Always Know Your Numbers
The difference between the Worth Value (aka “as is” value) of a property and the Money Value is that one is what the property is worth and the other is what it is worth to you.
In an earlier blog I spoke about the inspection process and how to carry it out. Before you do the inspection, ideally, you will have done the six-pack just before the appointment. That way, the owner might very well have seen you talking to all his neighbors and is very eager to find out what they were telling you.
Introduce yourself and thank them for inviting you out to buy their house and make a point of mentioning that you have just had some very interesting talks about the neighborhood. And that’s all you say. You want to give the impression that you were just told that this neighborhood is the worst one in town and that now you understand why he wants to sell.
As you walk around the house with the seller, you will be using the Ugly Uglier Ugliest repair worksheet to determine any repairs that will be necessary.
You must have the seller accompany you so you can indicate how ugly his house is. You are not there to tell the seller what a wonderful home he has. You are there to determine the final Worth Value AND to reduce the seller’s idea of the Worth Value. You want to embed ideas in his mind like “Once I buy this house I will have to fix this and that,” or “This is going to be an expensive rehab,” or “It’s going to cost a fortune to get that fireplace working again, but it’s gotta be done.”
It is very important that they have an idea of how much it is going to cost for the repairs.
As you are adding up your cost of repairs, compare the types of repairs with the types of repairs your three comp properties had, just to make sure you are comparing apples with apples.
There are three major items to consider when evaluating the property:
1. Type of Roof
What type of material is the roof made of? Tile is better than wood shake. Depending on age, wood shake may be better than 3-dimensional composition shingle, however probably not. 3-dimensional composition is better than 3-tap asphalt shingle, and a flat roof is the worst of all types of roofs.
On a wood roof, always figure $1,000 in minor roof repairs in order to purchase a two-year roof certification, which is a guarantee from a licensed roofing contractor that the roof will not leak for two years.
2. Air Conditioning / Heating
Any central air conditioner and heat unit is better than a wall heater and window cooler / window air conditioner.
On the air conditioner, a visual inspection will tell you if it is the original unit or fairly new. If it is rusty and old looking, keep in mind that a normal change-out could run between $4,500 and $6,500 dollars, depending on the quality of the unit. Any unit older than ten years needs to be addressed and an adjustment made to your Worth Value (and especially, to the seller’s idea of Worth Value).
3. Kitchen and Baths
Are they run down, with broken cabinet doors and drawers, cracked tile or damaged countertops? Are there rust stains in the sinks or tubs? Any signs of mold on the walls or ceiling?
It is important to do a thorough inspection and find out how this house compares to your comp houses and the other listed houses you’ve seen. I often tell sellers who are living in a fantasy land that they need to drive around their neighborhood and find out what the amount that they want for their house buys them (it will be a lot more house than what they’re trying to sell).
Now, how much are you willing to pay for the house? What is your Money Value?
My simple formula is I always want to see a $52,000 difference OR pay less than 70% of the Worth Value, whichever is less. Remember, Worth Value the “As Is” value and the formula for converting ARV to worth, although easy, still requires a few conversations and is not as simple as the 70% x ARV minus repairs. IMHO that formula will cost you money.
The $52,000 represents what I must earn on each house I buy.
Some books will talk about “After Repair Value,” which is the amount a house can be expected to sell for after repairs are done. In a word, this concept is nonsense. Let me show you why.
Let’s say you have a house that in its current condition is worth $160,000 (it’s Worth Value). After $20,000 of repairs, you think you can sell it for $200,000 (After Repair Value).
The HUGE issue is the amount of money you attribute to the cost of repairs and that cost is not equal to the actual cost of repairs. Doing so is a huge mistake.
Using my formula, $52,000 from $160,000 is $108,000. Or 70% of $160,000 is $112,000. So I would not pay more than $108,000 for the house (the lesser of the two figures).
If I used the same formula on the After Repair Value, $200,000 less $52,000 minus repairs is $128,000. Way too much. 70% of $200,000 equals $140,000, less $20,000 in repairs equals $120,000. Still too much.
You only want to determine Worth Value and Money Value of a house in the condition the property is in right now. If you rehab the building and sell it for more, great! You make more. But what if something happens to you or you don’t have the funds to rehab it right away? You are stuck with an overpriced house. Remember that you are an investor, not a speculator.