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How I Buy Houses Below Market Value

Every house I buy I pay substantially less than its true market value.  My secret? It pays to be in a strong financial position. Having sizable cash reserves and a ton of home equity allows us to make great deals.  In real estate investing the money is made when you buy the property, not when you rent it out and not when you sell.  I view myself as a value investor in real estate.  I buy single family homes with the same thought process that Warren Buffet uses.  I look for undervalued assets that I can get a high multiple of income generation from them, and I buy as if I won’t be able to sell the asset for another 20 years.  I combine several strategies to buy houses below market value and beat out my competition at the same time.

Strategies I Use To Buy Houses Below Market Value

Cash offers: I buy houses with an all cash offer, this not only increases my competitive advantage over another bidder who needs to get a bank loan, it also opens up the door for me to buy properties someone needing a loan can’t.  Many properties are listed as cash only deals because the house is not in a condition that a bank would issue a loan for. Cash is King! Sellers prefer cash offers because there is no worry about a loan falling through and the house can close much faster. This isn’t like paying cash to get a 3% discount on a furnace.  An all cash offer is about taking away uncertainty from the seller and speeding up their timeline.  Paying all cash is the foundation to buying houses below market value.

Quick Closing: On the first 2 rental homes we purchased I offered a 14 day close, which I figured was good enough to give me an advantage.  On our most recent acquisition I offered a 7 day close, and in addition to the bank accepting our offer, they also closed that quickly too!  Our offer was accepted on Saturday October 26th and we closed on October 31st. It takes over a month to close a purchase with a loan and even your typical cash buyer who wants an inspection will need 14 days to make it happen.

No Inspections:  When Mrs. C. and I look at a house we spend about 30 minutes doing as thorough of an inspection as possible.  We plan that everything that can be wrong is, and then make our offer with no contingencies.  Especially on a low value house banks love no inspection contingencies. We can only do this because we have cash reserves to handle these potential repairs.  This one is sketchy, and I’m still on the fence overall as to how often I will employ this tactic to buy houses below market value.  A home inspection can turn up significant problems that I personally can miss.  This may be an approach I should only employ for a competitive bid situation. As an example, we didn’t realize the well was shot on the last house we bought, costing us over $6,000!

Can Afford To Walk Away: I don’t need to buy another house.  Mrs. C. and I are not emotional buyers at this point in time.  We have overpaid before, and we are not afraid to let a deal fall apart now to get the price we want. Our goal is to eventually get to 10 houses, but it doesn’t need to be this year or next year. Having walking away as our best alternative to negotiation is a big advantage that I can’t stress enough.  The seller has a property that they need to unload, I don’t have to do anything.

Low Closing Costs: On all 3 properties we paid under $600 each in total closing costs.  Title insurance and recording fees are pretty much all we have to come out of pocket on.  With a traditional loan closing costs even on a low dollar house can exceed $3,000. This $2,400 delta would be 10% of the purchase price on my last house!

Long Time on The Market: In general I am making offers on houses that have sat on the market for greater than 60 days.  I keep a list of properties I am interested in and if they make it to the 60 day mark the owner or the bank is much more apt to accepting a low ball offer, this also reduces the odds of there being a multiple bid scenario. I check the MLS daily.

Buy Low Dollar Houses: The houses I am looking at are all sub $30,000.  The 3 houses I have bought so far have been $19,000, $20,000, and $24,000 respectively.  This is advantageous for multiple reasons.

First of all, far fewer people are looking to buy in this price range, so fewer competition equals better deals. Most first time home buyers are getting a mortgage and buying a much more expensive house in nicer condition.  Even a single earner making minimum wage in Michigan can get approved for a mortgage of $544 a month ($9.45/hr x 40 hours x 4 weeks x 36% Debt to Income ratio).  Subtracting $150 for taxes and insurance, gets us to a mortgage payment of $394. On a 30 year mortgage this a $80,000 house.  An FHA mortgage only requires 3.5% down and often closing costs are negotiated with the seller, meaning the buyer is only coming out of pocket $2,800 to buy their first home.  Far more buyers will go this route than buying a $20,000 to $30,000 fixer upper with cash.  A first time buyer with car loans / student loans might be approved for a lower loan amount, but typically they will still be buying closer to a $50,000 house than a $20,000 house.

When it comes to investors most investors are looking to get loans on their properties.  The economics of bank loans don’t work well with these low priced properties.  Banks don’t want to deal with sub 30K properties and if they do the closing costs are often 10% or more of the home value.  You also can’t get a loan for many of these properties due to condition. So if virtually no first time home buyers are going after these properties, AND the vast majority of real estate investors are also not going after these properties, AND I’m in a small market, then there is extremely limited competition.

