Every investor wants to pay as little as possible for single family rental homes. Have you ever stopped to think why you should negotiate for the lowest possible purchase price? Yes, I know every real estate guru talks about no money down or little money down as the correct approach to investing. Yes, but why?
Let's say a home you are interested in buying has a true market value of $100,000. If the owner was financially distressed you might be able to buy that home for $80,000. The moment the deal closed you would seem to have a free and clear equity in the home of $20,000.
If course, you could not put that $20,000 in you pocket to spend on something else. But you could turn around and sell the home and be left with a portion of the $20,000. There would be selling costs, so it all would not be profit.
Suppose you wanted to take your profit as soon as possible so you put the home on the market, but it took six months to find a buyer. Your six mortgage payments would eat up some of the $20,000 along with other normal selling costs. Even so, chances are you would still have a nice profit and all because you negotiated a below market purchase price.
What if you decide to find a tenant and rent the home for a couple of years? Oops! During those years the local economy falters and real estate in your area actually goes down in value by about 10%. That means your property is now worth about $90,000. Since you paid $80,000 you are still in a comfortable position and all because you were smart enough to buy below market.
What if you find a house you would like to own, but the seller will only lower his asking price by a few thousand dollars. You need a little better deal to have a profitable investment. As part of your offer ask the seller to pay for your non-recurring purchase cost. Those expenses would include pre-paid interest, taxes, insurance impounds and so forth.
Lenders will allow 2% to 3% in seller-paid costs on a conventional loan. That means that you would be paying less cash out of pocket, or even no out of pocket costs if it were 100% financing.
The seller would pay those costs out of the proceeds of the sale. It's a painless expense for the seller since those expenditures are all items on a closing statement and the seller does not have to write a check for those costs.
This tactic is the same as getting a discount on the purchase price. Remember, as an investor your goal is to buy below full value and this is one little way to do that.
Now I must make a confession. For the last couple of years I've been able to buy nice homes in nice areas for full value and still make a fat profit. In my area prices had been climbing by 20% to 35% yearly. I could find a motivated seller, give them $1,000 to cover moving costs and buy their home by taking over the payments. Within 12 to 18 months I was able to sell that home and cash out for a profit of from $30,000 to $90,000.
Yes, it was an exciting time, but very risky. By paying full value there was no room for error. If values had plunged I would have been in a tight spot. So... the best practice is to always make your profit when you buy. You do that by buying 20% to 30% below market value.
Mark Walters is a real estate investor who shares his experience from his web site at http://www.cashflowinstitute.com
