Why Is Your Fix and Hold Offer Wrong?

If you're a real estate investor like myself, you've most likely attended many seminars, workshops and the like. If these courses involved fix and flip real estate, they have undoubtedly included a formula to make offers to buy investment properties to rehab and resell.

However, I cannot seem to think of any documents in the real estate investing game that shows how to appropriately calculate offers on single-family homes that are to be used as long-term rentals. Surprisingly, it is on these long-term hold properties that investors can get into trouble, because they are trying to use a fix and flip calculation/method on a fix and hold deal.

To make correct offers on rental property, the savvy investor has to work backwards, using Time Value of Money formulas, to come up with an offer. They have to consider many parameters, including: desired monthly cash flow, prevailing local rental rates, local vacancy factors, rental-based repairs (not flip based), loan amount(s), length of the loan(s), prevailing interest rates, and closing costs. Keep in mind, we also want to purchase the property with a sufficient of amount of equity remaining. In a nutshell, the correct formula and method for making offers on single-family rental property is complex.

I believe this is where the term "How Much Can The House Afford," comes into play. In this statement, the offer price is derived by how much the house can afford to support the required cash flow, the loan repayment, and other monthly expenses. When the formula and methodology is not implemented properly, the investor is left with cash out-of-pocket and monthly negative cash flow (and, not to mention, tenants).

In the old days of real estate appreciation, the investor would simply wait for a while and let appreciation handle the mistake by selling the property at the appropriate time. In today's downward-trending real estate market, selling soon after a purchase could make it difficult to unwind a rental property purchase that was miscalculated from the beginning.

Can we say "future foreclosure"?

After years of doing these equations by hand, my partner and I have developed a software program that gives us an unfair advantage when computing offers on long-term hold rental property. We can actually iterate all of the variables, including interest rate, loan terms, rental repair cost, vacancy factors, monthly rent, desired cash flow, and first year pretax cash-on-cash return, while we are on a call with the seller (and so can you).

The fix and hold market is perhaps juicer today than it has been for a long while, but one has to really zero-in on the correct offer strategy.

To Your Success,

Tom & Svein