Secondly, the listing agent typically receives a flat commission on sales in this price range, which means his/her motivation is to close a deal, not to get the top dollar possible.  Many of these are bank repos and the banks have a similar motivation.  They don’t want to have an abandoned house either,  they would rather lose a few grand off a sale price to get the thing off their books.  Banks are motivated to sell properties prior to fiscal closing dates such as end of the month or end of the quarter.  Sellers of these houses, including banks, are typically highly motivated to sell.  The headache of the properties and the liability of the properties make it easier for them to take a much lower percentage of the list price than sellers of higher dollar property.  Back in 2009 I was in that position.  I put ALL of our money into a tax repo house, Mrs. C. and I were constantly fighting over it and we decided to sell it.  We had it listed at $20,000 and ultimately took a $6,000 offer.  After paying a flat rate commission and closing costs I walked away with $1,800. If I did it, someone else could be in the situation to do it as well. (BTW If I could buy that house today for $6K I’d be all over it.)

Buy In The Off Season: In Michigan the majority of transactions occur between May and August.  Buying houses in November through February provides the best deals because not only are the listings stale, but there are far fewer buyers to compete with.

The Big Secret:  I buy where no one wants to buy.  This is probably the most important strategy to buy houses below market value.  I’m investing in a city (and the surrounding township) that has the highest violent crime rate in the state, and one of the highest in the country.  I believe that over the long term Benton Harbor will see an increase in jobs, a decrease in poverty, and a decrease in violent crime.  In the exact neighborhoods and blocks I am investing in I feel comfortable walking down the street, but these areas are by no means exempt from property crime or violent crime.

How We Are Setup To Buy Houses Below Market Value:

Mrs. C. and I have been aggressively paying down our principal residence mortgage for several years.  We have a Home Equity Line of Credit (HELOC) on our primary residence with a $60,000 cap. We use this heloc to purchase our rentals and to pay for the rehabs.  After we have owned the rental property for 6 months we can do a cash out refinance on the property for its new appraisal value.  We have to pay closing costs on the transaction, but we can typically pull out all the money we put into the house and then some. We are not doing this with all the houses and will have a mix of paid for houses and houses with loans.

As an example, the house we just purchased for $24,000 will have us all in at around $30,000 after the rehab.  It should appraise around $50,000, allowing us to get a $37,500 loan at 75% loan to value.  We can then reimburse ourselves the $30,000 cash we invested in the property, pay the $3,000 in closing costs, and have $4,500 left over, then repeat. This is called the BRRR method in real estate investing for buy, rehab, rent, refinance.

We also keep 6 months of living expenses in cash so we can weather any unexpected expenses that come up. Our average savings rate of 40% also helps greatly with this. We have margin in our lives to be flexible and we have significant positive cash flow.

Essentially we are reusing the same cash over and over again. We didn’t just fall into this money either, this home equity represents savings that has been built up for over a decade.  With most BRRRs we should be able to take out more cash than the acquisition cost and rehab cost, making our net cash into the property after 6 months a negative number.   Even with taking that cash out, whether we use that money to invest in another house or use it to pay ourselves for our labor,  we are still cushioned in the event we need to sell down the road because we have 25% equity in the house above the loan amount.

 

Improvements We Are Making To Buy Houses Well Below Market Value:

Mrs. C. and I are getting our Heloc modified at our credit union at no cost.  We are transferring our $49,000 balance from our primary mortgage to our Heloc and getting our Heloc based off our total house value of $169,000 giving us a Heloc of $135,000.  With the $49,000 primary balance this gives us $86,000 rather than $60,000 to make deals with, and as we pay down our primary mortgage balance this available credit increases.

We also had the terms changed from a 1.5% minimum monthly payment to interest only. This is huge! On a $60K balance before we had a $900 minimum payment.  Now the same balance would have a $250 monthly payment.  This greatly reduces anxiety over carrying costs, and our primary residence minimum payment drops from $570 a month to $204.

Where it gets really good is that we now have enough room in our Heloc for full self financing.  For lower dollar properties that would appraise for well under $50K getting a traditional bank loan doesn’t make sense because the closing costs are such a high percentage of the loan.  With roughly $80,000 available we can self finance 4 properties and with 25% cap rates essentially pay 1 off each year, allowing us to self finance buying 1 extra property per year and snowball from there, saving huge amounts of money on refinancing closing costs. The interest rate is variable instead of fixed, but is at a lower rate than what we can get a fixed for an investment property on.

