Epic Real Estate Investing - EPREI 043 : Level 2 Property Evaluation - The Money Saver

Episode Date: December 10, 2012

The biggest mistake investors make lies within their property evaluation. Most investors pay attention to the wrong factors and use the wrong figures in determining value. On this episode, Matt walks you through his property evaluation method step-by-step so that you can virtually eliminate the risk from your real estate investing. Enjoy! Get your free real estate investing course at FreeRealEstateInvestingCourse.com Learn more about your ad choices. Visit megaphone.fm/adchoices

without further delay. Your guru. Sorry. Your guide to a better life through real estate investing. Matt Terrio. Hello and greetings from the epic real estate investing podcast. This is episode number 43. And this is the podcast that will show you how to build wealth through creative real estate investing.

So you'll have the option to realistically retire in the next 10 years or less. And enjoy the good life while you're still. young enough to do so. My name is Matt Terrio, author, full-time real estate investor and family man. If this is your first time listening to the show, welcome. I am so glad that you're here. And now you're going to want to do two things. First, go back and listen to episode one for the ground rules of the show. And two, download the free real estate investing course, how to do deals, no money required. And you can get that for free at free real estate investing course.com. And in case this is your first episode, you'll want to know that this is a step-by-step course of where I

unveil the mystery around doing deals with no money or credit. To this point in my investing career, knock on wood, I've implemented 12 different strategies of investing in real estate using none to very little of my own money, and I've yet to use one point of my own credit score. Who needs credit, right? Inside the free course, I'm going to give you the first two strategies of which are really the easiest two, and they are the two that can generate the quickest success for you. And you can get those for free at free real estate investing course.com.

Okay. we are level two evaluation let's get right into it uh no announcements no nothing let's just get into the meat of the episode today and that is level two evaluation now you should only be at level two evaluation and we're continuing from episode 41 because we went over level one evaluation so this is your first episode you're going to need to listen to at least um episode 41 okay so you should only be at level two evaluation if your property passed level one evaluation, meaning the property is what you're looking for. You are dealing with the decision maker, and it's been established that there is seller

motivation. Got it? Now, if you don't have that, don't waste your time here. I mean, if your property hasn't passed level one evaluation, don't even go to level two evaluation. Don't even waste your time, as this really can be the time-consuming portion of your evaluation, one of the more time-consuming portions of your real estate investment. You know, level two evaluation

that begins with formulating your own opinion of value. Your own opinion of value. Now, your own opinion of value is going to vary greatly depending on what your exit strategy is. As you know, or maybe you don't know, I find that many investors do not know, but there are four basic exit strategies. Four basic exit strategies.

There is wholesaling, there's fix and flip, there is lease option, and then there is buy and hold. All right? Wholesailing, fix and flip, lease option, and buy and hold. Those are your four basic exit strategies. And that's how you get paid. You know, you've heard the saying that you make your money when you buy real estate. Very, very true. You do make your money when you buy real estate, but you get paid when you exit. So you got to know your exit strategies. And there are four exit strategies. Wholesaling, fix and flip, lease option, and buy and hold. And when formulating your opinion, of value, you'll want to begin with the end in mind.

What will your exit strategy be? You need to know that, or at least have a couple of those as options. And by beginning with the end in mind, you'll be able to establish the maximum amount that you can pay for property and have it still move you forward, still move you toward your goal. In other words, profit. In other words, make money. Now, I go into a very detailed explanation about this and my way.

workshops and the Epic Pro Academy. But actually, funny thing, stay with me on this. I had a dream last night that really kind of just simplified this entire concept of how to determine your own opinion of value. Sounds weird, I know, but I knew I was going to be podcasting on this subject, and I guess it just kind of crept into my REM sleep, and it evolved as a dream, and it just kind of really simplified the whole thing. So I woke up with this thought, and I've seen.

said this before, but this is in a new context. First, you are an investor. That's who you are. And your job is to make money. And in real estate, you do that by buying low and selling high. That's your job. The market conditions, they don't matter, whether good or bad, slow or fast, whether loans are easy or difficult to get.

As long as people actually live there, there is a low price and there is a high price for a property. So you want to identify the low price. That's where you want to buy. Then you want to identify the high price because that's where you want to sell. Now, you can sell really fast by either wholesaling or flipping a property, or you can sell slowly over time via renting a property to a tenant or a lease option. But to keep it simple, you either sell fast or you sell slow.

