If you pay too much for a property, you've already screwed yourself before you even get going. It's important to "buy right". But how do you know where your limit is, what your maximum price to pay is, for any given property?
You need to plan it out - build a spreadsheet for yourself that lists all the costs involved in what you're doing - either flipping, or buying and holding - and make sure the numbers will work for you.
For flipping, you start with the ARV price - what you can sell it for. Don't overestimate that, pick a good or slightly lower ARV, so you can sell it quickly when all done fixing it up. Then subtract from that all the costs - cost to buy, cost to sell, cost to repair, cost to hold the property (taxes, utility bills, insurance, etc.) - subtract a little buffer amount, since repair expenses often exceed the planned amount. And lastly, subtract the amount of money you want to make on the deal, when all is finished. The remaining number is the MAXIMUM you can pay to buy the property! It's often a lower number than you expected. Many flippers look to buy properties at 60-70% of ARV. If you're just starting out, you need at least that low of a buy-price, maybe more.
This helps you know the most you can pay for a property. Over time you'll be better at estimating ARV for a given house & neighborhood, as you become more familiar with the area you're trying to work in.
For buy-n-hold's, the spreadsheet is a little different, at least the way I do it. Note the amount of cash you're putting into it, including all repairs & holding costs you're paying before it's rented (cash). Get rental comps for that type of house and neighborhood, and also add up the monthly holding costs when it's rented out -- rental income, minus those monthly expenses, is how much left-over money you'll have at the end of each month, which is called cashflow. Remember that any annual expenses need to be divided by 12 and added to those monthly expenses! (i.e. insurance, property tax). Now you can calculate what your ROI is:
ROI = (monthly cashflow * 12 months) / (amount of cash you spent on getting it going)
For example, if your down-payment plus repairs etc. was paid in cash, and it totals $30K, and your monthly cashflow of leftover money each month is $300, then a year's worth of cashflow is $3600, which is 12% ROI (3600/30000 as a percentage). This means that every year you operate the property, you roughly get back 12% of your initial money. So after 8 years, you got back all your cash that you put into the deal! (100% / 12% = 8 approximately).
My threshold is: cashflow each month must be >= $300, and ROI must be 10% or greater.
Over time, you can improve that spreadsheet. Once the deal is completely done, go back and see where your numbers were not accurate - make a new spreadsheet, and compare it to your original one. What did you miss? What was underestimated? overestimated? It's easy to underestimate cost of repairs, for example, or miss something that was an additional cost. From that you can make future spreadsheets more accurate on future deals! Keep iterating, and learning this way. It's a never ending process because things change in the industry, it can differ from neighborhood to neighborhood, laws change, taxes change, insurance prices change, interest rates change, etc.
That's also why investors focus early on some of the big-ticket items: roof, A/C, heater, foundation. If you have big issues with those, you want to know up front, and get repair estimates quickly - those big expenses get added to your spreadsheet right away, because they can make or break the deal if you don't notice an issue with those things at first, and have to pay for it later.
I negotiate purchase price based on the results of my spreadsheet. If I found a wholesaler selling a home for $5000 too much, according to my spreadsheet, I try to negotiate it down with them. Sometimes it works, sometimes it doesn't; if not, then I just look for different properties. The numbers have to work. I'm not going to sacrifice my own profit and happiness by paying too much for a property. Keep looking. You can find deals anywhere like this, even on MLS; although finding deals on MLS is rarer than through other channels, like wholesalers or auctions. We've even gotten amazing deals from friends, by simply sharing with everyone we know what it is we do, and telling them what we're looking for. You never know where your next great deal is going to come from.
