You need to know the market value of what you are buying.
Perhaps the biggest myth in the world of foreclosures is that just because a property is foreclosed on it is a great deal. That is like believing everything you find at The Dollar Store is cheaper than you can get it at the grocery store or Wal-Mart. The fact is that you need to shop for foreclosures and do your research so that you have a pretty good idea of what you are getting yourself into, what exactly it is you are buying, how much it will probably cost to fix up and sell, and how much of a profit you can reasonably expect. Foreclosure investing is no different from any other type of investing. In real estate investing, unless you plan to rent the property, your profit comes from the difference between the purchase price and the sale price. The difference must be large enough to cover all you cost and still generate the profit you are looking for. It is that simple. Some properties are terrible deals because you can never recover your costs and make a profit. Others are great deals because you can buy significantly below market value, make needed improvements, and still sell for a handsome profit. The only way to determine the possibilities is to analyze each opportunity.
It is a very simple formula: Sale Price-(purchase price + costs) =Profit.
Each of the three variables (Sale Price, Purchase Price, and Costs) is made up of smaller components. Some, like the purchase price, you have direct control over because you will determine what you are willing to pay. The price you will eventually sell the property for (sale price), on the other hand, must be estimated. You can check out comps to predict the fair market value of the property, but in the end the true value of any property is what someone is ready and able to pay at that point in time.
As an investor, you must purchase the property at a low enough price to afford the holding costs and the necessary improvements and still make a profit. If you plan to upgrade the property, you must have a low enough price so it supports the planned improvements-and again still leaves room for profit. If you have no chance of making a profit, you should not purchase the property.
Costs are the next variable in the profit equation, which include holding the property, making repairs and improvements, insurance and taxes, mortgage payments, and costs of sale. Some costs are easier to calculate than others. Here is a breakdown of the major costs involved:
Holding Costs: Holding costs include loan interest, taxes, and utilities. How long you hold the property determines the total cost. Many investors assume they will hold a property for at least four months, assuming two months to make repairs and two months to sell the property. Your real estate agent and contractor can help you estimate the time it should take to make repairs and sell the property. (Keep in mind that how quickly a property sells is often a function of price; if you list the home at somewhat below fair market value, you are more likely to sell quickly; list above market value and you may hold the property for a long, long time.)
Repairs and Improvements: Cosmetic improvements are relatively inexpensive; major improvements can cost tens of thousands of dollars and take months to complete. Regardless of what you plan, you must estimate the cost to determine whether a deal makes sense. The cost of repairs and improvements represents a major portion of the project’s overall expense. In some cases, the market will not support the cost of the repairs and improvements and return a decent profit.
Cost of Sale: At the closing of a real estate deal, certain costs of the transaction are apportioned to the buyer and seller. The real estate commission is typically the highest-cost item, averaging 6% of the sale price. Legal fees and other costs are also included.
