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How Do I Know if the Price of a Property is Fair?
Joe: How do I know if the price of a property is fair? The first thing you need to know is how to value your property, how do you determine what the true value of a property is? And nobody really knows for sure what the value of that property is until a buyer pays money for that property. The buyer ultimately determines the value of a property when that cash changes hands.
Joe: But there’s a way that banks do it, a way to help them understand how much money they can loan on a property and be reasonably safe that they’re not loaning more than that property is worth. And they way the do that is through appraisals. And appraisals work based on sold comps – sold comparable sales. So they’ll look at properties that are inside the MLS, so if you don’t have access to the MLS you won’t necessarily have access to this unless you use a service that gets you access, and there are some of those online. But what they’re going to be looking at is properties that have sold in the past three months, maybe six, maybe they have to expand it if there’s not very many that have sold in that area.
Joe: But they’re going to look at properties that have sold recently and then they’re going to extrapolate based on the size of the property, the amenities, the location, they’re going to look at the immediate area, the subdivision that they’re in and they’re going to look at these other properties and say, okay, this property is worth this much. We know that for sure because it sold, this was the sale price on this property and we have this information from the Multiple Listing Service. So if they’ll look at this property, they’ll look at this property over here and they’ll look at this property over here.
Joe: So they’ll look at three, at least three different properties. And then they’ll extrapolate based on those three properties, you know, reducing the price of properties that are better and increasing the price of properties that are worse to be able to come to a value. And that’s how you come up with the value of a property. So if you’ve got a property over here that’s worth $100,000 and it’s been completely rehabbed and is in great condition and it’s right next door to this one, and it’s exactly the same square footage, has all the same amenities, and you decide to go fix it up it’s probably going to be worth about the same as that property.
Joe: Another way to do this without MLS access is to go into Zillow. Zillow has what they call the Zestimate and it’s sort of right, it’s not always right, but it’s kind of right. And it’s got a pretty good idea of where the values are. One of the things that I’ve noticed with Zillow is their algorithm for coming up with that value is different for almost every area across the country. Because Zillow is getting their information from different places. They’re not getting their information all from the MLS. Sometimes they’ll get it on the tax assessor. Sometimes they’ll get it from public records. Sometimes they’ll get it from other properties that are for sale and they use that to create an algorithm that gives them the value for that particular area.
Joe: So once you start to understand Zillow’s algorithm in your particular area, you’ll know that, okay, they may tend to be a little bit high. They may tend to be a little bit low in these areas. And that way you’ll be able to look at the properties you’re looking at and know whether or not Zillow is on track with that.
Joe: Sometimes you run into areas that the prices are just all over the place. There’s some places like that in Indianapolis. They’re redevelopment areas where you can buy houses for you know, $10,000 but there’s also properties that are just on the same street for $350,000 that have the same square footage. But one of them has been completely rehabbed and the other one is in terrible condition. So those are pretty interesting areas to get into but it makes you a little bit nervous when you’re trying to buy that property if you know that hey, it’s going to cost me $50,000, $60,000 to do this rehab because it’s a, you know, 1900 circa property that needs new roof, new decking, you know, maybe has knob and tube wiring, needs all that stuff replaced. But once it’s done I’m going to be able to turn around and sell it and I’ll have a pretty good chance of getting, you know, over $300,000 for that property. So those are the hardest ones to comp because the values are all over the place.
Joe: If I go into a subdivision that’s maybe twenty years old and it’s got lots of properties that look just like it those are going to be easy ones to comp and it’s going to make it a lot easier for you to make that happen.
Joe: Now when it comes to sellers who are asking a certain price for their property, trying to determine whether or not the price is fair or not, that’s not really the issue. The issue is can you make a profit on it? You know, if they’re making a profit, that’s okay, as long as you’re making a profit that is adequate for your risk tolerance. So what I do when I go into a deal, I’ll look at it and say, okay, what’s the future value of this if it’s been completely rehabbed? And then you want to back out of that. So if I know that it’s going to be, you know, $200,000 for a property and I know it’s going to cost me $30,000 to do the rehab, that means if I bought it for $170,000 I’ll break even, right?
Joe: No. That’s not true because you also have purchase costs, you have selling costs. So figure another 10% in selling costs and holding costs, so figure $20,000 for that, that brings it down to $150,000. And then if you have costs for your money, let’s figure another $10,000 for the cost for your money, that brings it down to $140,000. So now you’ve got $140,000 is break even for you on a deal like that. That means that you want to get that thing for $100,000 so you’ve got $40,000 of profit built in to the deal. So those are the ways that you’re going to be able to value that property and determine whether or not the deal is going to work.
Joe: Now in order to do that you’re going to have to know enough about construction or have somebody who knows about construction if you’re doing rehabs, to be able to tell you how much it’s going to cost to do that rehab. Most of the time one of the biggest mistakes that I see beginner rehabbers make is the rehab ends up costing them twice as much as they expected. Because if you just go in and you figure out what the cost for the materials are for that rehab you need to double that cost to get to the actual rehab cost. And if you’re not working with a good contractor it may take you a lot longer which costs money or it may cost you a lot more because the contractor wasn’t fair with you. So keep those things in mind when you’re doing rehabs.
Joe: Maybe one of the best ways to solve that problem is not spend a lot of your own money. Put deals together that don’t require your money to make that happen.
Joe: All right. I hope that helps.