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So far, I have covered Location, Property Type,  and Type of Tenant in Part 1 and Property Condition in Part 2  in my series on defining real estate investment criteria.

In this post, I will cover the fuel to wealth creation, FINANCIAL METRICS. A grasp on the financials is what separates investors from traditional home shoppers. As a fellow investor, I know that it also helps you sleep well at night after a deal. I encourage my clients to get better at crunching more numbers on paper before even viewing a house.

There are many potential ratios and estimates to calculate, but I will start at two that are critical for the determination of profit.

1. AFTER REPAIR VALUE (ARV)
It is common for seasoned investors to say that you make your money on the buy, not the sell. When you estimate the ARV, you take a view on the future value of the property when you are ready to sell or refinance. The conservative approach is to base your estimate on recent sales with similar size and rehab condition and only modest appreciation. It is hard to make up ground after making too lofty an assumption later.

Once you understand the ARV, you can begin to determine a purchase offer strategy.  Many investors shoot for a 70-80% discount off the ARV in the Philadelphia area on rental properties and an even deeper rate for a flip to allow room to finance the expected value-added repairs. Similarly, a motivated seller targeting an investor buyer would be wise to consider an asking price strategy that leaves some of this value on the table.

In the end, you have to make sure that your rehab costs plus your purchase price don’t exceed the ARV.  Your profit wiggle room can quickly disappear if you don’t factor in a worse case scenario in your more detailed rehab estimate that includes both labor and materials. Fortunately, the older housing stock around Philadelphia allows for many opportunities to profit with value-added repairs.

2. MARKET RENT
For rental properties, the market rent defines your income ceiling. If your income forecast is based on fantasy monthly rental rates for the area, you can run into trouble. I recommend that you factor in the rent that the middle 80% of the tenants in your area are willing to pay.

Often, there is an opportunity to increase the rents from the previous owner. I have observed that many motivated sellers have tenants in place paying below market rents. One way to justify higher rents is through making cosmetic repairs. However, there are limits to the feasible rent boost based on the geography, as discussed in the first post in the series.

I encourage you to share your thoughts on your ideal targets for ARV and rents with your agent early. Instead of just saying “send me a good deal,” you can say that you say “watch out for homes in neighborhoods with properties worth $75K per unit fully rehabbed and rental rates around $1,200 a month”.

To wrap up the discussion on financial metrics and criteria, we will review two more real estate benchmarks in the next post.

Want more insight?

Schedule a New Investor Discovery Call

Schedule a Seller Strategy Session

Schedule a Rental Income Strategy Session

In the last post, we covered how investors evaluate where to invest and your options for the type of property and tenant before selecting properties. In this post, I will review how to define investment criteria and due diligence around the next criteria:

4) PROPERTY CONDITION

Unless you are considering investing in new construction (which has its own challenges), the property likely has some defects which can range from small maintenance items that the previous owner delayed addressing to major damages that may need immediate attention to pass local building code inspections. Smart investors know that repairs offer the opportunity to create value.

Here are the main questions to answer for yourself to evaluate which projects to pursue:

1)    How flexible is your repair budget? Your budget may look different if your strategy is to Buy & Hold, Buy & Flip or even Buy, Rehab & Refinance. Your budget must cover what your contracting team can easily identify as well as a buffer for more complex or harder to estimate repairs. Ultimately, you have to validate your repair budget against the estimated ARV (After Repair Value) and expected market rents to win on your investment.

2) What repairs can your current team handle? Quite frankly, many of the defect conditions I observe in homes were caused by DIY owners or low-skilled handymen. Do you have a general contractor that can manage the required specialists to rebuild a shell into a livable property? Or, do you just have a handyman that can handle mainly cosmetic repairs? The reality is that the best deals require the most rehab work. However, these jackpot deals could be out of your reach if you do not have a capable crew to complete the project on time and budget.

3) How does the condition of your target property compare with the other buildings on the same block? Real estate professionals rate both neighborhoods and buildings into a class from A to D that factors in the age of the properties and the included amenities. To maximize your return, a smart investor will match their rehab budget to the features available within the other existing housing stock on the block (i.e., put Class A amenities into a building in a Class A neighborhood). If you are an early investor on a block, you may have to rehab multiple units to justify putting in Class A amenities on a Class C block or risk a negative return on your investment.

In summary, these questions can help you:

1. Be clear about your feasible repair budget. A mistake with your repair budget can lead to additional holding costs and reduced profit on your deal.
2. Decide what kind of repairs to pursue. Your current team will largely dictate your decision. If you think you are ready to take on larger projects, you will need to add more experienced contractors to your team.
3. Move through your due diligence faster. The goal is to put your negotiating chips on the table early and confidently head to the settlement table.

In the last part of this series, I will cover financial metrics.

Want more insight?

Schedule a New Investor Discovery Call

Schedule a Seller Strategy Session

Schedule a Rental Income Strategy Session