My Takes On The Book On Flipping Houses #2

In this weeks post I will be continuing sharing my thoughts on "the book on flipping houses" by J. Scott.

Chapter Five

We finished the last chapter by deciding what market we are going to look at for properties to buy. In this chapter we will be discussing what type of house you should be looking for. First of all he highly recommends looking for distressed properties and not retail ones. Retail properties are a lot more common in the market, they are most of the time in move in conditions and they are marketed heavily on the internet in all the mainstream channels. Although there are a few deals that might be good for investors, the competition on them will be very fierce and will make it hard for a new investor to get the upper hand. He then continues by giving a brief explanation on the foreclosure process while defining a few key terms such as auctions, REO, etc. I will not go over all that, but the bottom line is that I was convinced. I will be focusing my effort on finding distressed house in which I can give the owner a good solution for what ever problem they are facing while getting a good deal, with a large profit to be made. I will probably be less inclined to try and buy of auctions mainly because a lot of the time you can not get a thorough inspection before you buy which widens your risk factor.

The next step when trying to decide how to narrow your search is to establish what kind of houses are selling more in your market. Each market has it's own criteria but he gives the basic ones he used and they should apply for most other markets:

• Age- In most markets there was a big construction boom a few decades ago and one previous to that. He states that most times the more recent one will be good for selling a house for retail and the one before will be more suitable for rentals.
• Type of houses- Ranch, SFH, townhouses, etc.
• Construction style
• Number of bedrooms and bathrooms
• Lot size
• Subdivision or stand alone

There are more criteria and you will need to do a thorough research in order to decide what properties you should buy. The goal is to buy the houses that you will be able after the rehab to market to the largest pool of buyers to make the sale quick. It is very important to not let personal preferences lead the way, you need to think what most people want, not what I want.

The last decision when choosing houses to target will be the state of the house, in other words what is the amount and type of rehab I will be able to pull of. In this chapter he lists the 4 levels he gave to rehab work. The ones he recommend new investors should pursue is level number two, which consists of advanced cosmetics. Below this level you will have a lot of competition because of the simplicity of the project (even might attract retail buyers) and above it you will encounter much more complicated renovations that might require permits. The level he recommends will include basic cosmetic work like carpet, paint, etc, plus some more complicated cosmetic repairs that might include replacement of cabinets and counter tops, doors and windows, basic exterior work, etc.

Chapter Six

The next step in focusing your property search is deciding what type of seller you will be looking for when trying to find deals. In this chapter he divides all sellers in to five types:

1. Home owners with equity- Thes are home owners that have already paid of most of their mortgage but some thing happened in their personal life that put them in a position in which they need to sell the property quickly. In this cases an investor can try and understand their situation and help them find a solution that will make their life easier while providing a good deal to the investor. The good things about this kind of deals is that if the seller has enough equity, there is a lot of profit to be made. Another thing is that the deal will be closed quickly in most cases, seeing as how I'm planing on using a hard money lender or a privet lender it will probably allow me to pay in cash quite fast. The main thing that concerns me about this type of owners is that there might be substantial title complexities, but I think that using a good title company and real estate agent will help me coupe with this problem.
2. Absentee homeowners- These are homeowners that don't live in the house, most cases they will rent it out. This type of sellers are most cases real estate investors them self's so that might have benefits but also drawbacks. On the upside in most cases they have a good amount of equity in their house which leaves you, the buyer, a nice profit to be made. Moreover absentee homeowners are easy to find and in many cases are very motivated to sell. On the downside because most owners are investors they will be familiar with the market value and it will be difficult to make them sell for less. Another downside is that there might be a tenant in the house and in some cases he has a legal contract to stay and you will need to wait until the time is over or try to motivate him to leave willingly.
3. Homeowners without equity (short sale)- A short sale is done when a homeowner owes more then the house is worth. In these cases the lender might allow the owner to sell the house for less then the loan because it will cost him more to go through the foreclosure process. this kind of deal puts me off a bit because there seems to be a lot of legal difficulties surrounding them, but if I get a good real estate agent and attorney that might compensate my lack of knowledge. The benefits of pursuing these sellers is that because the bank and the owner are in a difficult spot you might get a nice discount on the property which will leave a big room to make a profit. Moreover in struggling markets they are very common, and you can just look for them on the MLS plus there will be less competition for them because the process might take a long time because the bank is involved and needs to approve. This last benefit can also be a big downside if you are not willing to wait months to close on the deal, the deal might even be canceled after all this waiting. The last thing you need to have in mind when considering this option is that a lot of the time the banks will have a selling restriction that makes it so that you are not able to sell the house until a certain amount of time has past.
4. REO- REOs are properties that were foreclosed by the bank, weren't sold at auction and are now being sold as a typical property via real estate agent. These properties are easy to find, seeing as how they are listed as any other property, and are most of the time being sold at a discount because they are not very attractive and have been foreclosed on. In an REO process there is not much room for you as the buyer to be negotiating the price, you simply send a proposal and the negotiation is done by your agent. While some would see this as a drawback I see it as and advantage because I am investing from over seas and doing a meaningful negotiation might be problematic for me. One downside that I will be taking in to consideration is that a lot of the times the contracts are one sided towards the bank. I will need to read the contract carefully and make sure I understand every little ramification that might arise. Some more drawbacks are similar to the ones with short sales, a long process to get the deal done and selling restrictions that are needed to be taken in to consideration. 
5. Auction sales- I am not very fond of this option and in the book he doesn't recommend new investors use this method so I will not be talking about it