Those are your exit strategies. I'm going to sell it fast, but I'm going to sell it slow. And as long as you buy at the market's low price and sell at the higher price, you make a profit. Got it? So that's first. You are an investor, and that is your job, to buy low and sell high. Second, your opinion of value is unique. It's unique to you only.

Nobody else's opinion matters. Nobody's. I don't care if the bank rep says a property is worth $100,000, the appraiser says it's worth $90,000, the realtor says it's worth $95,000. or the seller themselves thinks it's worth $120,000. None of those matter. You know, most people don't realize, if you went out and hired 10 appraisals,

or 10 appraisers to conduct 10 individual appraisals, you realize you're going to get 10 different answers. That's really important to understand. You're going to get 10 different answers. Everyone's got an opinion, and all you care about is yours. I mean, the only way that those opinions would matter if they were actually the buyer,

if they were going to be the one they're writing the check for you. Are they cutting you a check? Then no, it's just an opinion. Property is not worth that. It's just their opinion of what it's worth. A property is only worth what someone is willing to buy it for.

I mean, some people will give you a lot for a property, while others will give you a little. And that brings us to determining your own opinion of value, level two evaluation. So if some people will pay a lot for a property and some will pay a little, then to determine your own opinion of value, you must determine first who you are going to sell it to.

If some people are going to pay a little bit and some people pay a lot and some people pay in between, well, wouldn't it be kind of nice to know who's going to be your buyer? Who are you going to sell it to? Of course. I don't mean specifically which person. I mean, that would be good if you did know which person,

but what I do mean is what category would this typical person fall into. You're the typical buyer, the person most likely to purchase your property. And here are the basic categories of buyers. First, you have investors. Yes, investors buy property. And investors can sell to other investors. I sell a lot to other investors.

Investors buy from other investors. Second, you have the retail market, right? People looking to purchase a home of which they're going to live in. Okay, so the people buying their primary residence, another type of buyer, another category of buyer. And third, you have tenants, right? People who give you your profit slowly over time via rent or a lease. Those are your three primary customers. You've got investors, homeowners, and tenants. So when you're looking at a deal of which you're considering purchasing, first thing is first. Determine who you are most likely, who you're most likely customer or your

most likely buyer is, and how much they are likely to pay you for the property. And that's where we'll start. Okay, that's where we'll start. And as I'm writing this, I'm thinking of a question that I received on the Academy group coaching call the other night. It came from long-time academy member, Nathan. Nathan, thanks for the question. And I won't get into the exact details of the question because I want to stay on topic. But Nathan's question was around a very common formula for determining value. And you've probably heard it before. Or you're at least, have heard a variation of it. And it goes something like this. A property's value is 75% of fair market value minus repairs and expenses and then minus your profit.

75% of fair market value less the repairs and expenses, less your profit, and whatever is left is what your purchase price should be. Now, that formula, it might be okay for developing your quick initial assessment or what I like to call quick and dirty math. But first, there's some things to think about with this formula. to not put too much faith in it. Or not too much, don't base your decision on it. You can do it for quick thinking,

your quick assessment, your quick and dirty math, but how do you come up with fair market value? Right? How do you come up with that? You've got to really establish to who. Who is the value fair to, right? I mean, what's fair to me as a buyer

is not always going to be what's fair to the seller. I mean, certainly an investor with the intent to flip and a homeowner intending to live in the property are not going to see eye to eye on what's fair either, are they? No, because the investor that wants to flip the property, he's going to see one value because he's got to have some profit in there. So he's going to have an opinion of value that it's way down here somewhere.

And a homeowner intending to live in the property, you know, they probably aren't looking necessarily for an investment. They really are considering their standard of living, of what their lifestyle and how comfortable they're going to be, and that's what they're paying for. And they're willing to pay a premium for that. They're willing to pay the retail price for that property. Now, also, as Nathan pointed out on the call the other night,

that 75% of fair market value in a Midwest market might leave a buyer with $10,000 of equity. And in Arizona, that same 75% of fair market value could leave the buyer with $25,000 of equity. And right here in California, where I live, purchasing a property at 75% of fair market value would leave you maybe with $100,000 or even $200,000 of equity. So that number, 75%, it's random, it's arbitrary.

And it doesn't apply universally. And, you know, fair market value, it just leaves a lot of questions as to who it is fair to. It doesn't answer a whole lot. Like, who is this market value fair to? So you want to always keep that in mind. And that's why I recommend first identifying who your customer or who your buyer is. Is it an investor?

