20 Steps To Your First Deal – Part 2

Welcome to Part 2 of the 20 Steps To Your First Deal…let’s get right to it:

1. Determine Where You’ll Find Houses

   So, you know what types of houses you want to buy, you know what neighborhoods you’ll be looking in, and you know your price range…now you just need to figure out where you’ll be finding these houses for sale. Most house flippers these days use one of two methods for finding motivated house sellers that will sell at a major discount to market value:

   • Buying REOs: REO properties are foreclosures that have already gone to auction, but didn’t get a buyer. After the auction, the bank uses a real estate agent (a listing agent) to put the REO properties right on the MLS along with all the other houses listed for sale. Sometimes, the starting prices for these houses is pretty high, and the houses aren’t much of a bargain. But, other times, the banks are desperate to move these foreclosure properties and will list them very low to get a quick sale. Even the high-priced listings will eventually come down in price — most banks will drop the price of their REO properties every 30-60 days until it sells.

     So, if you want to let your real estate agent do much of the work for you when it comes to finding houses to buy, just ask him/her to search the MLS to find you REOs that meet your criteria.

   • Finding Motivated Sellers: The other common way of finding properties to flip is to market for motivated sellers. These are people who are desperate to sell their houses either because of their financial situation (they are near foreclosure) or their personal situation (divorce, death, disability, moving for a new job, etc). These home-owners will often sell way below market value to someone who can buy quickly and/or for cash. Finding motivated sellers takes time and effort, but if you’re good at marketing (sending letters, knocking on doors, etc), you can find some great deals this way.
2. Estimate a Purchase Price

   It’s time to start looking for houses to buy, but you’re probably asking yourself, “How can I start looking at houses if I don’t even know what a good deal is?”

   Keep in mind that almost any house can be a good deal if you purchase it at the right price. But, without experience, how do you know what that right price is? This is where things start to get a little bit complicated for the first-time investor…but I’m going to try to make it easy…

   We know from The Flip Formula that to determine the maximum purchase price (the “right price”), we need to know the selling price, the rehab costs, your fixed costs, and your desired profit. And while we need to figure out all that information before committing to purchasing a house, coming up with all that information before putting in an offer can be both expensive and time consuming. And if you try to come up with all that information before placing an offer, there’s no way to be sure the house will still be available by the time you’re finished.

   So, for a first-time investor, I would recommend using the following rule-of-thumb for making offers:

   You maximum offer should be no more than 50% of the market value of the property.

   Your real estate agent can help you determine what market value is for a particular property, and if you stick with offering no more than 50% of that price, there’s a good chance you’ll find that your numbers will work out in the end. The purpose of this rule-of-thumb is to help you arrive at an offer price for your house — once your offer is accepted, you will go through all the steps necessary to verify that the project will be profitable.

   If, after you do your full analysis, you determine that the offer price was reasonable, you’ll go through with the deal. If, on the other hand, you determine that your offer price was too high, you will be able to back out of the deal — or maybe even negotiate a lower price with the seller. The point of this exercise is to help you start making offers without requiring you to spend too much time or effort upfront plugging numbers into a spreadsheet. They’ll be plenty of time for that once you have the house under contract.

3. Start House Hunting

   Okay, now that you have a rule of thumb for making offers, it’s time to find a house! This step is pretty easy in theory, but in reality, may prove somewhat trying. For some, you’re out there looking for your first great deal, and everything you look at has one or two little flaws that make you think, “Nah, this isn’t the one.” For others, it’s just the opposite — the first house you see you’re ready to jump on.

   It’s important that you don’t let either of these emotions cloud your judgment when seeking your first deal. For those who look at 100 houses and can’t find a single one you like, consider that perhaps your fear of actually buying a house is keeping you from recognizing a great deal when you see it. And for those who want to buy every house you look it, consider that maybe you’re excitement is overshadowing your logically side — while there are lots of great deals out there, certainly not every house is one of them.

   Remember from above that almost any house can be a bargain at the right price (and we have our rule of thumb for making offers), but there are some things you should be asking yourself before you decide to put in that first (or second or third) offer:

   • Does this house meet all my criteria from Step #8?
   • Is the house close enough to my home that I’ll be able to handle the daily commute?
   • Is the house in reasonable shape? Houses that only require a little bit of rehab (think “paint and carpet”) are much easier for a first-time flipper.
   • Is the house a reasonable size? The bigger the house, the more time, energy and money will go into the rehab.
   • Is this the house I want to spend the next 2-3 months of my life working on?

