Potholes #4 & # 5 - Holding & Selling the Property

Please pay attention, dear reader. This is critically important. These expenses can suck all the profit right out of your project, and if you're a beginner you'll never see it coming.

Sometimes, the real problem isn't in the getting, it's in the having.

In other words, you can do a bang-up job renovating your project property.  But, if you don't sell it quickly, those holding costs will eat up all your profit.

Let's say, for the sake of argument, that you bought your property for $100,000 and put $60,000 into it with the expectation that it would sell for $200,000.  You'll probably have to put about $50,000 of your own money into the deal by the time it's ready to sell.

You're thinking $40k / $50k = 80% return on investment (ROI), right?  Uh...nope.  Not even close.

You're probably going to pay somewhere between 8%-10% of the selling price for closing costs, sales commissions, etc.  So half of your profit disappears at the closing table.

So that means $20k / $50k = 40% ROI, right? Nah, sorry.

Every month that you don't sell it, you're going to pay another month's interest, plus other holding costs like insurance and utilities.

A typical renovation loan will run 4%-6% over Prime, interest only, with a 12-month balloon.  If you've used hard money instead, you may be paying 12% or more.  At 6%, a month's interest on $170,000 = $850.  At 12%, a month's interest is $1,700.

And don't forget those other pesky holding costs. We'll budget $500/month for those - making $1,350/month at 6% interest, and $2,200/month at 12%.

It takes a while to find a buyer and get to the closing table.  It'll take 2 months, if you're lucky. Maybe as much as 6 months if you're not. So, your holding costs might be as little as $2,700 or as much as $10,200.  That means your profit would be...

$17,300 / $50,000 = 34.6% ROI

- or -

$9,800 / $50,000 = 19.6% ROI

Now, don't get me wrong - 19.6% ROI is a pretty darn good rate of return in today's world. It beats the heck out of the 1% certificates of deposit being offered by banks.

But, think about the big picture. What if your project ran into unexpected problems, and you had to spend an additional $10,000?  Suddenly, your numbers change DRASTICALLY.

$7.300 / $60,000 = $12.2% ROI, if you have a 6% loan and close in 2 months.

Or, you lose $200 if you have a 12% loan and close in 6 months.

Okay, class - here's your pop quiz.  What lessons can we take from this?

1) ALWAYS know and take into account ALL your deal costs
2) Be really conservative because things will probably go wrong somewhere
3) Be fast because every month chews up your profit due to your holding costs

That's it for today's blog posting.  Stay tuned for Pothole #7 - Taxes.

You didn't forget about your uncle, did you...?