Is it a homeowner or is it a tenant? If it's an investor, they too are in the business of making money in real estate, just like you. So you're going to have to subtract not only repairs, expenses, and your profit, but you'll have to subtract their profit also. You have to leave some profit in the deal for that investor. or they're not going to be your customer. And you've got to leave enough profit that doesn't present any real significant risk for them either.

I mean, if you get too greedy selling to other investors, you won't be selling to other investors very long. I mean, that type of business is, it's built on volume. So you're not going to go for the big home runs. Those are a bunch of little base hits, and you've got to do a lot of them to make a good amount of money. And some people do that very well. and if you want to go for home runs,

then you need to focus more on the retail buyer, the homeowner. They are typically the customer that will pay the most for the property. And here you'll determine the price that you can sell the property to them for and then subtract your repairs, expenses, and your profit. That's a simple equation. But where do you begin?

You know you're going to subtract the repairs. You know you're going to subtract the expenses, and you know you've got to make room for your profit. And, but where do you begin? We're missing that fair market value number, right? How do you find that starting number of which to start subtracting expenses in your profit? Well, there's a lot of ways to do it, and we've already covered one in detail. But here's how I come up with that number.

Here's how I do it. I look for comparable properties. You've heard of that, the comps, right? That's short for comparables. Properties of first. This is what constitutes a comparable property. These are the three most important factors. First, got to be a similar location, a similar location.

Second, by the way, that location, you've heard this before in real estate, location, location, location, it's absolutely true. When it comes to determining a property's value, the location is, can comprise anywhere from 75, up to 90% of a property's value in some markets. Okay, so first, got to be locations, got to be within a close proximity or a similar location. second got to have similar square footage similar square footage most places properties are somewhat somewhat valued on price per square foot there's you know your higher end of luxury markets your stuff on the coast and stuff that can vary because you have other things like like the view that comes into play and and proximity to to freeways and stuff like that

but most for the most part it's all about the square footage that's the second that's another i don't know anywhere from 10 to 20 percent of a property's values and the square footage. Now, beds and bathrooms, they do come into play, but it really is about the square footage. And third, similar condition to what you expect your property to be when you sell it. The condition, the amenities, the quality of the property, of what you expect your property to be when you actually sell it. Meaning if you buy it at a lower quality, a lower condition, and then you fix it up, you want to use the fixed up ones as your comps. Okay, make sense? Great. Now, I like to find at least three comparable properties. I like to find at least three

comparable properties, at least three sold comparable properties within the last 60 days. Okay? If I only find three in 60 days, I do get a little nervous, though. I do get a little nervous, especially if my intention is to flip the property. But you want three properties. Three properties is the absolute minimum. The more or the better. And if you find like 10 or 15 properties, then reduce the number of days.

Reduce the number of days and try to find, say, five to six sold in the last 30 days. Okay. The timing there is really important to. The timing is really important to when they actually sold. Let's see. There is an operative word, though, in all of this. These properties must be properties that have actually sold. Okay?

They must be properties where the property was for sale. The buyer came along. He put his money down. He went through the entire escrow process and justified that. price the property has to have actually sold i'm not interested in pendings or properties currently for sale at least not here in in level two evaluation okay i i take these recently sold properties and if i found five or more i'll throw out the two highest price sales something i do i do that for two reasons first i don't want to gamble with the top of the market numbers remember i'm an investor i'm here to make

money i'm not here to gamble so i'm not going to gamble with the top of the market numbers there's a lot of reasons that properties can sell at maximum price. And for those instances, it's a very difficult thing to duplicate. So I don't want to gamble with those top of the market numbers. And two, I'll throw out the two highest price because

it builds in an extra little comfort level for me. All right, you don't have to do that. That's just my own personal preference. It's my own personal logic. But that's what I do. Now, after eliminating the two most expensive properties, I simply average just what's left. I just average. I just average what's left, and then I take 95% of that.

And what this final number is, it's a number that's 5% lower than the average properties that have most recently sold. It's 5% lower than the average price properties that have most recently sold. That's my starting point. And here's why I dip below another 5% or so. And it doesn't...

Just like that 75% of fair market value, it's not universal. The 5% is not necessarily universal, either, but I'm just using that as an explaining point right now. I just want to be a little bit lower than the average. It's because when flipping properties, selling them fast, holding costs, all of that, that will cut into your profit. So you want to be able to sell the property as fast as you can. And in most markets, buyers will start from the bottom and work their way up.

