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FLIPHOW TO FIND, FIX, AND SELL HOUSES FOR PROFIT
By GARY KELLER RICK VILLANI CLAY DAVIS
McGraw-Hill, Inc.Copyright © 2007 Rellek Publishing Partners, Ltd.
All right reserved.
Chapter OneDefine Your Target
After reading this chapter you will know how to
* Target investment neighborhoods
* Determine what elements make a good target neighborhood
* Select the target neighborhoods that are right for you
Would you buy investment properties in Kathmandu? Unless you live in Nepal, you probably don't have to think too long about your answer. And if someone pressed you for an explanation, it would be easy to come up with some practical reasons why not: It's too far away. It's too difficult to travel there. And what do you know about the Nepalese real estate market, anyway?
When successful real estate investors make decisions about where to search for investment properties, they apply some of the same reasoning you just did in ruling out Kathmandu.
In this chapter you will learn how to use a set of tried and true targeting criteria to determine the target neighborhoods that will give you the best profit potential for flips. In essence, you'll learn how to create a personal house-buying bull's-eye.
Defining target neighborhoods is a two-step process. In the first step, you'll identify the various factors that go into evaluating a neighborhood. We call these factors your targeting criteria. Some will be proven investment criteria; others will be more personal criteria. In the second step, you'll apply the criteria to choose your target neighborhoods (Figure 1-1).
Targeting neighborhoods helps you focus your resources so that you can find the best possible investment property leads. Those efforts can be time-consuming and costly—all the more reason to identify and target the neighborhoods with the greatest potential for success (Figure 1-2).
We can't emphasize enough how important it is to target neighborhoods and become an expert on the properties found in them. Your decision making will be clear, confident, and quick. Even the best investors sometimes make avoidable mistakes when they invest in areas with which they are not familiar.
We've learned this lesson firsthand. We once bought a house that was literally just a few hundred yards outside one of our hot target neighborhoods where we'd done about a dozen rehabs. We were able to get the house at such a low price that we thought we'd have no problem making a good profit. But we didn't do our homework—the house was across a major highway. The rules that governed our target neighborhood simply did not extend to this area. Selling prices were falling and nicely remodeled houses were nonexistent. Eleven months later, the house finally sold resulting in a profit of less than $1,000.
WHAT MAKES A GOOD TARGET NEIGHBORHOOD?
It's worth pointing out that we're not necessarily talking about "hot" neighborhoods that are increasing in value rapidly. Flipping houses is primarily about buying at a great price and adding value with well-chosen improvements. If you also benefit from the appreciation of the house's value during the time you hold it, that's an added bonus. Just remember that if you rely on appreciation to make your profit, you are acting like a speculator, not an investor. As an investor, when you look for investment potential in different areas, you'll consider a variety of factors. The six most important ones we call The Six Neighborhood Targeting Criteria (Figure 1-3).
It is important to keep in mind that during the weeks or months that you're working on an investment house, you'll probably need to be there on a regular basis. Choosing a house in a distant neighborhood will take a toll on your ability to monitor or participate in the rehab. If you have the flexibility and free time to travel across town—or even across the country—by all means, go for it. But if you don't, you should absolutely consider keeping your projects close to home.
2. SELLING PRICE
Flipping an expensive house certainly has the potential to be more profitable than flipping a less expensive one, but it takes more money. You need the capital not only to purchase the home but also to fund the high-end rehab improvements. And these improvements take time, during which you'll have to pay taxes, insurance, interest payments, and other holding costs. There are people who will lend you money to flip a house, but there's a limit to how much you can realistically borrow (we'll cover this in the Buy stage). You don't want to waste time focusing on neighborhoods where the average price is beyond your ability to purchase, hold, and improve a property.
In contrast, the investment challenge in low-end markets lies in being able to buy the property, do the required improvements, and still have a margin of profit that makes it worth the risk. In addition, there tends to be a much smaller pool of interested and qualified buyers for these low-end homes.
One of the biggest factors in maximizing your profits on a flip is how fast the house sells: Every day you hold a house costs you money. Ideally, you want to sell the house in three weeks or less. So everything you do and every decision you make is geared toward the outcome of a quick sale. In general, the more potential buyers there are, the faster a good house will sell. You'll have the largest number of potential buyers if your house is near or just below the median home price in the area (Figure 1-4) and that is a great price point to target.
