Bad Deal: Purchase Price 112K, Total Value 117K, Equity 5K, Labor 5K.
Good deal: Purchase Price 96K, Total Value 132K, Available Equity 36K, Labor 5K, After Labor Value 162K.
Good: Purchase Price 117K, Labor 4K, Total Value 137K, Available Equity 20K, Rent $875/month, expenses $925/month (indicates $50 negative), rise in equity in 18 months, sold for 185K.
The long story short, in considering taking on a deal, you need to know the properties’ present market value (to a regular consumer, as is). You also need to consider the demand in the area. Are sales in the area stagnant, are there more sellers than buyers (which means you will have to give more concessions) or are there more buyers than sellers (which means you should negotiate in a savvy manner without overpricing yourself). You need to then know how much work it will need (and are you equipped to take on the work?). After a certain amount of work, is there any value created in the property?
In an extreme example, there was a certain L.A. neighborhood where a 2 bed, 2 bath home was relatively affordable (for L.A.), but (and I never did find the driving factor, but why look a gift horse in the mouth) instead of a regular renovation, adding 1 bed and 1 bath (without turning it into a “McMansion”).
The Mc Mansion Phenomenon:
The term “Mc Mansion” was thrown around quite a bit, but not many people really, truly know what it meant. I’ll start off with using my grandmother’s house as an example. Her house measures 2500 square feet. At the same time, there’s an average front yard, and the backyard still has enough room for a pool, patio, and yard space to comfortably park two cars in the back yard, maybe more if you got rid of the trees. In comparison, there’s a McMansion in the neighborhood. Just using estimated numbers, let’s say the property lot measures 50’ x 100’. Again, I’ll estimate the city zoning setbacks at 6’ all around. Doing the math, that means you have a strip around the property that is not buildable by law, leaving an area measuring 38’ x 88’. That gives you an actual buildable area of 3,344 square feet. In comparison, the previous home measured approximately 1,600 square feet and left you a decent size yard with room for a garage and off-street parking. It was purchased for 150K, and built out to the limit of 3300 square feet. At the time, my grandmother’s home was valued at approximately 550K. So for throwing another 50K at the house (to be the McMansion), the owner made an investment of 200K. Once the work was completed, as a technically “new” structure, the McMansion was able to then “justify” (using that very loosely) now being valued at 750-800K.
So what you have is a 150K property that went to 800K, but the new owner basically has a gigantic apartment (I call it an apartment when you don’t even have parking space). The neighbor’s complaint is that it is an eyesore as it breaks the neighborhood’s architectural consistency. I mean, McMansion’s didn’t cause global warming, but it was an exploitation of the system’s limits to make a quick buck.
You need to do market studies if you decide to work in a new area. For example, the adjustment coming from Los Angeles to Las Vegas is that a 100 year old house in Los Angeles is no big deal, while in Las Vegas, a house built in the 80’s-early 90’s is considered ancient. And the prices for what you get are much cheaper in Las Vegas, but you can realize the same profit margins. Now for Atlanta, what I was unprepared for is the prices are much cheaper than Los Angeles or Las Vegas, but the resale is also cheaper, so the profit margins are much lower in trying to be a 100% home flipper. Now what I could’ve done in hindsight was look at long term rentals. The rents are almost comparable to Los Angeles, but yet you can purchase the property for a price that would be a steal in Los Angeles.
Some investors like to get into what is known as capitalization rate analysis, and I am aware of what they do and why, but that is for long time, highly sophisticated investors and would probably cause more confusion to the newbie. As a newbie, you just want to know that at some point in the near future if not right away, the property you decide to purchase has a positive output and is not costing you money.