Do Cheap Properties Always Mean High Returns?
By Paul Esajian on August 16, 2017
There is something exciting about getting a really good deal. Whether it is saving money on groceries or lowering the interest rate on your credit card everyone loves a deal. In real estate, there is the constant search for the home run deal. These are the high profit deals that we find maybe once a year if we are lucky. There is the perception that the lower the purchase price the better the deal. In certain situations, this is the case but low price does not always lead to high profits.
An inexpensive property is priced that way for a reason. Even if the property is in a good location there is something about it that has decreased demand. In most cases these properties are distressed and need a complete facelift. The upside potential may be there but there is also plenty of risk associated. Getting any property at a discount feels good but there is usually more than meets the eye. Here are four things you need to consider when buying an inexpensive property.
- Low price often means high cost. The basic concept of a rehab is to buy low, add value and sell for a profit. With a distressed property, you have the ability to buy low but the cost of repairs is much higher than a traditional property. For starters, you need to have access to large amounts of capital before you even consider an offer. Most of these properties have been abandoned or not lived in for months so you need to financially prepare for anything. It is a good idea to add 10-20% to your estimated budget. In that budget, you can expect to pay for a roof, kitchen, bathrooms, electrical and various surprises you don’t anticipate right now. These are big ticket items that cost tens of thousands of dollars. Throwing money on repairs does not automatically mean you will make money. If you are not careful with your expense budget you may be spending tens of thousands of dollars for a marginal return.
- Creating value. Inexpensive properties are not like your traditional rehabs. They are usually gut rehab jobs where everything, or almost everything, is replaced. This provides a blank canvas where you can get creative. While this can be a positive if you know what you are doing it can also be a challenge if you do not. With these properties, it is not enough to slap some new paint on the walls and call it a day. You need to be precise with the finishes, the backsplash and every little detail with the rehab. It is the minor things that help separate the property from the others in the area. If the property has been distressed for a while it may be a black eye that has gained a negative reputation. This means you need to do extra work just to wipe away the negative vibes attached to the property. It is critical that you know exactly what you want to do and how to execute it before taking on a rehab like this.
- Surprises in every corner. Think about the unexpected issues that come up with in your primary residence from time to time. Most of these items are easy fixes but they still catch you off guard. Now think about the deferred maintenance on a property that hasn’t been lived in for a year. There will be plenty of surprises that pop up during the process. Knocking down walls and starting over doesn’t mean the items are fixed. The deeper you get inside the house the more trouble you can find. This can only add to your budget or open a can of worms you were not expecting. From the start of the rehab until you find a buyer you need to be ready for anything. In addition to adding to your budget you need to have the right mindset to tackle these properties. You can’t let one unexpected curveball get you bent out of shape. There are going to be issues and you will have to make tough decisions. The more you accept this the smoother the process will be.
- Buyers buy on finished product. One of the biggest issues rehabbers have with inexpensive properties is comparing the starting point to the finish. You can be proud of the work you have done but it doesn’t mean buyers will overpay for the property. Showing the before picture on a listing sheet means nothing to buyers. All they care about is the finished product and how it stacks up to other properties in the market. There is a natural reaction to list your property too high based on the improvements you have made. You may have done great work and given the property a completely new look but by listing too high you are setting yourself up for failure. Regardless of the work you have done you should look at comparable sales and listings and list your property accordingly. Your work is not over with the property until you are at the closing table.
With any property you want to look at the potential upside and the rate of return. An inexpensive property may fit the mold but there is risk you need to account for. Never judge the strength of a deal based on how low you can purchase the property for.