3. SALES ACTIVITY
The desirability of a particular area of town can be measured quantitatively by analyzing current housing sales information. Sales activity is a great indicator of a good target neighborhood. Houses just seem to sell faster in some sections of town, while for-sale signs linger in others. In this section, we'll explore the data that will help you understand what makes these neighborhoods attractive to buyers and which can help you determine whether a neighborhood is desirable for real estate investing.
To evaluate current sales activity in a neighborhood thoroughly, you probably will need a real estate agent, who has access to your city's Multiple Listing Service (MLS), to run some reports for you. The MLS is a membership database service developed by and exclusively for licensed real estate brokers and their agents. A good real estate agent will be an invaluable member of your team. In general, real estate agents like working with investors because serious investors buy and sell multiple houses in shorter time frames than most home buyers. Every business loves repeat customers.
The MLS data will provide a detailed picture of what has transpired over the last year or so in terms of market activity in your target neighborhoods. Figure 1-5 shows the nine key areas of information you can ask a real estate agent to investigate about the houses for sale or that have sold in a particular geographic location. When you see sales activity or a lack of it, you will want to understand the cause behind it. These nine areas should provide that insight.
You want to invest in neighborhoods where a fixed-up house won't sit on the market for months. When you target a geographic area, you'll want to have a good handle on which houses are for sale and why they haven't sold, as well as which ones have sold and why they did. The MLS can provide important underlying data about this sales activity, such as the number of houses on the market and how many are pending for sale and/or have been sold in the last year. In addition, you can see the average number of days these houses were on the market before they sold. In an active neighborhood, houses can routinely sell within a few weeks. In an inactive neighborhood, homes can stay on the market for months.
One particularly interesting bit of data you can gather from the MLS is the selling price per square foot (a 1,000-square-foot house that sold for $100,000 had a sales price of $100 per foot). Why? Selling price per square foot gives you a way to compare the relative value of houses of approximately equal size. For instance, when two houses of similar size are priced very differently, you will want to understand what is causing the difference. This may indicate an investment opportunity.
Specifically, you're looking for neighborhoods with two clusters of house values: a group of homes that sold for a relatively low price per square foot and another group that sold for a higher price per square foot. The first group represents your pool of potential investment properties; the second group indicates that there could be a market for flipping houses (see Figure 1-6).
For example, a neighborhood with a group of homes that sold at $100 per square foot and another group that sold at $200 per square foot looks attractive. The range of $100 per square foot means that some 1,000-square-foot houses are selling for $100,000 whereas other houses the same size are selling for twice that price.
A quick word of caution. If there is no group at the high end, you need to consider carefully whether you want to be the first investor to push the limit on price per square foot in the neighborhood. If you find that there aren't many houses with a relatively low price per square foot, you may want to consider whether other investors have been there before you so that now the opportunities are limited.
The age of a house can be a plus or a minus. If a house is too old, the repairs may be too expensive. On the other hand, a house in an older, established neighborhood is likely to have been owned longer, and that can translate to higher owner equity. This makes it easier for the owner to sell for less than market value because he or she has paid off a substantial portion of the mortgage. If a house is too new, there might not be enough opportunity for improvement and the owner may not have built up enough equity to accept a lower offer.
Here are some general rules of thumb to follow when targeting neighborhoods by age for flipping potential:
* The houses should be older (twenty-plus years is best).
* Some of the houses should show signs of aging. This includes dated or distressed paint, siding, fascias, exterior trim, roof, doors, windows, garage doors, driveways, walkways, fencing, and the yard. These are your opportunities to improve.
As you evaluate a neighborhood on the basis of its age, you'll always need to balance the benefit of increased owner equity with the risk of the extensive repairs that often are needed in aging homes.
One of the most important investment criteria is the general appeal of the location. In short, you must invest in neighborhoods where people want to live. We are talking about finding neighborhoods that are family-friendly; are close to retail, office, and recreational areas; and have schools with good reputations.
Remember, the adage "location, location, location" never loses its truth. The same type of home in a great neighborhood versus one in a less desirable neighborhood always commands a higher price.
