2012 has seen a market where investors and home buyers are going toe to toe on many listings. Inventory is tight, buyers of all types are overwhelming the market and bidding wars are almost expected on anything priced well. What options do you have if you’re out there looking to buy? At this point, you can pay up or be patient.
If you’re an investor, my advice is to be patient. Buying property to fix and flip is a great way to make money but you have to buy right to be successful. Generally, this type of investor is looking for net profit margins of 20-30%. Buy and hold investors will have varying expectations for returns but if you’re leveraging your cash (i.e. financing the deal), lenders will require a minimum debt coverage ratio to ensure they are lending on a property that can carry itself financially.
So, if you’re an investor, how do you ensure that you don’t overpay?
1: Set a max buy price right off the bat and don’t exceed it. If you think the property is priced right, that means a hundred other buyers, brokers and investors who know the market as well as you, think so too. In most cases, you’re not asking yourself how much of a discount to the list price you can get, you’re asking how much over ask you can pay. To keep emotion out of the purchase, set your max buy price and don’t second guess yourself unless new information becomes available.
2: Go into the purchase with a specific exit strategy. If you’re a long term buy and hold investor, determine the minimum level of return you can tolerate on your investment. If your strategy is to fix and flip the property for a quick profit, estimate the potential resale price and work backwards from there subtracting construction and development costs to determine the max purchase price.
3: Find out what the seller’s expectations are and what types of buyers you are bidding against. Are you dealing with an independent seller, a bank, an heir to the real estate asset, or other? There was a time when asset managers responsible for selling bank REO took cash offers with a quick close over any financed offer because it was a sure sale in a short amount of time.
Now, financing is getting a little easier for the average owner occupy buyer to procure, their certainty to close is improving and lending packages for buying distressed homes and fixing them are more readily available. As an investor, if you’re competing against this type of buyer and the seller is open to working with them, know that they can pay more for the same asset because they are not necessarily seeking an immediate return. It would be a mistake to think that you can pay over your max buy price and still make your projected return just because the property works for someone else at a higher price point.
If you have money burning a hole in your pocket and you’re not afraid of overpaying at today’s market levels, you will probably still be satisfied when you look back in five years. For all others, keep in mind that this market is still artificially inflated by low interest rates and the unwillingness of major banks to unload their huge inventories of foreclosed properties, not to mention those who would love to sell but can't because they are still upside down on their mortgages.