Now that the house is officially mine I guess it’s time to share with you guys the financial details and how I plan on making this investment work. Before I begin I want to take a moment and recognize why real estate makes for a poor investment. Obviously I think the house will make a good investment or I would have never liquidated my stock portfolio and made an offer on a house that need a lot of work. However, it would be foolish of me not to consider the reasons that could reduce the likelihood of making money off my purchase. This is a useful exercise and one I try to utilize in all aspects of my life. If you believe that real estate makes for a poor investment and I believe that it makes for a good one then it should be just a matter of determing who is right; right? Taking this approach would cause both parties to miss out on the potential of increasing their understanding of the subject, real estate investing. So instead of looking at it as a debate that needs to be won, I look at it as a chance to increase my understanding by letting another persons point-of-view merge with my own and by doing so come away with a greater understanding of both the potential for gain and loss that real estate (or any investment) offers.
Illiquidity
Real estate is not even close to being as liquid as stock investing. Before if I wanted to sell off some shares for whatever reason I could wake up in the morning and if Mr. Market was offering a fair price I would click sell and BOOM!, instant cash. Owning a house is a little different. I first have to complete the rehab before I can get my initial capital back and any of the additional expense of rehabbing the property. Then I have to find a buyer and this can be significantly more challenging than just clicking a “sell” button in my brokerage account. If someone were in a position where they would need a large sum of cash quickly it is doubtful real estate would be the best investment choice. I will agree with the opponents of real estate investing that illiquidity is the least attractive characteristic of real estate.
Expenses
Owning a home can certainly be expensive and I say this with a bit of experience as I’ve owned a couple of houses before. However, housing expenses are like expenses in general; they are only as high as you choose to let them be. If you were to read this article over at Kiplinger’s you would think that owning a home is outrageous, at least I did! Controlling expenses is foremost in my mind going forward, however it is a little different when your residence ends up being an investment as well. Property taxes and insurance are costs that I will recoup when I sell the home; when your housing is just a place to live you end up eating these costs and hoping the property appreciates enough when you sell to break even or hopefully make a little more.
These are just a couple of the reasons that could potentially make real estate an undesirable investment. Each persons will enter into real estate with unique circumstances that will make the transaction good or bad on its own merit. Always remember that when claims are made for or against a topic there is usually a set of assumptions underpinning the claims. If your circumstances fall outside of those assumptions then the claims themselves are likely not applicable. I’ve chosen an uncommon path to real estate investing by purchasing a foreclosure and living in it until it is rehabbed. This fact alone make a huge difference in determining whether it will be profitable or not. Never forget to question assumptions…
The Numbers
Little house you are about to undergo a complete transformation!
This house is a little under 900 sf. It is not a large home by any measure. It currently has 2 bedrooms and one bath. There was a third bedroom but that was torn out for some reason. Part of my rehab will be adding the bedroom back to the floor plan and hopefully making it easier to sell when the time comes. The asking price was $40,000.00. The final cost for me including closing cost, which I requested the seller pay (3% is what they would cover), was $36,061.55.
I initially estimated it would take $20,000.00 to complete the rehab. My contractor friend who came and inspected the property suggested I plan on $30,000. Ouch!! That is not what I wanted to hear contractor friend! He told me he didn’t think it would actually be that much, but would rather me go in estimating higher and being ok with it than to underestimate and end up screwing myself (my words not his). Comparables in this area and the same size as this property have recently sold for $103,000 at the high end and $89,000 at the low end. I’m thinking this house should sell for $ 90,000 when completed and that is at the low end. I think it is better to estimate expenses high and resale low than it is to hope for low expenses and an unrealistic resale value.
Selling price: $90,000.00
Purchase: $36,061.55
Expenses: $30,000.00
Profit: $23,938.45 or 36.2% Return
There you have it, my plans going forward with this project. These are projections and could easily be off one way or another. I think by estimating conservatively on both the expense and resale estimates that I have given myself a margin of safety. I’m going to work hard in both reducing the cost of repairs and on getting a higher selling price. Hopefully it won’t turn into this:
The Stoic Investor 
Hey Stoic,
Way to go on a flip. Its a great way of making money. The only thing I might have done differently is DIY vs. hiring a contractor. While DYI will save you money it will also take way longer compared to a crew of professionals. Hence I would have taken a lower profit of say $15,000 instead of $23,000 but over a 3-month instead of 6-8 month it will take to fix on your own time… In the same time-frame you can flip 2-3 houses with smaller margin yet be ahead on the overall profit.
For the first house though its fine, whatever works and makes you a return is good, even if its not as “efficient” as it could have been. Its a part of learning too, not just about pure profit taking.
