couldn’t sell their wholesale deal was that they’d over priced it, and the reason they’d over priced was that they’d made a common logical error in figuring out the value.
See if you can tell what it is:
The subject property has an after-repaired value of $100,000, and the house has an outdated kitchen, bath, furnace, and flooring.
However, the house also has a section 8 tenant living there who’s been there for 5 years and doesn’t want to move. The house is rented for $1,000/mo, and the annual section 8 inspection just came back requiring that the basement walls be painted and that one room of carpet be replaced–$1,500 in work, total.
You are offering this property to landlords for $68,500 because $100,000 x .7 – $1,500 in repairs = $68,500.
Why is it not selling?
The answer is that it’s not a good deal, and you’ve conflated two different ways of analyzing a property.
You based your “value” on an “after-repaired value” calculation, and then didn’t estimate enough for repair costs to put the property into after-repaired condition.
By saying “This house is worth $68,000 to an investor”, you’re basically saying that with $1,500 in repairs, it would sell for $100,000. In fact, $1,500 will only put it into RENTAL condition, not RESALE condition.
It might even be TRUE that your buyer will only do the $1,500 in work required to keep the tenant there, but that doesn’t mean he wants to pay a price that effectively nets him very little real equity.
The correct way to have done the analysis would have been to estimate the full cost of bringing the property into after-repaired condition, even if you didn’t think a buyer would do that right now. In this case, that number is probably $15,000 minimum, so the proper sale price should be
$100,000
X .7
-$15,000
$55,000
And you should have it under contract for no more than $50,000.
This is a common miscalculation in bread and butter areas where a property could either be retailed or rented; in rental areas, where few properties actually sell in after-repaired condition (and would only be improved into rental condition anyway), we usually use a return-based “trashflow analysis” to double-check values anyway.
If your property isn’t selling, it’s always about price, and now you know how to set the price right.
Thank you for the insight
You’re very welcome!
I secured Jerry’s #s, and for the four major repair items in about two minutes quickly “gestamated” $22,000 for those upgrades,and under contract for no more than $46,000 (including my $5,000 fee).Although I did not utilize much of your very good training to come up with these numbers, I felt “encouraged”, that basically, 1)I understood the point you were attempting to draw out of us,and 2)I was somewhere in the ballpark as for as my offer to the seller.
This is a fantastic site Vena…Thank You…(I am working at it)!
What is the .7 used for in this calculation?
That’s a standard formula that buyers use to decide what to pay for an investment property, and it’s the ARV x .7 -repairs formula. The 30% reduction in the after-repaired value pays for the holding, finance and sales costs and build in the profit on the deal.