Evaluating a big fat juicy deal
How many of you romance the idea of getting that big juicy deal that nets you $75,000 or more in profit? I know I do.
Logic dictates that in order to get bigger profits like this, you’re going to need to work with houses at higher price points. Right?
Well, it just so happened that we got a call last week on a house that looked like it would be just that — a big fat juicy deal. Needless to say, our whole team got excited.
This week I’d like to tell you about this house, walk you through the numbers and then let you determine if it was a good deal or not.
The house in question was big — like 3,600 square feet of living space big. It featured five bedrooms, three full baths and was nestled on three acres in the city limits of Calhoun.
When I say three full baths, that doesn’t quite do it justice. The master bath had three different chambers. The first had a commode, a bidet and a large vanity in it. The next room had a L-shaped his and hers vanity with a massive master closet built in. And the final room had a larger-than-normal jetted tub as well as a stand-up shower. The square footage of this one bathroom was more than many master bedrooms in the houses we deal with.
The seller’s situation was it was their primary residence for many years. They decided to move to another property and had rented this one out to the same tenants for the past 10 years. The mortgage payment, however, was more than the rent rate, which made for negative cashflow on this house. That was OK, because our sellers where high-income earners and used the loss to offset their income for tax purposes.
This past year, however, the husband passed away and the wife was left with a house producing negative cashflow. On top of that, the tenants gave notice they were moving. At that point, our seller was having to pay the entire mortgage payment, and also come up with enough money to deal with 10 plus years of deferred maintenance, which she didn’t have.
She sounds like a potentially motivated seller, right? She did to us — especially when she was saying things like, “I just want this off my back.” With all that in mind, let’s delve into the numbers.
We believed this house would conservatively sell for $400,000, and there was an outstanding mortgage balance of around $200,000. Buying a house for close to 50 cents on the dollar ain’t bad, right?
Next, the house was pretty sound, but did have some uneven floors. That being said, the rehab would mostly have been paint, floor coverings, landscaping and some minor updating. But still, since the house was 3,600 square feet, a minor rehab would easily have cost $75,000, which is only $20 per square foot.
Now, let’s do the math. Our formula for evaluating a deal looks like this:
Conservative after repair value (CARV) – rehab – closing costs – purchase cost = our gross profit.
$400,000 – $75,000 – $44,000 (11 percent of sales price) – $200,000 = $81,000 gross profit.
Is that deal? Well hold on. We left out a big cost — the cost of money.
To buy this house we were going to need close to $300,000, which would include the purchase price, rehab, holding costs and any “oops” that could occur.
If you could get a hard money loan for one percentage point and 12 percent interest only, your cost of money would be $39,000 if it took you an entire year to flip it, which is not an unreasonable time frame for a house this big.
Taking that into consideration, the cost of money just reduced your profit to $42,000. And since it took you a year to make it, your profit was $3,500 a month. And that’s assuming no big surprises during the rehab. That’s a lot of risk for that kind of money.
So, the moral of this story is just because the house is big with a fat price point, doesn’t make it a big fat juicy deal. Bigger houses cost more to fix and take longer to sale. And those two factors will kill your profit.
Joe and Ashley English buy houses and mobile homes in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.