So they're looking at the lowest price properties first, and they're working their way up through the market. And if your property is priced among the lowest, your property is going to be seen before most. And if it's seen by more people, it's likely going to sell faster. I'll take that fast nickel over the slow dime every single time. So that's how I get to my starting point.

And why that is my starting point. So hopefully I explained all the details of why that's my starting point, not just 75% of fair market value. That's too random for me. Okay. Now, if my intended customer is an investor, I'll take that starting number and I'll subtract my estimation of repairs and closing costs, my profit, and then the profit that I want to pass on to the new investor. Okay?

So that's how I come up with my, that's my starting point, and then I just subtract the closing costs, subtract the repairs, subtract my profit, and if my end buyer is another investor, I make sure I include their profit in there as well. Now, if my intended customer is a homeowner, I do the same thing, less the additional profit that I would pass on to my investor in the previous example. That I get to keep for myself.

That's the home run part of this, selling to the end buyer, the homeowner. Now, maybe I want a little more profit under the scenario, or maybe I'm okay with a little less. But that's how I get to my own initial opinion of value, and I use the word initial. opinion. That implies there'll be another opinion of value later on, right? Because I'm really not done yet. I'll get very detailed with my numbers while I'm conducting my own due diligence.

But this initial number is good enough to at least enter contract with, to at least write up an offer. And then if after my due diligence, I find out I was wrong anywhere and I have to make some adjustments to what my opinion of value is, then I'll just go back to to show the seller the facts and I renegotiate. Just like that. And if they aren't willing to renegotiate, I cancel. That's no big deal.

Okay? I'm here to make money. I'm not here to appease everybody. I certainly want to create win-win scenarios. I want to get the seller what they want, but not at the expense of what I want. So after I go through and do my due diligence and I come up with a different opinion of value

that's going to cost me money or increase my risk, I cancel. Cancel the contract, no big deal. And, you know, when you're getting down to the point when you're consistently submitting offers, when your business has reached a level where you're consistently submitting offers,

you want to be just as comfortable as canceling contracts as you are with closing them. I mean, when you cancel, I mean, look at it as you didn't lose any money. That's a win. I didn't lose anything. And when you close a deal, you look at that as you made money.

That's a win. You made money. that's what investors do. They make money and they don't lose money. That's your job. Both of those are positive scenarios. But to get to that point, because I understand it can be difficult in the beginning,

especially if this is your first deal. You know, you got, you found a motivated seller. They accepted your contract, and now you've got to cancel. That can be tough to do because you really want that to go through. I understand. I was there, been there, done that. But you've got to get to the level

where you're consistently presenting offers. You've got to get to a, where you're consistently presenting offers to motivate a seller to where that any one deal isn't the make or break deal for you. So you can make your decisions based on the numbers, not off your emotions. Emotions are really, really, really bad.

Emotions are really bad for investing. You want to just look at the numbers. Anyway, so that's how you determine your own opinion of value when you intend to sell fast, either to an investor or a homeowner. Okay? That's how you determine your own opinion of value when your intention is to sell fast,

either to an investor or a homeowner. Okay, we covered both those scenarios. Now, what about when you want to sell slow? Say to a tenant. Okay? And when I say sell slow to a tenant, I don't mean you're technically selling the property slowly to the tenant,

but you're pulling out profit slowly. Okay, you're pulling out the profit slowly. And I don't know, maybe I should, maybe I should change my wording from selling fast and selling slow to profiting fast and profiting slow. That actually makes more sense. I think I'll do that.

Anyway, if your end customer is a tenant, The first number, your starting point, it's not going to be 75% of fair market value. You're not really going to care so much at this point how much that property sold for last month, or a comparable property, how much it sold for last month. Your starting point, it's going to be, what will the property rent for?

That's your starting point. What will the property rent for? What is a tenant most likely going to pay to live in that property? That's the starting point. And here's how I find that out. The quick and dirty way is to go to rentometer.com. Love this website.

It's a very snazzy, handy tool. It's a website for tenants to figure out if they're getting a good deal on their rent or not. That's what it's really for. But it also serves as a great... It serves investors. It serves as a good purpose for investors by revealing what the median rent is

for the area for comparable properties. It reveals the minimum. median rent. And that's at Rentometer.com. R-E-N-T-O-M-E-T-E-R. No dashes, no hyphins, no spaces, nothing like that. Rentometer.com.

