Note from Justin: Mike Simmons from Just Start Real Estate is here again sharing the 5th of 6 limiting beliefs that keep you from making 6 figures in real estate. If you haven’t had a chance, be sure to check out parts 1, 2, 3 and 4!
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Over these six weeks, I am going to go over what are, in my opinion, 6 Limiting Beliefs That Will Keep You From Making 6 Figures in Real Estate.
At times, I am going to use tough love to deliver the message. This is not with the intention of discouraging you or making you feel bad about yourself, but I really think the best thing an experienced investor can do for someone who is starting out is to be frank with them. Sugarcoating the facts only gives the impression that it’s not that big of a deal.
Justin has a saying: Fail Forward Fast. He uses the word “fail” because that is exactly what you will do in the beginning. You will fail and you will have setbacks. He doesn’t use a soft or vague word; he is deliberate in using the word fail, just like I am going to be deliberate in telling you what beliefs are going to hold you back in this industry. Then, I’m going to tell you why these beliefs are absolutely ridiculous. So get ready for the truth, and get ready to grow as a real estate investor and to shed the BS that 95% of would-be investors use as an excuse not to get started.
Here is the fifth limiting belief that is holding you back in real estate:
You think that the more money you spend on a rehab, the more money you will make when you sell.
As a real estate investor, there are four important financial indicators that determine whether or not you will make a profit. I have given you the formula in past posts so I will not cover it in detail here, but here are the four critical financial factors. You only have total control over two out of these four.
- You control – Purchase Price
- You control – Rehab
- Mostly out of your control – Fixed Selling Costs (taxes, commissions, etc)
- Mostly out of your control – Sale Price (controlled by the market)
I’m sure some of you would argue that you do have control over selling costs. You might sell the property yourself in order to avoid realtor commissions, but you will still usually end up paying a buyer’s agent their commission. Or you might argue that you do control the ultimate sale price, but you are mostly at the mercy of the market and appraisals.
The two factors that you ultimately control are the purchase price and the rehab. Once the property is purchased, the only factor that you have total control over is the rehab budget. The rehab budget is often what is going to make or break your investment. Blow the rehab, and it can have a big impact on your profits.
As a house flipper and real estate investor, your number one objective is to make money. Your rehab will have a tremendous impact on how much money you make with your flip, or even on whether or not you will make money. It is even entirely possible that you will lose money based on the decisions you make during the rehab.
A property that you are going to flip should be renovated to a level that meets or exceeds buyers’ expectations. It should go without saying that all of your materials should be new, and that the quality of the work should be very, very good. When I say that the rehab should meet expectations, I am specifically referring to the types of materials that are used.
The easiest and best example I can give you to illustrate the importance of meeting expectations is the decision to use or not use high-end materials such as granite.
In some neighborhoods, it is expected that countertops be granite, marble, quartz, or some other high-end material. In other neighborhoods, laminate countertops are all that is expected. Most new house flippers generally think that if they use all high-end materials to do their rehab, they will make exponentially more money when they sell.
And it’s true that, in some houses, it will look very unusual to install a $60 sink from Home Depot. If the other houses in the neighborhood have very expensive kitchen features, you will have to conform to what is normal for that market. In other markets however, anything more than a $60 sink from Home Depot will be completely unappreciated and will not increase the value of the house. In many markets, crown molding, although nice to look at, will not do much, if anything, to increase the price of the house. The buyer may appreciate it, but the sale price will not be affected much.
A very important factor that many new real estate investors and house flippers fail to understand is that the after-repair value of the house that you are flipping has a limit. In other words, the market will dictate the maximum sale price for any property.
For example: in my market, I can buy a house for $50,000 that will ultimately have an after-repair value of $150,000. In order to make that house worth $150,000, I will probably have to invest $30,000-$40,000 in the rehab. If I choose to blow my budget and spend $90,000 on the rehab, that does not mean that the house will sell for $200,000.
Spending more money does not guarantee selling for more money.
If all the other renovated houses in the area have sold for between $140,000-$160,000, it is unreasonable for me to expect my house to sell for $200,000. It simply will not appraise that high just because I chose to overspend on the rehab. When the buyer tries to get financed to purchase the house, the banks will require an appraisal.
Appraisers use comps from the surrounding area, and those comps generally dictate what your house is capable of selling for. If you want to know what the market expects and what the market will support, you need to check out your competition. Go to open houses in the area. There will inevitably be houses for sale that have not been updated in a very long time—you should not be concerned with those. You should pay attention to the houses in your market that have been updated. These houses are your competition. Look at the finishes of these houses. What types of materials are they using? Your house should use, at a minimum, the same or better materials.
The idea here is to try to look nicer than your competition without going overboard. If you estimate that someone in your market spent $6,000 to renovate the kitchen, you should not spend $30,000 renovating your kitchen. But if the renovated houses in your market are all using granite countertops, you should be using granite as well. Your ultimate goal is to make your houses look a little better than the competition without spending any more money than you budgeted.
Most of your competition will probably consist of houses with outdated kitchens and baths. Most of them will not be freshly painted with new flooring. So as soon as you put new materials into your flip, you will instantly surpass 80% of your competition. New always beats old and outdated. Even inexpensive materials, if they are new, will beat outdated materials.
Finally, it’s very important that you do not treat the property that you were flipping like you would your own house. Remember that a flip property is an investment. The goal of that investment is to buy it for the lowest possible price and then renovate it as much as necessary in order to sell it for the highest possible price.
Please note—renovate as much as necessary, not as much as you would your own personal home. Falling in love and getting personally invested in a flip property will almost always lead you to spend more money than is necessary.