Fundamental for making money in any endeavor is to buy low and sell high. In a real estate context, this means that you must find property that you can sell for a higher price. While some real estate investors do speculate in markets with rising real estate prices, this is a challenging proposition most often met with failure. For most real estate investors, the road to riches is paved with finding cheap properties, which are purchased and then sold for a higher price. This necessitates the question: where do I go about finding cheap properties to sell?
It’s important to first define what cheap means. For each individual investor, cheap is a different absolute dollar figure, far different for say, Donald Trump, then the average public school teacher. The relative definition of cheap for each investor is based on their existing finances (including how much financing they can obtain), their risk profile, their definition of a reasonable return, and their investing goals.
Cheap is also defined as property considered undervalued. Valuation is based on a property’s historic and current underlying market price, especially as relative to assessments of the property’s underlying value. These other assessments can come from professional appraisals, comparable market analyses (CMAs), discussions with real estate brokers, and online home valuation tools. A property on the market for $300,000 – ten percent less than it is appraisal value may be considered cheap by one investor. But to another, given the estimated costs of the property’s needed repairs, the property may still be expensive. For another investor, who can only obtain $250,000 in financing, $300,000 may be expensive for an investment property.
In short, whether a home’s price fits your definition of cheap, or otherwise worth your time and money is ultimately a decision you must make based on your own criteria. However, real estate investors have traditionally found properties they consider undervalued using a few common methods.
In this article, we will cover these methods including, 1) finding fixer-uppers, 2) non-traditional locations, 3) online searches, 4) short sales, 5) foreclosure sales, 6) building your own house, 7) HUD housing, and 8) obtaining a discount through negotiations.
The term fixer-upper typically applies to a residential property in need of significant repair before it can be either occupied and/or sold. Often, but not always, fixer-uppers are undervalued, as they are usually sold at a discount relative to neighboring property prices. But one must calculate the cost of repairs in determining a proper valuation.
It is critical to get a reliable contractor you trust to look at these kinds of properties, especially if you are not a contractor yourself. Often, getting a contractor’s opinion early can save you multiple headaches down the road. It is important to develop a relationship with a contractor who you can trust not to gouge you, for just this kind of assessment. However, once you establish that you are buying multiple properties and therefore the contractor will likely have a steady string of jobs from you, he or she will be more likely to be a reliable voice when you conduct pre-purchase assessments. Use defects in negotiations to help drive the price you pay down.
Remember, that in assessing the potential ROI of a fixer-upper you must also estimate the opportunity cost of the property. How much time will you sink into? Could you have spent that time on another, more lucrative investment? For example, if you estimate that a nearby property can be rehabbed and flipped in two months for a seven percent return, all other things held constant, does it make sense to spend three months on a property that will return eight percent? Keep in mind that these are estimates. A good contractor on hand might be able to tell you that the former property has structural deficits that has a fifty-fifty chance of taking either two months or four months or more, whereas the latter will take at most three months, knowledge which will almost certainly influence your final decision.
If you plan to flip the property within a couple of months, then a property in extensive need of repairs is probably not for you. Properties requiring light or cosmetic renovations are not considered traditional fixer-uppers. But whether your time-frame is two months or twenty months, make your renovations with an eye towards the market. Look at comparable properties in the neighborhood by attending open houses, searching online, and talking to real estate brokers. Determine what features sold and what buyers are looking for. Make sure that your improvements are in line with those insights. For example, if multiple buyers have expressed a preference for stucco countertops, and several houses featuring them have sold recently, then install stucco countertops. Make sure if your time frame is longer, that your renovations are in line with what you expect to be in demand when you plan to sell. The home improvements that universally increase home value, most experts agree, are kitchen renovations.
Look in non-traditional locations. Areas with lots of new developments and rising housing prices are the obvious areas to look. Other investors are looking there and likely driving prices up. Check out locations that are off-the beaten path for cheaper prices, such as surrounding cities. The Midwest and Southeast are good markets for relatively cheap real estate.
Areas with large numbers of distressed properties, foreclosures, and fixer-uppers may be an option, although often these areas are marked with other undesirable features, such as crime, blight, and schools underfunded by the area’s low property tax rates. This may depress the price of your property even if you make improvements. You should assess the local government’s efforts to revitalize the area, as well as any developers who plan to build in the area. You should also determine whether there is an influx of residents in the area. Any and all of these are indicators that the area may be headed for an upswing. But make this determination before you make any purchase in this area and be planned with more than one exit strategy.
Where is America’s cheapest real estate?
One of the first places people begin to look for any products or service they plan to purchase these days is the Internet. It’s no different with real estate. But where to start? Should you just Google cheap real estate and scroll through the results? Or maybe check Craigslist and hope you can find something in your price range?
No. Unless you are looking to surf through tens of millions of websites and online ads, you should be strategic in your online searches. Start with web sites of real estate brokers in your target area(s). Check the websites listing short sales and foreclosure sales in your area (see below for more information on both). Also look for online notices of public auctions. Death notices and divorce settlements are other notifications to keep an eye out for. It may seem macabre, but often moves accompany the passing of individuals and the dissolution of marriages. Another place to look is Multiple Listing Services – a list of all of the homes listed by local Real Estate Board brokers. Properties that have been on the list for a long-time or have expired unsold, may be those for which the seller may be willing to accept a lower price. You can also place online ads listing your criteria as an investor and may receive calls from brokers and/or sellers with listed properties that meet them.
