First Purchase: A distressed REO???

Question

Hello,

First poster here.  I have been studying up on real estate investing for some time now, and I finally am getting serious about taking the plunge.  I live in northern Virginia and am interested in purchasing a REO.  I am about to go through the process of getting bank pre-approval, bringing in a contractor to give me some estimates (only plan on using contractors for the big jobs), and planning out the finances to ensure I can make it all work.

My biggest question is regarding how I should go about making my initial offer to the bank.  They are asking in the mid-200s for a place that, if fixed up, could go for almost 300k. Probably would take 30-40k to really fix it up. It has been a REO for nearly 6 months, and my understanding from the listing agent is that the bank is flexible on price.  So how low should I go? I know that it is not a straightforward answer, but any advice would be much appreciated.

Thanks in advance.  This looks like a great forum, I look forward to learning from you all.

Casey

Jason Shaffner · Answer

Dude,

If you are going to live in the house while you are rehabbing it, then you will want to work on the primary sections of the house first.  IE the kitchen, the bedroom you are going to use and the associated bathroom.  Living in a construction zone is a pain in the #$%.

Note what Wheatie said ... he spent as much time making space to work as he did working.

Outside of that, your plan is the way to do it.  Find a beater, live in it while you fix it up and then sell after two years and take the tax break.  Rinse and repeat.  I've done that, but I have three kids now and the wife put a kibosh on the moving thing.  But a buddy of mine has done this for the last six years like clockwork.  24 months and on to the next house.

A little caution on starting a rehab with little secured funding.  You are not under the gun, so you have that working for you, but a lot of projects have ended up sitting for years if not forever because of a lack of money.  Just make sure it's not your house.

Good Luck,

Jason

N/A N/A · Answer

My rough timeline is to try and put a bid on this property in a few weeks. It has been sitting for a while, so fortunately I do not feel so rushed. I am waiting to look at the inspection report, then I will be able to get the ball rolling.

I am kind of jumping ahead here, but how do much effort do you put into the rehab plan? Do you focus on the big projects first (i.e. kitchen) or prefer to cover the easier tasks right away, such as painting the bedroom?

I will be pretty short on cash to fund this project, but I think that with a conventional loan, possibly a HELOC or HML for the rehab, and surplus from each paycheck I can make it work. Thanks for all the input.

Casey

N/A N/A · Answer

I find out what house in the area sold for in the last 2 months and start there then after subtracting what I want to make off of the house.Then closing rehab ,holding cost and all other cost marketing and oops. then I come up with my top offer once I have my top offer I start making my bid if I get the house I make it the best house on the block I want my house to look the best 
and be the best one on the block so buyers will want it over others in the area. I agree on using good neutral colors I also fix the house up nice I want something that I would like to live in and I am some what picky.
so I think that most try to cut the cost as much as possible and then you have a good deal that looks cheap.  I want folks to walk in and say wow that is nice I like this and be happy warm feeling while they are looking at the house.
like I said it just my 2 cents and maybe you can use alittle something from it.

Jon Holdman · Answer

I must congratulate you on thinking about the long term over the short term.  Wish I had done more of that when I was younger.

You should plan for some negotiation with the bank or any other seller.  Come up with the maximum price you can pay, and don't go over that.

Conventional financing will certainly improve the results.  Plus, it gives you more options long term.

If you can manage living in the property for two years, you'll also get the tax break.  Married couples can exclude gains up to $500K on a property they've lived in for two of the last five years.

But, as Chops says, it can be a challenge.  Our current primary residence was a fixer when we bought it.  We spent about a month doing floors and paint before we moved in, then spent the next two years finishing the basement to create enough living space.  It was very tight while doing that.  The area where I was working was full of other stuff, too.  So, I spent about as much time making work space as actually working.  We have another house some ways away that we also did the initial rehab while staying there.  Its a pain.  At the very least get the kitchen, a bath, a bedroom and some living space nice enough to live in while working on the rest.  That way you've got a retreat from the construction area.

Sounds like you're well on your way to financial success.

Jon

Brian Ristola · Answer

Be careful living in the place that you are rehabbing.  It is surprising how comfy a place without sheetrock and wires coming out of the walls can be.  I would think it may be worth the extra money to rent and keep the workspace just that, a workspace.

My wife and I have been living in our home that we have been building for the last two years.  Notice the present tense.

N/A N/A · Answer

Thanks, Jon.  I do plan on rehabbing the house but I will not be so hard pressed to make a quick sale.  I will probably go after a conventional loan, the place is not so bad that the appraiser would consider it un-livable. Right now my wife and I are moving from a modest 1 bedroom rental to an even cheaper living arrangement so we can increase savings. This scenario should allow us to move into the rehab house after the serious renovations are complete, that being the kitchen mainly. Thus the monthly out-of-pocket debt service is not such a hard hit since we can hopefully get some utility out of that money (i.e. living space).

I definitely also understand the point not to fix up the place as if we would be living in it long term, but rather to make it a marketable property.

Need to catch some shut-eye, but thanks for your post.  I will have to take a closer look at the expected costs and ARV. When I do come up with a price that I can afford to pay, should I underbid that number a bit expecting the bank to counteroffer? Or should I just put the number out there and hope for the best?

Casey

Jon Holdman · Answer

Oh, welcome to the board, by the way.  You might post an introduction in the new member forum.
Jon

Jon Holdman · Answer

To quote Stephen Covey, begin with the end in mind.  Figure out your exit strategy, and work backwards from there.  Asking price is irrelevant.

It sounds like you want to fix it up and sell it.  The rule of thumb is that you can afford to pay 70% of the ARV (after repaired value) less the cost of repairs.  That assumes you will be using hard money at a fairly high interest rate for the short term financing.  It should yield about 10-15% of the ARV in profit, if your projections are all accurate.  It gives you some wiggle room ifxx when it takes longer to fix and sell, costs more to fix, and sells for less than you expect.

If the ARV is $300K, and it needs $40K in repairs, then you can afford to pay $170K.  That should give you something like $30-45K in profit.

That ARV is critical.  You want to look hard and the market and try to figure out what price will move that house quickly.  If you're paying 15% on $210K, its costing you over $2600 a month, plus other costs to hang on to it.  Go look at all the nearby houses you can.  Look at recent solds.  Talk to realtors in those houses you look at.  This is the place to be conservative, not optimistic.

Control yourself on the fixup.  Fix it up comparable to other houses in the area or just  little better.  Use neutral colors and materials.  Don't fix it up as if you're going to live there.  Don't make it the best house in the neighborhood.

If you can get the money cheaper, you might be able to pay more.  If the bank will do a conventional loan or you can pay cash or fund it out of other money, you can save some of the costs, maybe allowing you to pay more and still make the same profit.  Don't put your own money in and have it working for free.  Making a small profit on the deal but having $200K tied up at 0% may not be as good a deal as leaving the money in the bank.  The goal here is to make money, not rehab houses.

Jon