All the best, keep us updated on the progress.
Hi AverageCFA.
If I were doing a quick flip in the traditional sense I would totally agree with you. However, there are a couple of factors that make this a “non-traditional” flip.
1. I’m committed to staying in this residence for a minimum of one year. I bid on this property as an owner-occupant and HUD rules require the occupant to stay in the home for at least a year. Although I didn’t factor this into my return, saving on rent each month will certainly help my cash flow.
2. This is the first of what I hope will be many more real estate investments. Since I don’t have any experience in this I thought the best approach would be to do as much of the work I can myself to not only prepare for estimating rehab expenses in the future, but to understand what actually is required on one of these projects.
In the future I may go the route you mention, but for now I’m committed to learning the ropes.
Have a great week! 🙂
That appears to be a very good buy. I also bought one of my houses this way. A HUD home financed at the lower owner-occupied interest rate.
Just a thought. Make the home appealing and comfortable without wasting money on high-end remodel items like granite counter tops, or expensive appliances, etc. Stainless steel sinks are better than ceramic. Your future renters will never treat them like owners. Ceramic is better than linoleum, Berber carpet will endure much abuse and cleans up well, or just laminate the living areas vs. carpeting. Buy upgrades that can take abuse.
I think you’ll do well. I’d be interested to see how this will cash flow as a rental. Although it appears it will do well.
Good job!
Payoffmyrentals– Plan A for this property is to resale, Plan B would be to rent it out. I’m certainly open to having a few rentals in the future. Finding a duplex or quadplex would be great if I went the rental route but there are some nice SFR that would make good rentals as well.
I am glad to see someone put the negatives of buying a home for investments as well. So many people will quickly want to fall in love with real estate but don’t have a plan. You can easily run into cash flow issues if you have to spend you money on the place. Homes also get expenses which means you need money for up keep. I still think homes are a great investment just like seeing both sides of the coin presented. It looks like a good return but some things you left out will be the commission’s when you sell which should be 6%, closing costs, and also did you put anything down up front? I see alot of people missing those when they look at total numbers.
yourdailyfinance– Thanks for stopping by. It is easy to lose balance when you fall in love with an idea, that is why I try to consider all the possibilities both positive and negative. This was a cash purchase and all the rehab will be paid for out of pocket as well. I know some say that using leverage is better when it comes to real estate, but due to my past I still have an aversion to debt. Maybe in the future I will use debt to my advantage, but not today.
Good luck with the reno and flip! And I’m glad that you’re abiding by the HUD rules and planning on living in the unit. When we were deep in the trenches of looking at places it was so frustrating to find out that HUD units went to investors who lied about occupancy or got straw men to sign for them and then flipped the property super quickly. We weren’t willing to bend the rules like that and we missed out on more than a few deals along the way…
What are some of the major repairs do you think you’ll need? On ours we did:
partial re-roof
brand new siding (that was HARD to do ourselves)
new AC (hired someone for that)
new kitchen appliances
new sinks/vanities/tile repair in bathrooms…
Not to mention the aesthetic stuff like bringing fixtures and style up to date.
plantingourpennies– Thanks for stopping by! I didn’t have problems with investors bending the rules. My biggest problem was dragging my feet and wanting to “think about it for a while”. I would say this cost me between 4-6 opportunities. I finally accepted that if I found a property that met my requirements I needed to make an offer. That is what happened with this one. I looked at it several times over the weekend and had a showing on a Tuesday. I left the showing and an hour later made an offer.
The updates are very similar to what you have listed. Doors and windows are at the top of the list followed by vinly enclosure around the soffits and on the front of the house where there is no brick. I need to have the drivway poured and will make the front porch much smaller and take down the wood railing. Adding a privacy fence and deck in the back along with replacing the hot water heater and possibly the HVAC system. Hell, it would be easier to just say everything! 🙂
I think I have a good mindset going into this and I’m not worried about doing a quick flip. I want it to be a nice home for me as well as the future buyers.
wow, that’s a pretty nice return! Great job on finding the deal. I might have missed it, but where is the property located and how did you locate this killer deal?
This is in Ky. Real estate here is similar to what you were looking at in Indiana(?). When I see some of the prices of RE in Cali. it makes my stomach turn. Amazing how prices can be so different in various parts of country.
This was a HUD foreclosure and I found it on one the of the RE search engines. Usually I will find something online that I like and go look at and see if it is in a good area and how much work needs to be done. I looked at this one on a weekend and had the RE agent show it on a Tues. and made an offer the same day. There are plenty of opportunities around here in just about every price range you can imagine. I would love to have more cash to do another deal… I’ll figure something out.