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More often than not, there is a great expectation by eager sellers who would seek to maximize their net sale proceeds. For owners of well-maintained properties–who have invested faithfully in the upkeep and ongoing maintenance of their properties—they are justified in seeking and obtaining the highest possible net proceeds. However, when it comes to the investment value of properties that require a lot of work and capital investment, most sellers expect too much. I believe the reason is because most sellers are left uninformed about the way an investor buys properties. It may be that such sellers hope to find a handyman type buyer who intends to live in the house, and who is typically not so concerned about immediate resale value. While these buyers are out there, they are not as plentiful as the investor community at large; most investors acquire real estate to earn a profit, and they must do so while balancing the cost of capital. It is due to these factors that an investor must offer what makes most financial sense for them to engage in a real estate investment opportunity.
Here is an example:
Let’s say that MLS sales statistics for the past 6 months indicate that remodeled properties are selling in a certain area for an average of $105.26 per square foot; and within this area is a property that is 1,292 square feet. It would seem practical that a buyer would expect to pay $135,996.00 for the property, if the property is in remodeled condition. However, the property in our example is a fixer, and the seller of this property has it listed for $159,000.00; which is a far above the $135,996.00 we calculated based on historical sales data from the MLS, and it does not take into account the $30,000.00 to $40,000.00 (or more) investment of capital it will take to bring the property up to a remodeled condition.
The Ideal Investment Scenario
The ideal—as many real estate investors learn —is the 70% Rule where an investor makes it a goal to acquire properties at 70% of after-repair value minus rehab costs. While the 70% Rule is always a good goal, it is not always possible. A lot depends on market conditions. With that said, an investor must justify the use–and cost–of capital, or they will be investing only for the pleasure of investing.
When it comes to acquiring fixers, sellers should be more realistic in their expectations. Instead of overpricing their property, they should place more focus on seeking a middle ground. When both sides are aware and considerate towards what the other side needs, a fair deal has a chance to materialize.
The Balance between Risk and Return
A house remodel requires an investment of capital; the use of that capital comes with a cost, and those costs must be taken into consideration when calculating offers. The resulting number is the amount an investor can pay for a particular property. It not only takes into account the cost of capital, but it also factors in the level of risk assumed by taking over the property. Prudent investors will not take on an investment where the risks and cost of capital cannot be justified by a decent rate of return.
I believe the growing stigma against MLS listed properties could be lifted a great deal, if only sellers would realize how investors actually see their properties; especially, fixers that are in need of a lot of rehab work. It is a realization that could mean the difference between a property that sells quickly for a mutually fair price, and a property that sits on the market unsold because it was overpriced to begin with.