Hello all new investors and welcome to the wonderful world of investing. Let me try to help keep it wonderful for you.
As you get going in looking for deals to flip or to hold, you are going to come across several deals being offered to you by wholesalers. They will all have in their clauses that their estimates (if any are given) are for informational purposes only, they do not represent you and that you should DO YOUR OWN DUE DILIGENCE before signing a contract. Several will require a large non-refundable deposit when you put your property under contract, because they want serious investors, and don't want to deal with 'tire-kickers' tying up their deals and then backing out. I can only think of two reasons that an investor would back out of a deal after going under contract. 1. After getting inspections and estimates, they realize that the numbers were wrong and it is in fact a bad deal, or 2. They can't get funding. TIP: If you can't find a hard money lender to fund your project in DFW, that means it's a VERY bad deal. Run away. The $5k deposit makes backing out very costly, but probably a better option than keeping a bad deal.
An option period exists to give the buyer the opportunity to examine the property PROPERLY and make sure that it is in fact what they were expecting to purchase. A $5k non-refundable deposit only serves to eliminate that opportunity for the buyer.
So, back to to topic - DUE DILIGENCE - WHAT EXACTLY IS THAT?
1. KNOW WHAT MAO IS - That's Max Allowable Offer, and it will eliminate the need to waste your time or a wholesaler's time, visiting a property that doesn't make sense on paper.
MAO = ARV x 70%, minus repairs, and don't you forget it!
Example: ARV (After Repaired Value) is $200,000, repairs needed are $20K
$200,000 x .7 = $140,000, minus $20,000 in repairs = $120,000- That's your MAX ALLOWABLE OFFER. You shouldn't pay more than $120,000 for this property.
That doesn't mean you're going to make $60k on a flip. Once you subtract purchase costs, holding costs, rehab costs and selling costs, you'll make around 30k IF NOTHING GOES WRONG. A popular target is 15% of the ARV. When rehabbing to sell, you can come across all sorts of things that eat up that 15% that must be addressed to sell the property. If you overpay in the beginning, you can very quickly rehab a house for free, or a loss, when things don't go perfectly.
If you're turning it into a rental and overpay, when you refi, you're going to have to leave a LOT of your own money in the deal, reducing your return on investment and decreasing your ability to purchase the next property.
2. FUNDING / EXIT STRATEGY - Begin with the end in mind, and have a worst case scenario ready. ie. If I can't sell this flip, can I rent it until it becomes profitable to sell? You'll need long-term lending available, as well as short term for the rehab. If you can't sell or want to make it rental, refi into a long term loan after the rehab. Consider: hard money, private money, conventional loans, lines of credit, seller financing, etc. - Need more info? come to the Club. Shop your hard money lenders if that's your route. Many wholesalers have preferred lender, but with a little work, you can find better lenders with fewer fees. You can ask them to send you a list of fees associated with closing that you can review. NOTE: Many wholesalers pass on THEIR closing costs to you in the double close. That's another $1k to $3k typically, depending on the purchase price. Don't forget to add that into your costs.
3. COMPS - Don't trust the comps that you are given by the person bringing you the deal. Get your own, either from an agent or on your own. Don't know how, or who can help you? Come to the Club. There are MANY details that can make a specific property comp well on paper, but not in reality. Bring a BUYER'S agent your first few times, and tell them to look for problems. They will help you find things that would make the property difficult to re-sell. Look for small rooms that don't suit their purpose, ceilings under 8 feet, rooms that you can't visualize furniture placement, roads that are busy compared to the neighborhood, yards that need excessive work or constant maintenance, bad neighbors, the list goes on.
4. INSPECTION - Experienced investors may forego this step for many reasons, but if you haven't done at least a dozen rehabs, I highly recommend getting an inspection. This will turn up things that you'll easily miss, such as an outdated breaker panel, plumbing issues, out-of-code issues, etc. Once you've gotten the inspection and bids, you may need to renegotiate your price. If the wholesaler refuses, don't just be out $350 inspection cost and walk away. Give them the inspection report with repair bids to justify your reasoning. It is my understanding that they are now legally obligated to present that information to any buyer, so they can't throw out your offer and go looking for the next buyer to miss those major items. Can anybody verify that obligation?
Plus, I'm sure that a reputable wholesaler would be willing to take that inspection information to their seller to justify a price change that would make for a reasonable deal for the investor. Right? They're not out to put investors in a bad position, after all.
5. CONTRACTORS - Not bids, but the contractors themselves - do your homework. A bad contractor will ruin you faster than a bad deal. Contact as many contractors as it takes to get you a list of 10 that you LIKE. Get references from their 3 most recent projects and find out how they did. Sound like hard work? Try hiring a bad contractor and chasing them around for months. That's work. Make the phone calls. Ask me how I know. If they won't sign a contract that includes steep penalties for missing their deadlines, move on to the next. FREE TIP - Finish a complete job with a contractor before giving them another. How they finish a job may not be reflective of how they start, or you may just find they aren't a good fit for your style.
The Club has several good options for GC's and subs, but expand your list. FREE TIP: Cheap contractors are in fact the most expensive when all is said and done. They miss everything and take forever, costing you more than the pricey guy with the detailed estimate and actual contract.
6. BIDS - Now that you have contractors, call the top of your list until you can get 3 to come out and get you bids. This should include a detailed scope of work with itemized prices for materials and labor. Provided they are investor-friendly and know your goals, the most expensive one is probably the most detailed and probably the closest to right. Share your inspection with your contractor and discuss what needs addressing to meet your exit strategy. If the cost of rehab is higher than expected, you're out.
Well, I didn't mean to write a novel here, that is 'DUE DILIGENCE'. ALL of that should happen BEFORE you choose to enter into a contract with a $5k non-refundable deposit, because once you sign, you're committed. Still, back out if you must.
You should have your funding, comps, inspector and contractors ready to go before you visit the property, but hopefully this makes it clear why, especially if you're new, you should not even be ABLE to put a property under contract with $5k at risk with less than 3 days of due diligence. This means that most deals will be gone before you have a chance complete your research, but you WILL be better off if you never buy a property than if you buy a bad one.
Unless you are a licensed lender, a licensed agent, a licensed inspector, AND licensed general contractor, you do not have the ability to walk a property and know in 30 minutes whether or not it is a deal. In fact just the contractor bid should take 3 days.
I purchased 3 properties this way, and should have re-negotiated all of them or backed out after getting DETAILED inspections and repair estimates, or noticing issues with the area that didn't present themselves on my first visit. I would have in fact been better off surrendering my $5k each time.
I hope this helps you newbies out there. Any experienced investors / wholesalers, please feel free to chime in.
I'd love to hear from anybody who has had experience with these types of deals, good or bad.
