Buying a distressed house suggestion for a BRRR

[Nami Sharma]

"I'm considering purchasing a distressed property priced at $300,000, which requires a complete rebuild. This property holds potential as an investment property. Nearby houses are 700k + I have two options: either convert it into a single large house or create two separate units to rent out. As a first-time real estate investor, I'm seeking advice on whether it's a wise decision to acquire and work on this property. Any suggestions or recommendations?"

[Randall Alan]

@Nami Sharma

There is a lot missing from your post to be able to offer much advice.  What will it cost to do each scenario you propose?  How is the property distressed?  Are the $700,000 homes in the area comparable to the one you are looking at?  Will the property cash flow with the current high interest rates if you did buy it?

The short answer is to run each scenario and see which one has the most favorable outcome.  But before you go there, you have to face the fact that you are a "first time RE investor".  Lacking experience, the shortest path is often the best.  Because if you have never done a renovation before, you may not know what you are in for.  You can quickly get in over your head, be it financially, or with your local building inspectors suddenly on top of you and you will be going, "What have I got myself into!?" 

The property values you are talking about aren't small.  You are going to need 20% cash down to buy it (likely), then money to renovate it, then money to hold it along the way (from the electric bill to the property taxes, etc), to the time it sits on the market.  Banks will look for you to have cash reserves before they go and loan you the money... and then they are going to charge you a rate closer to 8% for a conventional loan, and higher for a hard money loan.  It's a tall order for a beginner. It might be wise to think about partnering with someone more experienced on your first endeavor.  That way you split the risk, and get a lot of on the job training that you will absorb from your more experienced partner.  They will be able to provide guidance from their past experiences that will be invaluable!  The learning curve in real estate is fairly fast... but also fairly steep!. Just knowing how to handle contractors and not get ripped off is a master-class unto itself!  

You should start with running your numbers.  What would the property rent for each way you are considering doing it?  What is it going to cost you to get it to each of those points?  What will  your money cost you to hold the property - which ultimately leads you to a mortgage price that includes principle, interest, taxes and insurance, plus a maintenance reserve.  How does that number compare to what you can rent it for (what is your profit)? 

At the end of the day the question I would ask is this:  Is buying this house the best use for your money at this time?  If you can let your money sit in the bank at the moment and make 5% interest... what percent profit will you make on your investment in this house?  If it is less than 5%, the RE buy is a bad deal.  If it is 6-7% - is it worth all the effort compared with a no-risk 5% you can make at the bank?  For comparison, the properties many of us bought 3-4 years ago are yielding profits in the 20-30% range.  Those days are gone (for the moment)... so starting out in a really tough buying environment, you need to ask yourself, "Is now the right time to be buying this property?" 

If you are really looking to BRRRR the property - keep in mind that you have to leave 25% of the value of the house in the property. Translated - that means that the most the lender will cash out is usually about 75% of the value of the house (after paying off the other indebtedness of the property. When you put numbers to that it looks like this. IF your property would appraise for $700,000 after you renovate it, the most the lender will loan you will be $525,000. It will probably cost you 3% in fees to refi it... that's $15,750. It will cost you another 3% in fees to buy it in the first place.. that's $9,000 on the $300,000 purchase price. Let's say it costs you $100,000 to renovate the property (a blind guess). If you had to put 20% down (of the 300,000) to buy it - you have $60,000 invested to acquire it, $100,000 in renovations, and just under $25,000 in acquisition costs, for a total of $185,000 into the property (neglecting insurance, taxes, etc, etc... so this is very simplified. When you BRRRR it, you are going to receive 525,000, less the 300,000 purchase price, and then would recover your renovation costs of $100,000 and recoup your acquisition costs of $85,000. Total expenses $485,000, so you would potentially get a check at closing for $40,000, with a mortgage of $525,000 on the property. But there are A LOT of ifs and buts along the way that can wreak havoc that you will not know going in, not the least of which is, "Will it appraise for $700,000. Because there have been plenty of us that have received appraisals that didn't go the way we wanted them to. So if it came in at $600,000 value. Maximum loan would be $450,000, so you would be into the property with $35,000 invested. Next you need to see if it makes sense. The principle and interest on $525,000 at 8.1% interest is $3,900/month. Taxes?... let's say 1 1/2% a year for $9,000 based on $600,000 valuation - or $750/month. Insurance?... Let's say $5,000/year - or $417/month. So your monthly bill for the property would be $5,067 before a maintenance reserve - which lets call it $200/month. So $5,267 / month before you get to your first dollar in profit. Now you need to know what you can rent it for to see if any of this makes sense to do... which is where Zillow rentals will come in handy to see what properties in the area are renting for.

Hope some of it helps!

Randy