Recently a Property locator contacted me about a lead in Grant Park, one of the better known neighborhoods in the city of Atlanta. This lead came through someone who was acting as a wholesaler. The Property locator reported the following details to me based on information given them by the wholesaler.
Asking price $157,000
Repairs and renovations $40,000
After repair value (supposedly) $350,000
Gross profit well over $100,000
The subject property is a 2 bedroom 1 bath that has 1000 square feet.
The rehab would require the addition of a master bedroom and bath of approximately 200 square feet in order to bring it up to the standards of the other houses in the immediate area.
I instructed the Property locator to have a local sales agent do a comparable market analysis and find the properties that have sold during 2006. Grant Park is a diverse area, so I instructed the Property locator to only pull those sales that had occurred on the same street as the subject property. This is because prices can vary widely from street to street and even block to block in inner-city areas. There is a diverse range of housing and prices in this general area and in such cases it is very important to find comparable sales that are the most recent and are located as close as possible to the subject property.
I received a comparable market analysis with the following information:
Sale number one occurred on March 31, 2006 and went for $307,000.
Sale number two occurred on April 20, 2006 for $305,000.
Sale number three occurred on June 26, 2006 for $286,000.
All three of these properties have 3 bedrooms and 2 baths. I took each sales price and divided it by the square footage of the property. Then I averaged all 3 together. The result was $200 per square foot. This means that while each sales price varied somewhat, on the average each house sold for about $200 per square foot.
Looking at the closing sales prices, it appears that there is a downward trend. On a dollars per square foot basis it appears that prices are flat, with no real appreciation for the year.
I make this point because as an investor it's important to note which way the sales are going in a given neighborhood. Over the past 10 years prices have generally trended upward at a steady, healthy pace. This type of "sellers market" appreciation makes it easier to buy because price appreciation helps add to bottom line profitability.
But as of this writing, in September of 2006, it is becoming clear from sales data all around the country that the real estate markets are slowing and therefore prices are tending to remain flat and in many areas they are beginning to fall.
From the standpoint of an investor, with an exit strategy calling for a sale to an owner occupant it is important to know whether prices are rising or falling. This is because falling prices must be taken into account on the buy side or you will pay too much going in. And, the longer the renovation and marketing process takes the more likely it is that the price will have to be discounted to get a faster sale.
Taking the sales data provided and looking at our subject property we can do some quick math:
Current square footage = 1000
We anticipate adding an additional 200 square feet in the form of a new master bedroom and bath. This will bring the total square footage of the subject property to 1200 after renovations are completed. Keep this number in mind.
Using the sales data provided, we can make a quick assessment as to whether or not our wholesaler friend is correct about the after repair value on this property being something in the range of $350,000.
First I want to point out that none of the comparable sales listed above sold for $350,000. In fact, they were not even close.
Secondly, let's look at this in terms of the average dollars per square foot. We have already established that each of the three comparables sold for an average of $200 per square foot.
A 1200 sq. ft. property selling at $200 per square foot would equal $240,000. A whopping $110,000 below what the wholesaler is telling us the property will be worth.
But why such a dramatic discrepancy?
Assuming that the wholesaler is not attempting to perpetrate an outright fraud, the most likely explanation for this discrepancy is the fact that Grant Park does contain houses that sell in the $300,000 to $400,000 price range. However the houses at this price point tend to be larger Victorian style two-story houses built around the turn of the 20th century. These houses are not comparable to our subject property because our subject property was built in 1952 and is a ranch, so it is a completely different style from the higher priced properties even though they are both in the same neighborhood. (But NOT on the same street)
This is the main reason that I instructed the Property locator to pull sales data from the same street that the subject property is located on. It would not be difficult to imply a higher market value for the subject property simply by mixing these larger houses into the market analysis. This is a common mistake that new investors make when buying a property in a neighborhood with a wide variety of housing styles built over a long period of time.
So let's review the circumstances and make a decision.
We know that the repairs will be at least $40,000 because it's very difficult to add a bedroom and bath and update the rest of the house without spending something in this price range on the renovations. There is not much wiggle room in this repair estimate.
Also, taking into account the current slowing sales in the real estate market, it is reasonable to assume that our selling price could go below the estimated $200 per square foot . We need to make some allowance for this so that we don't accidently pay too much in a market where prices could go down.
So for purposes of this example I'm going to lower my anticipated selling price to $195 per square foot.
1200 sq. ft. * $195 = $234,000
If I budget this deal based on an anticipated selling price of $234,000 I am well below the wholesalers claims of market value but hopefully I will be right in line with what I call "Real Time Market Value"?.
This is the amount I feel I can reasonably expect to sell this property for given realistic comparable sales numbers and overall market conditions in the neighborhood.
So here's how this would break down -
My rule of thumb when selling to an owner occupant is that I want to be in this deal for no more than 80 cents on the dollar when all is said and done. This should give me a 20 percent net profit margin. Of course I would try to get more than 20 percent, but this is a realistic target in the current market.
$234,000 * .80 - $40,000 repairs - $15,000 for financing and carrying costs = $132,200
Assuming I feel comfortable with a 20% potential profit margin I can structure my buy price based on the formula shown. If I wanted to pad that a little bit I might change the formula from .80 to .75 for a little extra breathing room.
If my numbers are correct the deal should cost about $187,200 and sell for $234,000 for a net profit of $46,800 if I sell the house myself. If I have to list the property and pay a 6 percent commission, it will cost an additional $14,000. The smart thing would be to lower the offer price to about 119,000 to cover the cost of paying a sales commission.
Of course the question is whether or not the seller can or will accept my offer at that price. If he does, I can feel pretty good about my chances with this deal. This research gives me the ability to "nail" the price range in which I will have to buy in order to ensure that this deal will be profitable.
The moral of this story is you can make money in any market but it is critical to do an accurate market analysis and make adjustments to your buy price accordingly.
