House #25: Preliminary Budget

July 27, 2011 · 4 comments

We received word that our contract to purchase The Drought House has been signed by HUD and that we can call the closing attorney this week to schedule our closing for sometime in the next 45 days. Hopefully we’ll be able to get this one closed quickly, as we’re ready to get back to work…

Here’s the preliminary budget that I’ve put together for this project:

Preliminary Budget

While I’d love to spend more to do some higher-end finishes (like hardwoods throughout the main level instead of just in the entryway), the issue we’re going to have with this house is that it’s not going to appraise for as high as we’d like. You see, the buyer can only get a loan for the amount of the appraisal; so, if the buyer is willing to pay $110,000 but the house only appraises for $100,000, the buyer can only get a loan for $100,000. In that example, the buyer would either have to come up with an extra $10,000 to cover the difference, or we’d have to lower the sale price by $10,000 (or compromise somewhere in-between).

Since most buyers these days don’t have a lot of cash sitting around, we generally assume that if an appraisal comes in lower than the sale price, we’ll have to lower the sale price to the appraisal price. So, the appraisal price is generally the highest we’ll ever get for a property these days. And with this house, I have a feeling the appraisal will come in lower than what many buyers would be willing to pay, but that will still be the most we can get for the property. So, we need to make our budget decisions based on that restricted sale value.

In this case, if our rehab costs are more than $20,000, our profit will likely suffer. So, we’ve made our rehab plan based on that $20,000 budget. We’ll try to get it to come in lower, of course, but given the extent of cosmetic renovations needed for this property, that probably won’t happen. Hopefully there won’t be any major surprises…

We expect this rehab to take about two weeks, which is pretty standard for our “full cosmetic” rehabs these days…

4 responses to “House #25: Preliminary Budget”

  1. Kim says:

    First, thanks for your insight & especially your candor in sharing your transaction details! I’ve been doing rehabs full time for 2 years now, have been successful & really love it! Your blog has been a huge help! I’ve been trying to only purchase single family homes w/2 full baths as you do. Due to the investor (primary buyer) competition, I’m having trouble winning bids. All are REO or govmnt owned. I’m not sure whether to bid more & take a smaller profit (I’ve been getting approx 50% of invested cash but only do 3 or so per year.) I also could look at 1.5 bath homes, which are plentiful. What are your thoughts?

  2. J Scott says:

    Hey Kim,

    We ask the same question these days — overbid and take smaller profits or wait it out. For this house (The Drought House) we’ve decided we’re okay with a smaller profit, for a couple reasons:

    1. It’s a low risk project (we’ll make a small profit, but I don’t expect any major surprises)
    2. It’s an easy project
    3. We really want to have some work for our contractors
    4. There are lots of buyers out there looking for houses in our price range, and I hate getting calls from agents we know who have buyers and having to say, “We don’t have anything!”

    As for the 1.5 bath homes, it really depends on your area. In this area, those houses just aren’t selling, and I’m not sure we could make money on those no matter how nice the rehab might be. But, they may be selling in other areas, in which case, they’re worth considering if you’re careful and factor in the smaller buyer pool looking for those smaller houses.

  3. Luis says:

    Kim, I would caution you going the route of the smaller profit margin. The profit margin is what protects you from those unforeseen circumstances like rehab costing more or having to lower the sale price of the house because it does not appraise, or longer hold time, etc.

    I have discovered the tough way that sometimes no deal is better than a bad deal…

  4. Just briefly to thank you for the great post.
    I am the owner of the real estate agency in Croatia, Europe, and I read your post’s with a great interest.
    Just keep up with the good work 😉

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