   Again, this is where it’s great to have a strong real estate agent (or better yet, another investor) to look over your shoulder and give you input. While it may take a little while to find that first house you want to make an offer on (and while it may not just jump out at you when you see), they’re out there. Be patient, stick to your criteria that you developed earlier, and in time, you’ll find that great deal. And once you do, it’s time to “lock it up.”

4. Put in an Offer

   Once you find that first house that you’re looking for, it’s time to put in an offer. If this is a property that is listed on the MLS, you’ll have your agent put in the offer for you. To do so, your agent is going to need some important information from you:

   • Offer Price: How much do you plan to offer? Using The Flip Formula, you probably have an idea of the most you can pay for the property, but remember, unless you’re offering full asking price, it’s unlikely you’ll get the property at your first offer price. So, I would recommend starting your first offer at about 20-25% below your maximum offer.
   • Earnest Money: Remember our discussion of earnest money earlier? Now’s the time to actually “put your money where your mouth is,” so to speak. How much of a deposit will you put down on the property? If it’s a REO (a bank-owned foreclosure) property, I would recommend anywhere between $500-1000. Work with your agent to determine what is customary in your area and what banks are typically looking for. And remember, if you structure the rest of the contract correctly, this money will be refundable while you do your due diligence and decide if you really want to go through with this deal.
   • Due Diligence Period: Most contracts have a place for your to enter the number of days you’d like to have to do your research, run your numbers, get inspectors and contractors out to the property, etc. This is called your due diligence period, and it’s customary to have anywhere from 5 to 10 days to do all your investigation before you are actually obligated to buy the property. During this time, if you decide to back out of the deal (because the numbers don’t work or because you find some serious issues with the property), you will be able to get your earnest money back. Of course, if you don’t back out during the allotted time, your earnest money is no-longer refundable.
   • Closing Date: You need to determine when you will actually purchase this property. For investment properties, 3-6 weeks is pretty standard. This generally gives you enough time to perform your due diligence, get your financing in order, get your contractors ready to work, etc. However long you think you need, add an extra week just to be safe — there’s always something that comes up that you’ll wish you had a little bit longer before getting the deal closed.

   Those are the big questions your agent will need answered before you put in your offer. Be prepared with the answers up-front so you can get your offer in quickly and not have to worry about another investor taking your deal from you.

   Now, if you’re buying a property that’s not listed on the MLS (i.e, you found the motivated seller yourself), you’re probably not going to be working with an agent. In this case, you’ll need your own contract that contains all the information we discussed above, plus a bunch of boilerplate contractual terms that will likely be specific to your area. If this is the case, you’ll want to consult with a local real estate attorney and have him/her provide you with a good template to use for your deals.

5. Get An Inspection

   Hopefully after several rounds of negotiation, you’ve finally come to agreement with the seller on terms and you now have the property under contract! You’ve paid your earnest money and now have a week or so to do all your research and figure out if you’re going to go through with this deal.

   The first step in your due diligence is to get a property inspection. Call your property inspector (you found back in Step #5, right?), let him know you’re a on tight deadline, and get him out to the property to take a look. A typical inspection will generally cost about $200-400, and will take anywhere from 2-5 hours, depending on the inspector. During the process, walk through the house with the inspector, ask lots of questions, and write down everything he notes throughout the process (he’ll send you a full report within a day or two, but if you write things down now, you’re more likely to remember them).

   Use the inspector to the fullest — ask LOTS of questions, get clarification on any issues he finds, get his recommendation on how you might fix issues that you are confused by, etc. This is how I learned the bulk of what I know about inspecting houses myself — I spent hours upon hours asking my inspector questions as he did my inspections.

   Within a day or two of your inspection, your inspector will email you a copy of the full inspection report, which will note every issue he found with the house. Assuming there was nothing serious (structural issues and water/mold issues are things you want to avoid on your first couple flips), it’s time to take that inspection report, and figure out what it means it terms of $$$.

6. Estimate Rehab Costs

   Using that inspection report you have, you’re going to be able to do what many investors consider to be the most daunting piece of the flipping process — you going to estimate the cost of the rehab you have before you.

   But, you’re not going to come up with this estimate alone. Now is the time to call your General Contractor (again, remember Step #5!), and have him come out to your property to help you put together an estimate. Now, this consultation may not be free — depending on the relationship you have with the GC, and the likelihood that you’ll give him work if you get this house, he may charge a few dollars to help you out (he has to eat too, you know). So, discuss fees up-front, and don’t be surprised if it costs you $30-70 for the hour or two of his time you’ll be getting.

