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Making Money With Fixer Upper Homes

By - 2013

This page will cover how to buy at the right price when purchasing houses that can be fixed up and sold, what to fix for maximum gain, and some tips on preparing for the sale. Making profits with fixer upper homes can be about repairing drywall and planting flowers. But it is also, and more importantly, about knowing the numbers, so we will start there...

The Fixer-Upper Formula

In Tucson, Arizona, in 2006, I met a man at a real estate seminar who had been working on a fixer-upper for two years. He had been paying interest the whole time on the credit cards he used to buy the property. His story is a good example of what not to do.

He had no real plan. He just thought the house was cheap, so he bought it. He guessed at the time and money it would take, and underestimated both by a large degree. Worse, he had the unfortunately common idea that he would figure what he had into it when he was done, and then add some amount as a profit to arrive at his selling price.

We moved shortly after this, and around that time the market started its years-long slide, so although I don't know the rest of the story, I assume it did not have a happy ending.

Now, here's a question for you: Would you pay more than a house is worth just because the seller had put more money into it than he should have? No, of course not. The value of a house is not determined by how much money someone has spent on it. The market, meaning the prices of homes recently sold and (to a lesser extent) the current asking prices of similar houses determines the value. If you have $120,000 into a fixer-upper and similar homes are selling for $100,000, the latter amount is all you'll probably get.

And by the way, making money in a fixer-upper isn't about whether you can paint or do plumbing. Paint if you want, or pay others, but either way, making money in real estate is all about understanding the numbers. Here's a formula a friend of mine has used to make hundreds of thousands of dollars in fixer-uppers.

1. Find the probable after-repair value.

Always start at the end (the eventual sales price) and work your way back. This is the right way to safely invest in homes you'll be repairing and selling. To determine how much it will sell for when you're done fixing it up, don't look too much at asking prices of similar homes. It is good to know what the current competition is asking, but what the homes might be selling for a lot less (or even more) than the asking prices, so look at the actual sales prices.

A real estate agent might help you with information on what the house should sell for when ready, but you can find most of the information you need online now. In fact, if you search for "recently sold homes" plus the name of your city, you'll find a few good resources (Trulia.com seems to have the more recent sales, while Zillow has sales from years before, so watch those sale dates). To get more scientific about it -- and you should -- see our page on how to determine fair market value.

You could hire an appraiser, but you are looking for the market value of the house when it is done, and an appraiser may or may not want to offer an opinion on that. In any case, in my experience appraisers are mostly just facilitators of deals; they tend to look for justifications for assigning a value that is close to the contract price. This determination of the probable sales price is the most important part of the process, so it pays to learn to do it yourself.

2. Calculate all probable expenditures.

There are four basic categories of expenditures you'll have.

Buying costs: inspections, appraisals, closing fees, title policies, document preparation, filing fees, etc. You should know these fairly precisely before making the offer.

Carrying costs: interest on loans, property taxes, insurance, utilities, etc. These should be estimated for a worst-case scenario, like holding the property for six months if you think it will be three.

Repair and improvement costs: Unless you are very experienced in estimating contract work, get bids. You can guess when you first write the offer, if you leave a way out, such as making the offer "subject to inspections and buyers approval of the results of those inspections." Then get bids by the deadline for the contingency or hire an exterior inspector who can estimate the costs of your planned repairs and improvements.

Selling costs: commissions, advertising, closing fees, document preparation, title policies, filing fees, transfer taxes, etc. These should be easy to estimate.

Unexpected expenditures: How can you estimate what is unexpected? Experience helps, since this varies with the type of properties you choose to deal with, but assume there will be some surprises, and budget a minimum of $1,000 for these.

3. Choose your profit.

That's right, you have to decide what kind of profit makes it all worth your while. Real estate is full of unknowns, and you will have some work to do just finding a deal, so I wouldn't do it for less than $10,000, but that's up to you.

4. Subtract your probable expenditures and profit from the projected sales price.

Now you have the highest price you can pay for the house. Walk away if you can't get it for this price or less. Offer several thousand less, of course, to give yourself negotiating room.

An Example of the Process

Suppose you find a fixer-upper home and determine you can get $138,000 for it when done, based on sales of similar homes in the area. The buying costs will be $2,000. Carrying costs will be $3,500. You get repair estimates of $8,000. The sales commission will be about $8,300 (6% of the sales price). Other closing costs will be around $1,200. Throw in $1,500 for "unexpected" costs. Finally, you want $14,000 for your effort (your profit). This all adds up to $38,500.

Subtracting that from your expected sales price an you arrive a figure of $99,500. This is the most you can pay if you want a safe real estate investment with a shot at making a $14,000 profit. So you offer $97,000, and walk away if you and the seller can't settle on something under or around $99,500. To summarize:

- Determine the projected sales price.

- Subtract all costs and profit.

- Pay no more than that amount.

For information on how to finance deals like these, read the article on hard money lenders.

What to Fix for Maximum Profit

Let's say you're going to buy a house, a fixer-upper you can make some money on. What improvements and repairs should you make? This is something you should mostly determine before you buy, since that is the only way you can properly run the numbers to arrive at the maximum price to pay. But before and after you buy you need to have some simple rules with which to start analyzing possible fixes.

Return on Investment

Decades ago, when I briefly worked as a real estate agent, I was sitting in the home with the owners, a young couple, discussing the sale of their house. They were very disappointed when I told them it was worth $110,000. "We just put $40,000 into remodeling the kitchen!" they told me. I looked at the kitchen again. It was nice. They had added perhaps $10,000 in value to the house by spending $40,000. This is a classic example of a bad return on investment.

