A phenomenon I have noticed with new investors is the almost feverish desire to jump into a high-dollar property as their first rehab/resale project. I have had many people call me, new to this business, because they found a “great deal” on a high-dollar home. Many have only limited experience, and for some this would be their very first project. But is that “great deal” really a good idea?

One thing I often promote is the value of staying in the shallow end of the pool. I encourage investors to work on projects in the low- to middle-price strata for their area, and only get into a high-dollar home after they have had a lot of experience, and built up the reserves to manage a bigger project. In my never-to-be-humble opinion, I believe there is a lot more potential in the smaller projects than the bigger ones for a number of reasons.

As a side note, when I refer to lower-end homes, I am not referring to the run down homes in the less than desirable neighborhoods. I am referring to homes that are affordable to the middle class for your area, in good neighborhoods. Sure, there are buys in the low income sections, but most of the time these would be better converted to rentals, not flips.

First, there are a lot more buyers in the lower end than the top-end. Looking purely at demographics, there are a lot more people able to buy in the middle to low price as compared to the high price. Therefore, in most markets, you are able to make a faster flip on the project, and move on to the next investment.

Homes in this sector usually do not take as long to rehab as the higher end properties. For example, let’s think about a 1500sf. project as compared to a 4000sf project. When it comes time for flooring, which one is completed faster? How long will it take to paint the small house as compared to the larger one? How much time will be spent with contractors making the small project ready, as compared to the larger one? Generally speaking, the smaller projects can be done much faster than the newer ones, and back on market a lot quicker. This means a faster return on your investment and the opportunity to move on to the next project.

Buyer expectations on the lower end properties are lower than the buyers of the upper tier. I am not suggesting shortcutting the process or using cheap materials by any means. I am, however, saying that buyers of high end properties expect high-end amenities. The appliances you put in a $150k home would not be acceptable to the buyer of a $1M home. Stock cabinets are just fine in a cheaper home, while the more expensive home should have better cabinetry. Flooring, moldings, even the faucets and doorknobs are expected to be better than you would find in the lower end homes. And they should be. Therefore buyers in that higher strata expect a lot more, notice more, and will be a lot pickier than your lower strata buyers.

You will have a lot more expenses, and headaches, with the expensive property too. Sure, if you buy right the rehab costs are included in the loan, so that part is covered. But there are a lot of expenses that you will need to pay out of pocket. You will need insurance on the property while it is in rehab. You will need to cover electricity and water for the home while the workers are getting it ready. Unforeseen problems can crop up on either project, but the potential for more, and costlier, problems is greater on the bigger and more expensive home.

Then there’s the loan payments. You will need to cover the monthly loan payments until the home is sold. Obviously that payment is much higher on a $1M than a $100k home. And, since the more expensive home will typically be on market longer, that means more cash going out every month. No thanks!

Lastly, if you are looking at one of these high-dollar homes as a first project, do you really have the people in place to make it ready? As I said before, the buyer for this property will be a lot more particular. So your flooring contractor, painter, landscaper and every other sub needs to be up to the task of providing quality results. If you have never worked with these guys, can you be sure that their skill is up to the standards needed for this project? Take your bumps and bruises in the small end of the pool while you build your team of trusted subs. Then when that million dollar opportunity makes sense, you know you have the right people to get it done right.

I had a new investor call me last week, looking to get started on his very first project. He had found a home selling at $1.8M that he was certain could bring close to $4M when finished. That potential $2M profit on a deal was all he looked at, and never considered all the things I mentioned here. As much as I want us all to make seven-figures in this business, I have to say that I would rather make it on ten, $100k homes than lie awake at night worrying about all my eggs in a $1,000,000 basket!

So consider these things when looking for your projects. Staying in the shallow end typically means more buyers, faster turns, lower expenses, less headaches and more opportunity. You may start in these projects and build up to that front-page home, or realize that you prefer dealing in the faster paced environment that comes with the smaller homes. Either way, I suggest making the first few projects cheaper homes for a great education and a foundation on which to build.

Until next time, good luck and happy hunting!

New members and old have heard me chant this time and again. Yes, I know the grammar is terrible. I grew up in the deep south, and homespun witticisms are hallmarks of our culture. But why do I keep saying this?

One of the most frequent stumbling blocks for new members is knowing when a deal makes sense, and how to figure out the numbers. In fact, questions about calculating After Repaired Value (ARV) amounts and making offers that fit within our guidelines are addressed every day. So, for my first entry, I would like to go over the basic calculations that you should use when structuring your deal.

