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When it comes to real estate investing, there are many different ways to earn income and build wealth, but I would like to cover what I believe are the three best real estate investing strategies; wholesaling, fix and flip, and owner financing.
I've done many deals over the years, and these 3 strategies are the most common.
Unfortunately, late night infomercial gurus make people believe that they have some proprietary magic formula to do profitable deals, but here's the reality about real estate:
There are only a handful of ways to structure a deal. Anyone can learn how in a few hours. The real profit in real estate is made by hustling and creating solutions for motivated sellers. That's it. No magic sauce. Just good old hard work and problem-solving.
With that said, let's jump into the 3 best real estate investing strategies:
This strategy is particularly attractive to new investors as you don’t need a lot of funds to start. This strategy also requires less work compared to a fix and flip.
Wholesaling is where you find great property investment deals for other potential buyers. In return, they pay you for your service through a flat fee or you purchase and on-sell the property to your buyer for a profit.
There are many ways that a wholesaler can run their deals. However, as an example, while you are driving, you may see a house that has overgrown weeds, boarded windows and is clearly not being looked after. You do some research and find out who the owner is and send a letter, offering to help them get rid of the house in return for the money that they want for it.
The owner contacts you back and tells you they want $30,000 for it. You sign an agreement with the owner stating that either you or someone else may buy the house for $30,000 within 14 days.
You get to work contacting your network of active flippers and find Gary who is interested in the deal.
You work out the numbers and you and Gary believe that he can make the profit he desires if he were to buy it for $35,000, rehab it and flip it. You assign your contract onto Gary and your title company helps organize the closing.
The owner gets the $30,000, Gary gets his deal and you are rewarded with $5,000.
To find copies of contracts that you can use, you can use ones from your local realtor association, title company, Staples or OfficeMax or even find them online at websites like Tidy Forms and Law Depot.
To be successful in wholesaling, you need to be great at these skills:
- Communication with people in distressed situations
- Estimating real estate numbers and profits
Fix & Flip
Fix and flips have become extremely popular due to popular rehab TV shows which show rehabbers raking money in easily.
According to data released by RealtyTrac, the average gross profit in Q2, 2015 increased from $67,753 to $70,696. In other parts of California, these profits can be higher than $200,000.
While it is true that you can make more money from a fix and flip than from wholesaling, you will also have to deal with more stress, competitive rehabbers and the possibility of unforeseen expenses.
If you are just starting out, it’s advisable to have at least one year’s expenses saved up to cover unexpected delays or unexpected expensive repairs. You will also need to build an excellent team around you including subcontractors, realtors, a title company, an attorney and an accountant.
To be successful as a house flipper, you need to be able to estimate repair costs accurately prior to making an offer or have a subcontractor who can do it for you. Often this comes with experience but you can get a rough idea through a website like HomeAdvisor.
The general principle being thrown around in real estate circles is that you should only make an offer at 70% or less of the After Repair Value (ARV).
Your profit will be what is left over after you have taken out the purchase price, repair costs, holding costs and agents commission.
The simple formula is ARV – Purchase price – Repair costs – Agents commission = Profits.
However, depending on what markets you are in and how competitive it is, you may find that you need to offer more than 70% ARV in order to win the deal.
Create friendships with realtors who will give you access to the real estate multiple listing service (MLS) so that you can check comps and get an understanding of property prices. You will also be able to look for deals through the MLS. In return, after you finish the rehab, the realtor can sell it off for you for a commission.
Some rehabs only require cosmetic improvements but it is often acknowledged that you should focus on the popular ‘money-making’ areas of a house including the kitchen and bathrooms.
Increasing curb appeal through landscaping and new external paint is also a good return for money. Remember to rehab the house for your potential buyers’ preferences, not yours. DIY network has some good videos to show you how to do-up different areas in a home.
If you are unable to get a loan from a bank, try to look for owners who are willing to enter into an owner financing arrangement with you. Not only are owner financing arrangements less strict than banks normally but you also get the opportunity to negotiate the terms with the owner in a way that suits you both.
Owner financing is where the owner takes on the dual role of both seller and lender by extending credit to the buyer to purchase the house. The buyer normally makes a down payment and makes regular installment payments at an agreed higher interest rate over a period of time until the loan is fully paid off. If the buyer defaults on the payment, the owner keeps the house.
There are several types of owner financing:
- All-inclusive mortgage aka promissory notes- this is where the owner finances the entire purchase price.
- Junior mortgage- this is where the owner only finances part of the purchase price. This normally applies in the case where you have some funds but not the full amount needed to buy the property.
- Land contract- in a land contract, you only get the equitable title but not the legal title to the property until you complete payments.
- Lease options- You lease the property like an ordinary rental but the owner also promises to sell the property to you within a specified time period. Your rental payments will be credited against the purchase price.
- Assumable mortgage- Normally, you won’t be able to do owner financing on a property which still has an outstanding mortgage on it because banks normally want their loan paid off before it can be sold to someone else. However, there are some special FHA, VA or conventional adjustable mortgage rate loans (ARM) that are assignable which means that you can take over the owner’s existing mortgage.
Why would an owner want to provide owner financing to you? There could be several reasons. The owner may be persuaded to provide financing because he or she has been unable to sell the house at the price he or she wants.
Secondly, the owner may not need the money immediately and if you could offer a guaranteed payment with attractive interest, the owner may prefer that rather than getting a lump sum of money that sits in the bank for a low interest rate. There are also tax breaks that he or she could benefit from, in that he or she only declares the installment payments received in the calendar year.
For more information, the National Association of Realtors has a Field Guide to Seller Financing.
Every strategy has pros and cons and at the end of the day, you need to choose one that suits you, your personality and your goals. But regardless of whatever strategy you choose, go at it hard!