Determining Your Profit Before Buying Property
This article contains information that is especially relevant to real estate investors or property flippers. As a property investor let me inform you that one of the cardinal rules of real estate investing is this:
You don’t make money when you sell. You make money when you buy!
This runs contrary to general logic among property buyers in the market. As a property investor you should not be buying homes with the idea that you will figure out how to make a profit from it later on. But what you should be doing is that you should ensure that you get a great deal when you are putting up the money to buy the property right now so that you can see upfront the profit you can potentially make. Lets go into more detail on how you can determine your profit before you buy property.
The Past Is Not the Future
Most property investors operate under the false assumption that they will earn a profit because of some event that might take place after buying the property such as market factors which will help the property they have brought appreciate in value. While its true that the value of most properties does go up over a period of time that isn’t the case in the short run. Our planet is always in a constant state of flux and change. Unforeseen events as we have seen in the recent past (Covid-19) may depress property values.
Do not fall for the pitch that most investment gurus always use with their emphasis on appreciation as a particular tactic, “If you had invested in this project 10 years back you would have realized 100 % return on your investment”. Hindsight is always 20/20 and every economist is a guru when looking back.
When you are investing in real estate do not blindly presume that a property will increase in value. Do not be persuaded by the blind hope (based on the fact that the property appreciated in value in the past) that it will continue to appreciate if you hold it for a few more years.
Over the long run, indeed the real estate market always corrects an investor’s mistakes. Values of property rise and fall in cycles in the short run but in the long run (20 – 30 years) the market tends to go upwards at a steady and conservative speed. History has proved that the value of real estate has always outperformed inflation over the long run. However if as a real estate investor you are looking at the short term and counting on a 3 – 5 year strategy and assuming that since real estate values went up over the last few years you may be taking an unnecessary risk. The best strategy as an intelligent real estate investor is to always make your profit from the word go by getting a good deal when you purchase the property.
Comparing Real Estate to the Stock Market
To understand the idea of up-front profits and their relevance in a real estate deal it would be useful to compare real estate and the stock market. When you buy a stock that is undervalued you will assume that its undervalued. Thus for you to make a profit, your stock must go up in value.
Whereas when it comes to real estate the concept of value is different. Value is what a property will sell for today. For example if similar houses are selling are ₹ 5 Cr in a neighbourhood, buying a property for ₹ 2.5 Cr is a bargain because you can realize a profit by selling it quickly at the current property rate in your area viz. ₹ 5 Cr.
Lets understand what makes a real estate purchase a deal:
- You can buy the property below its current market value.
- There is some upside potential to the property that you are buying such as change of use from say residential to commercial or additions and improvements that can be made to the property that can increase its value immediately.
- It will provide sufficient income with relation to the price of purchase.
- Future market appreciation.
Point number 3 & 4 are quite similar to the stock market in the sense that they are driven mainly by earnings per rupee invested or future speculation, both of which are influenced by market dynamics. Whereas points 1 & 2 are generally based on seller distress or mismanagement neither of which have any relation to the current local real estate market scenario.
In the stock market a business may have a good plan on paper but lacks capital which can be infused by an investor in exchange for future profits. In the world of real estate a seller’s distress can translate into profits for a buyer. Market timing opportunities exist in the world of real estate too but regardless of the market condition one thing is for sure: Individuals are often in distress.
Reasons for their distress may be:
- Divorce
- Job or Business loss
- Foreclosure
- Death
- Quick cash needed
- Lack of interest in property
- Change in direction of life
- Dispute with family members
The reasons for a “distress sale” of a property can be many. Thus as a property investor even if you think that there are no deals in your neighbourhood because it’s a seller’s market, some property seller will always fit in one of the above categories. There will always be sellers who will sell you a property for less than fair market value. These type of sellers are called “Motivated Sellers”. Let’s discuss how to find such “Motivated Sellers” in more detail!
Finding Motivated Sellers
The key to getting great real estate deals and to make a lot of profit in the short term is finding motivated property sellers. Because after all only those set of people who absolutely need to sell are going to price their homes well below market value or accept unusual financing arrangements.
Motivated sellers for the most part are usually people who are facing some kind of crisis or hardships such as divorce or break ups, unemployment or financial instability. In such cases the property and the monthly expenses of owning the property are one of the many problems that such people want to get rid of. Which is why they want to eagerly sell their property to the first buyer who is able to match their selling price and can quickly furnish the funds to close the deal.
Here’s your dream scenario: A property owner says,
That’s it. I have had enough. I can’t take it anymore! I have to sell right away. I have to get rid of this house.
How do you find such motivated sellers? Fortunately in today’s connected world that isn’t such a difficult task. Start by scanning the property portals and websites for FSBO’s (For Sale by Owner Properties). Look for properties advertised directly by owners and not dealers. 90 % of property listings on Indian portals like 99acres and Magicbricks are advertised by run-of-the-mill property dealers. Most of these disorganized dealers use these portals mainly to find renters. Ignore them because the resale or distress properties listed by these set of dealers are a lot of hokum and full of false information. But a lot of distressed sellers aka Motivated Sellers in the market do take advantage of the one free listing package offered by these portals and list their properties directly for sale. Many of these property listing websites let you filter property listings and sort listings sold directly by owners. Look for keywords that signal distressed sellers such as “must sell” and “needs work”. Basically be on the lookout for anything that implies desperation and urgency on the part of the seller.
Apart from this strategy listed above which is the easiest one, a little detective work can also be handy to find Motivated Sellers. Search for public notices and bank foreclosure websites for foreclosed properties. In our next article we will discuss how to Analyze a potential deal after you find a Motivated Seller.
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