This subject is very important and is the foundation you build and grow your real estate investing. Many gurus will tell you “how to do this and how to do that”; however, seldom do they consider what is acceptable to you. Let's start with a “Comfort Zone” test question. Here is your test question and investment scenario.
It is 10 a.m. on Monday morning. You are contacted with a real estate opportunity. A good solid 3 bedroom brick ranch in a good neighborhood needing paint and carpet. After paint and carpet, the house will be worth $85,000. Paint and carpet will cost you no more than $3,000. You have absolutely zero cash. This property is scheduled to be sold at the court house at 11 a.m. tomorrow morning. If you can close before the court sale, you can capture this property for $45,000. Your only resource to cash to do the deal is from a private lender loan shark with the following terms.
Loan Amount: $ 45,000
Interest Rate: 48% APR Simple Interest
Payments: Interest Only (monthly payments)
Will you do the deal?
(That's right, 48% interest)
Be honest. What was your initial mental knee-jerk reaction? It does you absolutely no good to dwell on it and try to second guess me here. This is for your benefit. After verifying the condition of the property, the neighborhood, and needed repairs as noted, and with no other resource to cash to do the deal, I would not hesitate to do this deal. I do not like the 48% interest rate, but if this is my only resource to do the deal, then yes, I would do it without hesitation. Let's focus on the numbers and see why. Here is how I cipher my numbers. 48% APR simple interest with interest only payments can be broken down to simple easy terms in two ways.
– 48% of $45,000 = $21,600 for full year of interest
– $21,600 divided by 12 = $ 1,800 month interest
– 48% APR divided by 12 months = 4% per month.
– 45k X .04 = $1,800 monthly interest
Both methods give you the same answer. Simply choose one that seems easiest for you. I use the second method to cipher monthly interest. Now in analyzing your fast-on-your-feet real estate opportunity, you can see you can purchase this $85,000 property for $45,000 and it will cost you $1,800 a month in interest only payments. This is close to the cost of a furnace. Maybe change your method of doing the math. Factor the interest in the deal just like paint and carpet. So all totaled for 30 days, you would have:
Sale Price: $45,000
30 Days Interest: $1,800
To really be thorough you need to factor in property taxes, insurance, utilities, and closing costs; but the purpose of this scenario is a comfort zone test question.
There are two simple choices for you with this opportunity.
1.) You could purchase it using the 48% loan shark money and “refinance” it asap for a long term hold.
2.) You could sell it quickly to another investor. Surely you could find an investor who would pay 60 or 65k for a house worth 85k? This would net you a quick 10k to 15k for your knowledge.
3.) Your third choice would be to restructure the loan shark debt and get cheaper short term money and sell the property at close to retail price. This is painful and the hardest challenge. If you try to retail this property using an agent you will have additional expenses of:
- a 7% commission
- seller paid fees especially on first time home buyer programs
- nickel and dime repairs found by the home inspector to make them feel like their service is needed
- utility expenses
- lawn service
- more taxes, and insurance
Remember, most retail buyers are not cash buyers and need a mortgage to buy. Their loan application process could take up to 2 months and sometimes they are promised the moon by “mortgage brokers” only to learn after 6 to 8 weeks they can not be approved. In fairness to folks in this business, there are some investors who excel in this arena and take charge of the process insuring a closing within 2 weeks. This does happen, but normally after having experienced some of these things mentioned here. So back to the comfort zone test question. Don't lose focus of the purpose of the question. Yes, it is extreme and a “pie in the sky” scenario, but the point is – would you do the deal?
- Does it seem like a no-brainer or did you hesitate?
- Was your mental knee jerk reaction “Yes” or “No”?
This is a powerful excellent example of how your own comfort zone can limit your investing opportunities. Do you pass by and step over fantastic deals because they do not fit into your “comfort zone”? The simple challenge is to identify and e-x-p-a-n-d your comfort zone. What is acceptable to me? What do I like and dislike?
Education is the Key to Expanding Your Comfort Zone
Your comfort zone is not limited to knowledge and education. What kind of properties you choose, the locations you like, and more. Do you like one story houses in the suburbs or do you like big two and three story behemoths in the city or preservation districts? Do you like single family, duplexes, or multi-families? Do you prefer commercial properties such as strip centers, offices, retail, industrial, etc.