 

New Strategies For Us To Try:

“Driving For Dollars”: In the real estate investing community driving for dollars means driving around neighborhoods you would like to invest in, make a list of houses that appear abandoned or otherwise distressed and then research ownership information.  Contact these people and let them know you are buying houses for cash and interested in their property.

Realtor Referrals: There are a few realtors in our area that control the majority of bank foreclosure properties.  I want to work on my relationships with these Realtors to let them know what we are looking for and then they can contact us directly when they are listing something in our criteria. We may be able to pick up some listings before anyone else sees them.

Dual Agency:  The idea behind dual agency is that the listing agent is much more motivated to close a deal with a buyer if they will get the full commission.  If I have a buyers agent their commission is effectively cut in half.  So far we haven’t been able to do this.  We started out with a buyers agent because we were a bit apprehensive about going through the sellers agent, but long term he wasn’t a good fit for us.  Our next property we tried to get a hold of a sellers agent but got no response so we went with another buyers agent, who sprung extra fees on us that just don’t make sense for the price level of houses we are looking at.  She had a minimum commission fee that we had to pay if the total commission on the property is below a certain amount, plus a $350 fee to her brokerage.  We again tried to go with a listing agent on our most recent house and after 24 hours he never got back to us,  in fact even at closing he didn’t realize he lost the full sale by not answering his phone or returning our call.

We really like the buyer agent we are working with right now, we were able to get a quick showing and the transaction went smooth without any extra fees sneaking up. Time will tell if we continue with a buyers agent or pursue dual agency.

Package Deals: Often when an investor is getting out of the game, or passes away, all of their properties hit the market at once.  Offering to buy multiple properties at once in this situation can give a serious equity gain.  For example, an investor in our area listed over a half dozen of his properties at once.  I’m sure after waiting 60 days a great deal could be had in the form of a buy 2 get 1 free.

Stupid Low Balls:  I’ve been asking for relatively small reductions in prices on the 3 houses we have purchased. I offered $16K on a $23K listing, $20K on a $23K listing, and $20K on a $28K listing.  I want to start selectively targeting houses that are extremely stale on the market and offering 33% to 50% of list price on them.  I took a $6,000 offer on a $20,000 house, I’m sure occasionally other people are in the same mindset. I also need to continue working on learning the art of negotiation. I recently started reading the book Never Split the Difference: Negotiating As If Your Life Depended On It.

What We Do To Keeping Costs Low:

Insurance: Mrs. C. has a great relationship with our insurance company and does a lot of work to keep our premiums low.  We typically insure our properties for $50,000 each and have decent liability coverage.  We keep a high deductible of $2,000 on all our properties. On average we are paying just under $500 per house per year for insurance, our lowest is $430 a year.

Property Taxes: Property Taxes can be insane!  In Michigan if the house is not your primary residence there is an additional 18 mil tax on the property.  In some of the areas I’m investing in this can come close to doubling the cost of property taxes.

In addition to that these houses are often over assessed.  The house I just purchased for $24,000 and will need to put $6,000 into it to make it rentable is assessed at being worth $76,000 I need to appeal the assessment to get it lowered to $25,000.  This is a yearly difference in taxes from $1,900 to $630. Saving over $100 a month in property taxes is a big deal, and all it will take is 30 minutes of my time.

Self Manage: By self managing we are saving 10% of gross rents on the face value of the situation. A property manager will also be more liberal with our money than we will be.

We Do Our Own Work: Having the skill and time to do our own work allows us to save a ton of money on the rehab, and thus increasing our long term returns on the property.  We’ve been homeowners for 13 years and the more projects we do the more we learn. This also helps us with understanding the rates contractors charge and puts us in a better negotiating position.

So far I have done plumbing, electrical, roofing, door installations, drywall, floor finishing, cabinet installations, tree trimming, mold remediation and a host of other jobs.

Shop For Deals:  I try to get our materials on discount when possible.  I check sales and we buy some things from Restore and FB marketplace.  I got a toilet for $35 from Restore and several GFCIs for only 50 cents each.  Off the marketplace I bought an electric stove for $50.  I’m now buying new appliances for our rentals and typically get a scratch and dent from Lowes.

Current Goal:

I like the pace we are on right now of 2 to 3 per year.  Our current goal is to get to 10 rentals total, pause and see our comfort level.  At that point if we buy more we should be in a position to do all cash without Helocs or refinancing down the road.

Do you invest in rental real estate?  What are your strategies to buy houses below market value?

John C. started Action Economics in 2013 as a way to gain more knowledge on personal financial planning and to share that knowledge with others. Action Economics focuses on paying off the house, reducing taxes, and building wealth. John uses the free tool Personal Capital to track his net worth and posts quarterly updates on his finances. Check out the Action Economics archives section for all past posts.

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