Any online search should be complemented by an in-person visit. No matter how extensive an online tour of the property is, it cannot compensate for the details you will observe when you are actually inside the property. Moreover, have a contractor and/or engineer attend with you to ask the questions you may not.
Short sales are sales wherein the property in question has liens levied against it totaling an amount that the sale of the property will not satisfy. Such a purchase requires a careful analysis of whether the costs are offset by eventual profit (through either rental income or sale of the property at a premium). However, many short sale properties present a solid opportunity for real estate investors. Despite the connotations of a short sale, these properties do not always require improvements. However, these houses should be inspected as thoroughly as fixer-uppers to ensure there are no hidden issues.
You can find short sales through realtors, and MLS listings, though most will not be readily identifiable as such. You will need to look for listings that include terms such as:
- Subject to bank approval
- Notice of Default
- Give the bank time to respond
- Preapproved by bank
- Headed for auction
The Secret to Short Sales and Foreclosures
Foreclosure sales usually are initiated when the homeowner fails to make three or more mortgage payments to the holder of the mortgage note, usually a commercial or community bank. Foreclosure sales are often in need of repair, as the homeowner who was unable to make mortgage payments, more than likely could not afford maintenance and upkeep. Foreclosure sales are done through a bank, rather than a broker or a seller, which means that not only can the process be impersonal, there can also be a lack of disclosure about the condition of the property. The bank is less concerned with marketing and relationship building than removing an asset from its books. Therefore, careful inspections, by professional home inspectors, are necessary.
You can often find foreclosed properties by talking to realtors who may know of properties before they are listed through their relationships with banks and other lenders. Checking local real estate web sites and filtering by REO, which stands for Real Estate Owned (or owned by a bank), is another good way to find foreclosed properties. To find cheap foreclosed properties, look for REOs that have received no recent offers or activity. You can also check your newspaper to find legal notices of foreclosure auctions.
BUILD YOUR OWN HOUSE
Building your own home is another way to obtain cheap property, particularly if you build in an area with rising or high neighboring real estate properties. It can also be a spectacularly stressful endeavor, requiring more time and money than you initially plan, particularly if you do not have a plan, prior experience dealing with contractors, and/or appropriate capital on hand. You will need to consider, among other things:
- Building materials;
- Location and quality of grocery stores, entertainment, schools and transportation;
- Local homeowners rules concerning new construction;
- Connecting your home to city municipal services such as the water and sewage systems
- Availability of cable and Internet services;
- Quality, history and costs of the builder;
- Passing (multiple) home inspections;
- Insurance; and
- So much more.
A starting point is determining what kind of home you want to build, in as much detail as possible. Then, just as critical, is where you want to build it. If you are building with an eye toward flipping the property, it may be easier to design the property, as you will be looking to build something in line with comparables (comps) that have recently sold. If you are looking to own, rent or, especially reside in, any part of the property you build, it may be harder to separate your vision for the property from what makes the most sense financially. But if you are a real estate entrepreneur, the property you build should be driven by your financial goals, and therefore, should be built as affordably and quickly as possible.
Another source of cheap or undervalued housing is HUD. HUD stands for Housing and Urban Development and is a Department of the executive branch of the U.S. federal government. HUD oversees the FHA (the Federal Housing Authority), a subdivision that insures mortgages for single-family homes, and multi-family properties. When a homeowner defaults on an FHA-insured mortgage, HUD forecloses on the property, and holds a sale of the property to those who will be living in the property as their primary residence. Any properties that fail to sell during this period are offered for sale to investors at auction. These properties are typically considered undervalued because HUD discounts the price by the cost of repairs needed to make the property viable, often inadvertently using cost estimates favorable to investors.
HUD housing, available for sale from a variety of government agencies such as the Department of Veterans Affairs, can be found online on their website. Before investing in one of these properties, make sure you get a proper inspection and estimates of needed repairs. These are, after all, foreclosures, and may be in need of substantial repair. Also, if you plan to flip the HUD property, look at the market prices for comps that have recently sold. Many, but not all, HUD properties are located in distressed real estate markets. Nonetheless, you may be able to find some bargains here.
One way to pay less for the property you desire is through negotiations. Many negotiating tactics translate well to real estate, such as:
- Letting the other party make the first offer – allowing you to keep hidden your price ceiling and floor;
- Staying silent when the other party is talking – letting the seller reveal insights you can use as leverage;
- Learning why the seller is selling;
- Push for further concessions – which subtlety encourages the other party to stop pushing as hard;
- Do not be unnecessarily friendly or familiar – which can project weakness;
- Be okay with potentially losing the deal – which helps you avoid making fear-based decisions.
Of these one of the most important is the seller’s motivation for selling, which may give you leverage. For example, a seller who has recently purchased a retirement home out-of-state, may be in a rush to sell and willing to part with the property than advertised.
Further, a proper inspection by your appraiser and contractors may illuminate unadvertised deficiencies that you may use as leverage to get the seller to lower the price. In general, the more information you have about the transaction, the more leverage you will have and the better you will fare. Many a successful real estate entrepreneur, from Donald Trump to Barbara Corcoran, has found a cheap property through effective negotiation.