The last thing in this chapter are the things you should take in to consideration when choosing a type to pursue. Regarding personality traits and time frame I thing that I will be most suitable at working with REOs, but I think I might also try to find distressed homeowners with equity in their homes. I believe I will be able to pursue both types at once with out losing focus because with REOs most of the work is done by my real estate agent. There is one factor that at the moment I can not take in to consideration and that is the housing situation in my market. If there aren't many REO, it might not be good for me to look for them, a lack in any type of sellers will influence my choice.

Chapter Seven

After we have decided what types of properties and sellers we are targeting, it's important to understand where and how we will be looking for deals. In chapter seven he gives a few good ways to generate deals. I used this chapter together with a similar chapter from the book "How To Invest In Real Estate" which has more systems and goes a bit more in depth. There will be two main tools I will be using to find deals, the first quite passive and the second more active.

MLS- As I have already said I will be working with a real estate agent, so one way to find deals will be setting up an alarm system with my agent so that he knows which deals to notify me about. In this chapter he points out that one of the hard thing in the MLS is to know for sure whether the property is distressed or not. One solution is to have a keyword search for a few phrases that might indicate a distressed owner, an REO, etc. The main issues with using the MLS are the huge size of the competition and the fact that I am relying on my agent. I will need to make sure that I am at the top of his properties so that I will get the leads quickly.

Cold calls- Unfortunately he doesn't give a lot of tips about this method cause he believes it to be less rewording. Although he doesn't recommend it I think I will probably give it a try because I do want to try some sort of direct marketing because I believe that's where the best leads are. Other options are direct mail and door knocking but again being an overseas investors night make them too difficult and not very accessible to me. I will target the list of foreclosed houses, owners that are late on the mortgages and vacant houses.

Two more ways that I am considering are searching on craigslist and working with a whole seller. Craigslist is widely used but investors and sellers, I will post a post saying I am looking to buy houses plus I will try myself to filter through the houses that are listed on the site using keywords. I will need to see how much time and effort I will be putting in to this method and how many leads I get in return in order to see if its beneficial for me because similar to cold calls this is a pretty active method. Lastly I will try to find one or two whole sellers that might generate good leads for me. I will need to work hard to find good whole sellers that really know what they are doing because as he says in the book, a lot of them don't really know how to find good deals plus the extra money they take for them self's might cause the deal to not be worthwhile for the investor. Never the less once I find my trustworthy companions, with relatively little effort I might get some extra leads to choose from. 

Chapter Eight

This chapter revolves around J. Scott's flip formula for determining what is the most he can pay for a property in order for the deal to be worthwhile for him. The formula is the sale price, (ARV) minus fixed costs, minus desirable profit, minus rehab costs. He then goes on to explain each variable in the formula.

Sale price- This is the number that the house, after being rehabbed, will most likely sell for. In order to find this number a comparison between the target property and three other similar properties needs to be done. The first step is to find the right properties. there are a few criteria that need to be as similar as possible to the target property. These can be found using free sites such as Zillo or Trulia but will be more inclusive and thorough using the MLS, where having a RE agent will come in handy. After finding the three most similar properties (comps), adjustments are needed to be made in the price in order to compensate for any differences between them and the target property. After adjusting all the comps' prices to match as if they where identical to the target property either the lowest of the three or an average of all three will be our sale price. A few key things I've learned regarding this is first you need to be careful not to use properties that were sold through foreclosure or short sale. second he gives the five main criteria you need to have the most similarity between your properties and lastly he gives a ruff assessment on how each difference might effect the price.