With fixer-uppers, you have do things which give the most "bang for the buck." Aim for a at least a two-to-one return on improvements. If you're going to resurface the driveway for $1000, it better raise the value of the home by at least $2,000. Even when you're just guessing (sometimes that is all you can do), keep this two-to-one formula in your head if you want to invest safely.

With things like new curtains, you can't really estimate the increase in value. What you can do, though, is group together the many small repairs and improvements you are considering, and imagine how the house will look when you are done. Then you can estimate whether you will have increased the value enough to justify the cost.

It often is in the small details that you'll get the best return on investment, so look at these first. You could add a new mailbox, have flowers on the porch, rake yard and trim the trees for $30 total if you do the work yourself, and that could make a big difference in the first impression potential buyers have. First impressions are important.

Other small investments that pay big include shiny new light switch covers (less than $1 each), shelves, a birdhouse, new doorknobs, new light fixtures, curtains, new rocks or wood chips on outdoor paths, new faucets, new wood stain on decks, and general cleaning. Stand in front of the house and imagine what it might look like with various small improvements (flowers, wood-rail fence, birdbath, etc.).

The Big Fixes

Obviously, there are things that just have to be repaired to sell the home. The basic systems must function. Improvements, though, should be subject to the two-to-one rule. You may have to get creative here. An investor friend of mine once had one wall put up to seperate part of the basement from the rest, added carpet, and for a little over $1,000 created a new bedroom, probably raising the value of the house by $8,000. Now that's a good return on investment.

Bathrooms and kitchens are important. A $1,000 updating of a bathroom might add $3,000 in value to a home. Spend $2,000 wisely in the kitchen (re-finish the cupboards, add a garbage disposal, etc.), and you can add $7,000 to the sales price of the house. Look for changes which are the most universally valued (in other words don't paint the kitchen pink just because you like that color), to get a decent return on investment.

Depending on the home, there are many potential improvements that can be worth doing. These include adding a carport, new doors, fences, gazebos, sheds, painting, carpet, benches, a new closet, a new toilet, a new stove, a shower/tub surround, and trees or bushes. The bottom line is the bottom line: be sure anything you do returns more than you spend, preferably at least twice times as much.

Why Fixer Uppers?

Homes with problems have some advantages over other investments. One big one is that you have more control. If you see that expenses are mounting, for example, you can take over some of the work to avoid the costs of contracting it out. If you have time (maybe the best time to sell is still months away) you can shop for quality used appliances and even get items like cheap, decent, used countertops from rehab stores.

If the market is uncertain, there is another advantage of fixer uppers, which is that when they are turned around quickly they aren't so affected by falling prices. Suppose average prices fall 5% in the five months you own a home, for example. You're still okay if you're selling for 20% more than what you've invested.

Flexibility is another advantage. You'll buy cheap because of problems the house has, of course. Then if you resolve those problems efficiently, you can always rent the house for decent cash flow if you decide to wait to sell when the market gets better.

More Fix and Flip Tips

In good times and bad someone is making money in real estate, and with that in mind, here are some tips to help you make money with those fixer upper houses.

1. Create Great First Impressions

Often the first thing a buyer sees when coming to look at your house is the mailbox. The good news here is that it's also one of the cheapest things to replace, so never have an ugly mail box in front of your house when you sell it. Get a new one if necessary, and have the address of the property clearly showing on it to help people find the house. You might also plant a few flowers around it can help with that first impression.

2. Cheap Landscaping Options

Think of several possible plants and flower options that would more or less equally improve the appearance of the front yard or any parts of the property that are easily visible from the street. With those possibilities in mind, buy the ones that are cheapest at that moment you go to buy them. Have a plan, but avoid getting fixated on one idea, or you may pay more for landscaping that is no better than the alternatives. Keep in mind that if you sell for the same price in the end, every extra dollar you save along the way is a dollar more in your pocket.

3. Review Your Hazard Insurance

After you complete renovations you should increase the coverage on your property. A fixer upper you insure for $140,000, for example, could be worth $210,000 when your renovation is complete. You will be under-insured if you don't boost that coverage. The cost of raising the coverage is minimal compared with what you will lose if there is a fire or other disaster while you are waiting for a sale.

4. Prepare for the Unexpected

Budget for unexpected costs with fixer upper houses (and any real estate investments). As mentioned above, you should include at least $1,000 for "unexpected costs" in your planning. Even after the most careful planning and doing dozens of rehabs, one investor I know averaged expenses of $3,000 more that he estimated for his projects. Expect the unexpected with real estate - and plan for it.

5. Remember Holding Costs

Time costs money in real estate. You have to pay taxes, insurance, interest and utilities for every day you have a house. When working on a fixer-upper take that into account. Suppose your holding costs are $240 per week, for example. In that case it might not make sense to wait several weeks in order to get that "bargain" painter to work on your house if that's going to mean selling it later.

6. Update Your Education

Sit down at the local bookstore and look through the real estate books. It's is a great way to keep up on new ideas for your fixer upper homes and for real estate investing in general. Do this while actively investing and your unconscious mind will tend to guide you towards the books that can help you with your current challenges. Buy a few books that you think you'll refer back to later.

Here on the site we also have a free online book on how to sell a house, which, while aimed at selling owner-occupied homes, still has some good tips for investors too.


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