You'll want your target neighborhoods to have as many as possible of the factors shown in Figure 1-7.
There are two safety issues you will be concerned about: yours and your future buyer's. You should really consider your personal safety when targeting a neighborhood since you may be spending a lot of time there, often at odd hours. When you are working on a house, there may be times when you don't have proper lighting or locks on the doors (or even windows), so choose neighborhoods where you are comfortable working after dark, especially if you are going to be an active participant in the rehab. Besides, if you don't want to be in the neighborhood after dark, your potential buyers may not either.
IDENTIFYING TARGET NEIGHBORHOODS
There's an old joke about how easy it is to sculpt a horse out of a block of marble: First you get a block of marble, and then you chip away everything that doesn't look like a horse. Think of targeting neighborhoods as starting with a big mass—all the available properties—and then removing all the neighborhoods that don't look like they would have investment houses.
We have created a mapping exercise that we use called the X-it strategy. It's a process of X-ing out potential areas to narrow your investing field to the neighborhoods that meet your targeting criteria.
Before we begin this exercise, you will need the following supplies:
1. A map of the city you'll be investing in
2. A pencil and a highlighter or colored pen
First, open the city map on a table. Then take the colored highlighter or pen and divide the different zip codes, subdivisions, or neighborhoods. Many times, you can find a city map divided by real estate areas in the real estate section of your local paper or on a real estate Web site that serves your area.
Now take your pencil and mark the points where you live and work (or any other place you go to on a regular basis). Then indicate the distance you are willing to travel to handle your investment properties by drawing a boundary around those points. The size of the boundary is up to you. Be sure to consider the traffic during the time you're likely to be traveling.
Next, with your pencil, X out all the neighborhoods that don't fit your proximity range.
Now take a look at each neighborhood within the boundaries and X out the ones that don't fit your other criteria. Is a neighborhood too pricey or too cheap, unsafe, too new, in a bad location? This will take some time and research because you will be applying your targeting criteria to each neighborhood.
The map in Figure 1-8 shows an investor in Austin, Texas, who works downtown and lives in North Austin. Although there are great investment neighborhoods to the east and west, she X-ed out most of them because it's too far to get there. She also marked out four areas within her proximity. Two areas were too pricey, and the other two she excluded because of low sales activity.
After completing the exercise, you should have a clear visual representation of which neighborhoods are ripe for rehabbing. These remaining neighborhoods will be the focus of your lead generating efforts, which are the topic of Chapter 2.
Chapter TwoGenerate Leads
After reading this chapter you will know how to
* Prospect: search for investment houses
* Advertise: attract motivated sellers
* Network: connect with people who can connect you to houses and sellers
You can't invest until you have available properties to evaluate and consider purchasing. Information that helps you find these prospective properties and their owners is called leads. To succeed at flipping you must have leads and, to succeed at a high level, you'll need a lot of leads. The process of generating leads is the irrigation system that keeps your investment potential growing. Without a constant flow of leads coming in, your flipping business can dry up in a flash. We live in Texas, where it's hot and dry four months of the year. Keeping your lawn green can be a challenge. If you don't water it for a couple of weeks, it can take a lot longer than that for the lawn to recover. It's the same with house flipping: A healthy flipping business requires a frequent and consistent influx of leads.
Simply put, a lead is any information that "leads" you to a potential investment property or a potential seller of a house. It can be an address, a personal contact, or a name on a list. Leads create opportunity, and if you make a commitment to generate a healthy volume of leads, your flipping business will flourish.
The techniques we describe in this chapter represent what it takes to create a substantial enough flow of leads to support a fulltime house flipping operation. Obviously, when you're looking for your first flip, you'll focus on just a few of these lead generating activities. Done frequently and consistently, they will yield you the leads necessary to identify your first rehab project. From there, you can ramp up your activities if you choose to grow your flipping business. The choice is yours.
The important thing to remember whether you go big or stay small is the techniques are the same—it's just a matter of adjusting the volume to suit your needs. We group lead generation into three fundamental activities: prospecting, advertising, and networking (Figure 2-1).
Excerpted from FLIP by GARY KELLER RICK VILLANI CLAY DAVIS Copyright © 2007 by Rellek Publishing Partners, Ltd.. Excerpted by permission of McGraw-Hill, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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