Fixed costs- These costs are things you have to pay during the whole process of a deal not including the rehab costs. They are basically divided in to three parts, buying costs, holding costs and selling costs. I will not go in to detail about each one but generally it refers to a lot of surrounding and side costs that a lot of people don't take in to consideration. He mentions that these costs can pile up to around 15K-20K, which can basically decide if a deal is profitable or a huge loss. I will put a lot of time and effort in to evaluating these costs and determining what they will include and what range of prices they will have.

Desirable profits- It is very important to set this number before you start looking at deal as to not be making decisions through feelings and hunches, only taking the numbers in to consideration. He give a rule of thumb he uses a lot, which I will also be using. I am not planing to get in to deals that are a lot more than 150K ARV so I think I will stick to a 15K profit in the beginning.

Rehab costs- This will definitely be the part I will have to do the most learning in order to understand it thoroughly. In this stage of the process though you don't need a super accurate number, you will need an estimate of around 10%-20% up or down in order to know if you should even go forward and make an offer on the house. He gives  a few options you could use to evaluate the rehab costs but I will be talking about only one seeing as how this will definitely be the way I will go in my first few deals at the very least. The option I am referring to is a general contractor inspection and bid. This process should cost about 40$-80$ and will take between an hour or two. In this part there is a lot of very good and useful information such as where and how you can find a good contractor, what questions you should ask when filtering contractors and approximately how much it would cost more to hire a general contractor rather then hiring a subcontractor for every project.

The last advice given in this chapter is to be very careful when being offered deals by whole sellers that are saying that the house doesn't need a rehab or only a few thousand dollars of work, almost always they are too good to be true. He lists the repairs that he always does in a project, and they are very basic, and even they will cost at least 10k. 

Chapter Nine

After we have understood how to evaluate a deal it is time to start looking at potential properties. He recommends looking at 100 properties before submitting an offer on a property. This number can be cut down if the learning process that is done before hand is good enough but still you will use these test analysis' to get a grasp on what houses in your area look like and what you will be needing to do in your rehabs. The type of properties he suggests to look at are houses in very distressed condition and houses that have been recently rehabbed, to give you a before after picture for your projects. You should also look at houses that are for sale for retail in order to get a feel of whats the minimum level of rehab that needs to be done in order to sell. Lastly you should check out houses that are under contract but not closed yet to see how they are different from ones that have not been put under contract yet. 

In order to get the potential deals flowing it is important to get your funnel working at this stage. For me this will be setting up a daily mail from my real estate agent containing the houses that meet my criteria, starting to get lists of foreclosure and owners that are late on there mortgage to start cold calling and setting up keywords and posting on Craigslist. Once the deals start coming in its important to know where they came from. This will help you perfect your marketing systems and to know how to approach the caller. He gives in this chapter a very good and detailed lists of questions you should ask callers whether they are homeowners with equity or looking to do a short sale. Before I will start taking calls, I will learn marketing and negotiation methods, hopefully with emphasis about over the phone calls.

My main concern in this part will be going to the property to check it out because I am over seas. What I am planning is for the real estate agent to take a detailed video of the property and all so I can watch it as well. Plus, although he states that after one or two walkthroughs with a general contractor you should be able to make a ruff assessment of the rehab costs, I will probably be using a GC to do that in all of my deals, again because I am afraid that without being inside the property I will have a hard time making the assessment. While calculating the rehab costs, your real estate agent should start finding comps in order to determine the sale price.

Finally after you have put all the numbers in the flip formula you should know if the house will make a good deal or not. He suggests that If the minimum purchase price is up to 20% lower than the listing price you should make the offer. Even if it's more than 20% you can make the offer, however chances it will get excepted are slim.

Closing Words

We are about half way through the book. I have divided it so that up until now we have mainly focused on preparation for the deals and doing a lot of learning and homework. The next post will start with making an offer on a property, and from there we will jump to the deal it self.

I'll be sure to continue sharing, stay tuned...