What are the biggest things that will kill profit in real estate deals?
There you were... sitting in the seminar with hundreds of other aspiring REIs around you. The speaker’s voice rang out with the promise of working on your own terms (= on a beach, drink in hand), achieving “financial freedom”, and being profitable.
Well, we hate to be the ones bursting your shiny, real estate shaped bubble, but this isn’t overnight money. And not every deal is profitable. Lots of speakers (in any industry) making their money selling courses and filling seminars. Now, we’re not saying you’re in it for the wrong reason, or even that you won’t’ be profitable... but any time anybody says anything about easy money or overnight success, it’s wrong.
Anyway, the point is... it helps to know from experienced people what your getting yourself into, and be aware of what factors can kill profit in your deals.
Here are a few things that can crush REI profit like worem (Braveheart reference).
1. Poorly managed rehab costs (aka construction costs gone wrong).
Yep, once you buy that house, you gotta rehab it. Duh, right? Well, this is more complicated than it sounds. Nick, the owner of Sell My House Brevard points out that you’ve got two main options when it comes to rehabbing a house:
1) You can go with Pros who know what they’re doing, and don’t need to be babysat. The downside? They’re pricey.
2) You can go with cheaper guys and gals (usually called “handymen” and often identified by having just a truck and a ladder ;) ) but then you’re gonna need to be there, making sure there are no mistakes, the work is done right, and on time, and so on.
So the first thing you need to do so your profit isn’t killed is manage the rehab costs. Weigh out the Pros and Cons, and choose the one you’re most comfortable with.
Bronson, the owner of hard money lending company Borrower Solution recommends that you mitigate this risk by working with an accredited, experienced GC (as in, not handyman Joe), and by completing really thorough due diligence (like inspections) of the property so you prevent any cost surprises.
Another solution is to ask trusted REIs that have been around a while who they use and recommend. You can also find contractors that have expertise in home flips, or the REI Space. Jadden helps run Bodden Construction and is an example of one such person, who is involved in home flips or reale estate investment, and yet his company has a good handle on construction costs. Bottom line... you probably don’t want to use someone with no experience, or inexpensive guys/gals with a ladder on the back of their truck who just started yesterday.
2. Transactions gone south.
Let’s say you go to close on the home, but you either fail to secure the property, or you can’t successfully exit the investment. That’s a problem, and a profit killer.
Bronson says it’s important to understand how to time the market, market the property itself, and have a firm grasp on what price you should sell the investment at, etc.
3. Financial risk.
Here, Bronson says...
“Financial Risk ties closely into transactional risk. If a property is sitting on the market, you have to understand how the loan terms impact investment returns. High interest rates, unfair upfront fees, and expensive loan terms are too common in real estate investment lending and kill profits. Professionals and advisors understand how to ensure your profits are maximized by minimizing your funding expenses, minimizing the amount of cash investors need to bring to deals, and leveraging industry secrets to secure loan terms that investors can’t on their own.”
Nick, the owner of ND Residential Solutions LLC warns that having an unrealistic ARV (after repair value) is a related area that kills profit. He says that you need to have an accurate and realistic ARV so that when you factor your purchase cost, plus your rehab costs, you’ll still have profit at the end.
This obviously ties in with #1. So a chance at profit can be lost because you mismanaged the flip (or hired the wrong crew), or it can happen because you were never destined for profit. You looked at the home, and thought you could rehab it for $xx, but it really was always going to cost much more.
Brian left his job on Wall Street to pursue a life in real estate investment, and create the opportune life he wanted. He founded Rock Hammer Investments, and agrees that 1) underbudgeting a renovation, 2) under/overvaluing properties (either over-paying or under-selling the house) and 3) time (sitting on the house too long, not moving fast enough, etc.).
The takeaway... mitigate your risk.
Profit doesn’t just happen. You’ve got to watch your construction and rehab costs, make sure you know how and when to close a deal (and for what amount) and how to measure financial risk.
What about you? If you’ve got experience in the investment industry, what are the biggest profit killers you face?