I am certainly not going to take any credit for coming up with the term “prehabbing” or inventing it as a method of investing. However, I do want to share with you what I have been doing in this super hot real estate market in Baltimore.
As of late, I have seen a huge frenzy of people buying just about anything. It was only a few short years ago that homes which needed a little bit of work would sit on the market for quite some time if they were not priced right. In today's market, I see fixer uppers selling within days to homeowners and investors alike for top dollar.
As an investor who buys properties to be profitable, I'm amazed at what people are paying for properties that need work. I attend auctions, but really don't know why I go because I know that I'm going to be outbid! Before I can even raise my hand, the bidding passes the amount that I was willing to pay. I get a kick out of it and normally wonder how the buyer, who in many cases is an investor, intends to make money.
I'm convinced that this is the formula that investors are using today to buy properties:
ARV + 20% (appreciation by the time they sell) = ARV to be used to determine purchase price. Then they use this formula to buy: ARV (the inflated one) x 80% – Repairs = Offer.
Note of Caution- I'm not advocating the above formulas. This is just my observations of what I think investors are thinking when they buy these days.
After working through this formula, investors are paying near retail for homes that need work. I don't get it. I'm still buying well below market value in this hot market and don't even need to rehab the property to make a nice profit. Instead, I'm “prehabbing” the property. That means I'm simply cleaning the homes up, cutting the grass and laying some mulch, then selling “as is”. I've sold many of these “prehabbing” homes by listing them and having auctions. The auction route, with a good auction company, has proved to be extremely worthwhile.
An example of a deal that I just did the other day is as follows:
The home was in a $230,000 neighborhood and needed about $20,000 in repairs. I bought it for $151,000 (after all costs). Three weeks after taking title and doing some prehabbing work, I auctioned it off for $202,000.
The terms of the auction required the purchaser to put down 10% in certified funds and buy “as is” with no inspections. Additionally, the buyer has to pay 12% interest to me on the unpaid portion of the property up until the day of settlement.
After all expenses this deal will net right at $39,000.
If the investor who bought this property from me used the formula that I'm guessing he did, his numbers would look as follows:
$230,000 + 20% ($46,000) = $276,000 x 80% = $221,000 – $20,000 repairs = $201,000
Even if homeowners had purchased this property, they would have received a fair deal. They could have fixed up the house to their taste and still been into the home for a little bit below fair market value.
If the market continues to appreciate the way it has been, many investors using this formula will come out OK. They won't do great, but they'll get by. But if the appreciation just stalls a bit, I believe many investors will be hurting.
The moral of this story is that you don't need to do much along the lines of rehabbing in a super hot market. Will I ever rehab again? Sure I will! When the Baltimore market changes and investors need to offer the best house to get the most money, then I'll rehab again. But for now, I'm going to do as much “prehabbing” and not rehabbing as possible.