As you know, our guidelines state that we will lend “up to 65% of the ARV on a property”. The keys there being ‘up to’ and ARV. Remember that all deals are evaluated on their own merits. If you are in an area where home values are continuing to slip, or homes are sitting on the market more than six months before selling, we will want to be more cautious and may not hit that 65% mark – and you should be cautious too.

But let’s assume that not the case with your property, and we are in an area where 65%ARV makes sense. What does that mean to you? How do you properly structure your offer and your deal?

Step 1 is to determine the ARV of the property. This is typically done by looking at sold comparable properties (comps) from the last 60 days. Of those comps, they cannot have been on market more than 180 days. Why? Because your goal is to get in, fix, and get out as quickly as possible. If homes are generally sitting on market more than six months, you may want to reconsider that property. You don’t want to end up holding a home that you can’t get out of quickly. So pull your MLS sold comps and get a good, honest average of what this property would be worth when you have finished your rehab. I always look at the lowest comp as my ‘worst case scenario’ so that I structure conservative deals.

Step 2 is to get a contractor to go with you and look at the home. Make sure you are working with someone who has subcontractors at the ready to get in and do these repairs on time, and in a budget that you have agreed on. Some members elect to act as their own general contractor, and hire the subs themselves. If you have the time and experience to do this, great! You can save a few dollars. If not, hire a GC to give you estimates of the cost of repairs on your property. If you can build a business relationship with a good GC, and let him know that you will not just do one house, but one every other month, you will find yourself ahead in the game.

Step 3 is math. I know math may not be your favorite subject. But I am going to show you the very simple calculations you need in order to make your deal a sensible one.

1. Average the sold comps. I’m sure most of you know how to do averages, but here’s a refresher. Add up the total of the comps, then divide by the number of comps. If you have four comps at $100k, $110k, $120k, and $140k, the total is $470k. Divide by 4 (the number of comps) to get an average of $117,500.

2. Multiply your average by 0.65. Remember, we go *up to* 65% ARV on a property. So this number would be the absolute maximum we could lend on your deal. In this case $117,500 x 0.65 = $76,375. That amount would be the maximum we could loan on this property.

3. Subtract your repair costs. Remember, we will roll rehab costs in with the deal, as long as we are within our lending guidelines. Let’s say that this project needed $16,000 in repairs. $76,375 – $16,000 = $60,375

4. Subtract another 10% to account for points and closing costs to be rolled into the deal. I suggest 10% as a guideline when making your offers. There is no guarantee that we will be above, or below that number when your file gets to underwriting. But allocating this amount will usually keep you within tolerances when structuring your deal. Multiply $60,375 x 0.90 = $54,337.

5. This number should be your guidepost when making your offer. Or, when deciding if the deal makes sense. Offering this amount, or less, would keep you within the maximum allowed percentage of ARV for our loan.

6. Double-check your math by working backwards: Add your offer price ($54,000) and your rehab costs ($16,000), total $70,000. Divide that number by the ARV ($117,500). You should come up with 60% (rounded). This leaves you $6,375 room in the deal to cover points and closing costs. Assuming we are able to lend 65% ARV on this deal, you have a deal that makes sense!

Again, every deal is evaluated, and decisions are made based on the merit of the deal. These numbers should be used as a guide to ensure that you are not over the maximum we will lend on a property.

Now, can a deal make sense at 68% ARV? 70%? More? That’s for you to decide. You would be taking a thinner profit margin when you sell these properties, and would be left with less ‘wiggle room’ when negotiations start up. Also, if you are over our allowed limit, you would need to cover the overage in cash at the closing table in order to put your deal together. Keep these things in mind when structuring your offers. While 3% on a $50,000 home may not be a big deal, it can make or break you on a $250,000 home, when you need to come up with the extra $7,500 to get your deal done. Frankly, I prefer to error on the side of caution and stay below that 65% mark.

I have often been asked why we look at 65% ARV as our maximum. Simply put, it allows you enough room to make a sound investment, and a respectable profit on your project. We are here to protect YOUR interests. We want you to be successful and make a profit on every deal.

Plus, if you need to slash the price in order to move the home, you can do so and still take a profit. Should you wind up in month five, and not had any offers; you can comfortably reduce your selling price by 10% and still turn a nice profit.

Let’s say the home you are in has an ARV of $200,000. But you were smart and set your deal up right, so you are in the home for $130,000 (65% of $200k). If you need to lower your sale price to $180,000 to make a deal you are thinning your profit, but it’s still a very respectable gain on your investment. Your buyer got a great deal, you made a profit and everyone is happy.

So keep these facts in mind when you sit down to pore over the latest REO’s and MLS lists in your area. There are some great deals to be had out there. And if you work these basic calculations when determining your offer, we all win.

Good luck, and happy hunting!