   When you meet the GC at the property, give him a copy of the inspection report, and let him know that you’d like to fix all the issues it notes. Then walk room-to-room and let him know what other items you’d be looking to rehab. For example, what kind of flooring will you want replaced in each room? Will the whole house be painted? Will the kitchen cabinets be painted or replaced? Will the old light fixtures that still work be kept or replaced? Hopefully you’ve been thinking about these things since you walked through 100 of your competitors houses earlier in this process.

   Your GC should be able to help you figure out what needs to be done and what doesn’t, and if you really want to do this step right, have your real estate agent present with you while you walk your GC through the house. For example, your agent can help give you a good idea of whether you need granite countertops in this neighborhood, or whether you can get away with something cheaper.

   Hopefully, by the time you’re finished, the GC has enough information that he can provide you a ballpark estimate of how much it will cost to complete your rehab. He won’t be able to tell you to the dollar, but should be able to give you an estimate to within a couple thousand dollars, which should suffice for now. Add 20% to his estimate, and use that number as your conservative rehab estimate for this project.

7. Run a CMA

   The last piece of the puzzle before you do your final analysis of your deal is determining a realistic selling price for your property for after it’s rehabbed. And once again, a great real estate agent is your best resource.

   You real estate agent should be able to do what’s called a Comparable Market Analysis, or CMA. This document is essentially a report that tells the agent (and you) what other houses in this specific location with these specific characteristics and in this specific condition are selling for. If you have an idea what other — very similar — houses are selling for, you’ll have a great idea of what your house will likely sell for.

   Keep in mind that a CMA is a historical view of the local real estate market, not a current or future view. All the information in the CMA is about houses that have already sold; since your house won’t be ready to sell for several weeks or months, it’s important not to put too much faith in the CMA results. For example, if this neighborhood is seeing prices drop over time, it’s likely that your house will actually sell for less in a couple months. But, if the neighborhood is seeing an increase in activity and an increase in prices, it’s possible that your house will sell for more than the CMA suggests.

   Just remember, figuring out the selling price of a house that won’t be put on the market for several months is as much an art as a science, so be conservative in your estimates, and then be even more conservative.

8. 17.Do Your Analysis

   You should now have all the information you need to determine whether this house is a good first project or not. You know your purchase price (whatever the seller agreed to in the contract), you know your selling price (your conservative estimate from the CMA), you know your rehab costs (the conservative estimate based on what the GC told you), I’m sure you have a desired profit in mind, and you should be able to estimate your fixed costs based on our discussion of this earlier.

   If you plug all that into The Flip Formula, you should be able to determine if the numbers work out. Is the purchase price that you agreed upon with the seller less than or equal to the maximum purchase price advised by The Flip Formula? If so, you have a winner! If not, it looks like this isn’t yet a great deal.

   Let’s say that your numbers don’t work out. Are they close enough that you can make some adjustments and get them to work out? For example, could you cut down your desired profit enough to make the numbers work? Or could you decrease the scope of your rehab to decrease your rehab costs (though keep in mind that this might decrease your selling price too!).

   Another option is to go back to the seller and request that they accept an offer at your maximum purchase price. If the offer is just a few thousand dollars less than your previously agreed upon price, they very well might be willing to do that (I’ve actually done this several times). The key here is to make sure that this is all done during your due diligence period, so that if you have to back out of the deal, you’ll get your earnest money back, and the only thing you lose is the cost of the inspection and the GC consultation.

   If you have to back out of the deal, don’t let it get you down. It took me three tries to get my first property, and since I bought that first one, I’ve never had to back out of another deal. It’s all a learning experience, and hopefully all the information you picked up will be helpful when you put in your next offer.

   Of course, if numbers work, and you’re ready to move forward with this deal, don’t celebrate yet…there’s still a lot of work to do…

9. Line Up Your Financing

   Earlier in this process, you thought about how you’d finance your property. Now it’s time to make sure that your financing is in order and ready to go. If you’re working with a mortgage broker or loan officer, it’s time to give them all the information about the property and get confirmation that they’re willing to work with you on this project.

   If you’re working with a private lender, or are borrowing money from family or friends, now is the time to make sure the funds will be available at the closing.

10. Make Your Final Decision

    By now the due diligence period is probably coming to a close, and if there are any other loose ends that you need to tie up before committing to this project, now is the time. Once due