So go to Rentometer.com. Type in the zip code. It's totally free, by the way. Type in the zip code, and then just the number of bedrooms. That's all you got to include. The zip code and the number of bedrooms. And then you click,

I don't know, show me my rent, something like that. And presto. It'll give you the median rent. The median rent. So I take that median rent. and I subtract 5%. Same reason. For my quick and dirty math,

I use 95% of the median rent. I want that level of security in there. I want to make sure that I'm erring on the side of caution. I'm an investor. I'm not a gambler. You've got to build those little safety nets in for yourself. Then I subtract my maintenance costs. I subtract the vacancy, the taxes,

the insurance, management, all the monthly expenses that I expect to accrue from running their property. I want to subtract all those expenses from the median rent or 95% of the median rent. And what I have left is my net operating income. That's my net operating income. Now, from that number, I deduct my desired cash flow.

Okay? I deduct my desired cash flow from my net operating income. And that's just like the profit in our previous example. Your cash flow is the profit. it's whatever number you're comfortable with. Personally, my minimum is $250 a month. If a property generates $250 a month, I'm okay with that.

That's my minimum desired cash flow. Now, whatever I have left, I've taken my net operating income, I've subtracted my desired cash flow, so whatever is left is the maximum amount, the maximum amount that I can afford to pay any sort of debt service. Okay?

That remaining amount is the amount, the maximum amount that I can afford to pay any sort of debt service, whether that's through a conventional loan, seller financing, subject to, a master lease, or any combination of those. And that's how I determine my initial opinion of value when my intent is to buy and hold, to sell slowly. I mean, to profit slowly. The price I pay for the property is almost insignificant to me. I mean, it's the amount of cash flow that I receive is what determines a property's value to me when my intent is to profit slowly, when my intent is to buy and hold.

And this number, you'll hear referred to as CADs, C-A-D-S. It means cash after debt service. Okay, that's your cash flow. Okay, so there you go. That's level two evaluation. Whatever number comes out of this level evaluation is the number I consider a safe number to at least write an offer and enter escrow.

and that's the purpose of level of two of valuations, just to get into contract, just a number that will closely represent a number that you're going to close that deal at. Now, on a side note, we've talked about profiting fast and profiting slowly, and most people will choose the profit fast route every time, and that's okay to an extent,

as long as you know what you're doing. Just know that profiting fast over and over and over again, profiting fast will make you rich. Absolutely, you can get rich, profiting fast. And profiting slowly will make you wealthy. Make sure you have that distinction.

Profiting fast will make you rich. Profiting slowly will make you wealthy. See, profiting fast will always be a job. You make a lot of money, but you're working for it. Profiting slowly, that will be your escape from work. Meaning, you've worked hard for your money, and at this point, when profiting slowly, your money will now return in the favor.

It will work hard for you. And that's the ultimate goal. That's where you want to point your compass. That's where you want to go. Got it? All right. That's it for today. If that sparked any questions for you,

I mean, there's a lot of visuals involved, so I can understand if this is the first time you've heard it, or this is like only the second or third time you've heard this information, or if it's entirely an entirely new way of you thinking about evaluating a property, and you've got some questions, send your questions to Matt at Epicprofessionals.com. Matt at Epicprofessionals.com. And I'll respond to your email with an answer.

And also I'll bring these to the air shortly too if I get a bunch of questions because if I miss something in there, it's all very clear to me because I've done it over and over and over again. But I understand if this is your first time hearing it or if it's an entirely new way of hearing it, I could have missed something.

And if I did, certainly I don't want to keep you in the dark. All right. your questions to Matt, M-A-T, at Epic Professionals.com, and whatever questions I get, I'll certainly bring those to the air on a future episode, very short episode. And let's see, next episode, I'll begin my interview series with my past coaching clients. I'm going to start interviewing past coaching clients, and you're going to hit your, you get to hear the good, the bad, and the ugly, which all three scenarios, there is plenty for you to learn from. Shoot, there's plenty for me to learn there as well. And I'm putting my ass on the line.

in these interviews, there will be no edits. You're going to hear it raw. You're going to hear it all. And I can't wait to hear what my clients have to say. Should be fun. All righty. So until next time, as a very wise person once said, measure twice, cut once. To your success, I'm Matt Terrio, living the dream.

Thank you for spending this time with Matt Terrio and the epic real estate investing podcast. When you have a moment, stop by iTunes to leave your comments and let us know what you think of the show. And if you haven't done so already, get started investing today by visiting free real estate investing course.com. To access Matt's free course, how to do deals, no money required. Until next time, to your success. This podcast is a part of the C-suite radio network. For more top business podcasts, visit c-sweetradio.com.

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