Understanding Investors

For all the adverse hype about low purchase offers and stiff negotiations, real estate investors actually play an important role within the housing market.

It is generally true that experienced investors submit purchase offers at lower prices than home buyers. The real estate investment model, just like investing in the stock market, is about making a profit and trying to reduce risks.

During a boom period of the real estate cycle, home sellers receive enough valid offers from interested buyers that they are insulated from the reduced offers of investors. However, we are now in the midst of a foreclosure crisis that is rapidly depressing real estate values across the country. Additionally, we are experiencing a lender liquidity crisis that is preventing even well qualified buyers from securing conventional financing.

There is no question that in times like these many property sellers are increasingly open to any and all buyers, even an investor who makes discount offers.

So, if you are a homeowner or a Realtor who is trying to sell a property you may want to prepare yourself for working with investors.

It is helpful to have an idea of their perspective. Now we can address the investor's needs and conerns.

Overwhelmingly, the primary goal of investors is to make a profit. Thus, when an investor places an offer on a property they generally discount the price to make sure that they have room to generate a profit through collection of rental income or via reselling the property.

With profit as a top priority, investors tend to worry about things that increase their risk of losing money. You will often find that investors pay close attention to: 1) the repairs a property needs; 2) the condition of the surrounding neighborhood; 3) the potential rental income of a property; 4) any expenses associated with holding and maintaining a property; and 5) the after repair value (ARV) of a property.

For many investors the ARV, coupled with estimated repair costs and the acquisition price, are the only major factors considered when making a purchase. Therefore, if you want to better understand investors, it is in your best interest to know how an ARV is determined.

An after-repair-value is exactly what it sounds like; it is the estimated resell, or refinance, value of a property after repairs have been completed. The best, and most common way of calculating an ARV, is by selectively observing the recent sales values of nearby similar and comparable properties. Note:  Regardless of the present condition of the target property, investors only review sales of properties in good condition to determine the ARV of the target property.

Once an investor has obtained recent sales data for comparable properties, he/she can simply take the average value and apply that as their best estimate for the ARV for the target property.

Pinpointing a reasonably accurate ARV is essential to investors for a couple of reasons. First, the ARV represents the value at which a property will likely sell after it has been repaired. That means the ARV is an investor’s cash-out point. Secondly, given that the ARV is the assumed sales price at a later date, investors tend to work backwards from their assumed ARV to determine the offer price.

Although each investor may take a slightly different approach, ARV based offers are generally calculated along the same line of thought. Recognizing that the process of buying, repairing and then renting or selling a property takes time and costs money, experienced investors factor their estimated costs into formulating their offer.

That formula usually looks something like the following:

Purchase Price = ARV – (repair costs + holding costs +closing costs + desired profit)

What that means is that the amount an investor offers you (Purchase Price) is equal to what they believe the after repair value of the property (ARV) is minus all the expenses they expect to incur while repairing and attempting to resell the property. Of course, they also give consideration to the amount of profit they hope to gain. Notice we said “hope.” That’s because real estate investing is risky and many investors fail to make profits even when they buy properties below market value. This happens because investors either fail to anticipate all of the expenses involved, they miscalculate the ARV, or the real estate market detioriates and depreciation occurs (meaning the property loses value).

If this was your first time learning about ARV’s and Purchase Offer calculations then things might still be a bit unclear for you. Don’t worry. A simple way to guesstimate what an investor can comfortably offer on a property is to follow these steps:

1) Determine the realistic value your property would have if it were fixed up and in good condition

2) Take 20 to 50 percent off that number

3) That’s it! Your final numbers may not be precise, but they are very likely within the range of what investors will offer (unless your property is in such poor condition that it is better to knock it down and rebuild a new one)

Why do investors need 20 to 50 percent discounts off ARV? Try and remember that buying, fixing and reselling a property takes a lot of time, effort and most times money. Generally speaking, investors know they will have to pay a Realtor approximately 5-6% to sell the property; they will have to pay mortgage payments or financing charges on the house while they fix it up; they may have to spend 5%, 15% or even 30% of the property’s value in repair costs; and lastly, they will want to make a fair profit.

With so many variables to build in, investors really do need pricing cushions if they want to stay in business.

The moral of the story is that investors are people just like the rest of us. They are running a business, crunching numbers, and usually working hard to live a decent life. So,don’t be taken back by the discounted offers they may place on your property. Instead, understand their perspective and make an informed decision about how, and to whom, you sell your property.