For some reason or other, people who buy and sell houses like to call themselves INVESTORS. In many areas they have banded together in “Investment Clubs” that meet regularly. It's difficult to find many people at these meetings who earn six-figure annual incomes. This may be because they don't comprehend that buying and selling houses isn't an investment; it's a business.
A business that needs to be operated in a business-like manner with profit as its sole objective. The more things you can think of before you start spending money, the better.
It's always a lot cheaper planning your operations on paper to see a business in its entirety rather than just jumping in hoping that you'll be able to swim. Before starting up any business, the first step should be to write down a business plan. It should specify the WHAT, WHERE, HOW, WHO – and most importantly, WHY – of the kind of enterprise the business is going to engage in.
The WHY of any business boils down to how much money you expect it to earn, and why what you expect to do will be profitable. Assuming that you're going to either quit doing something that you're already doing to devote time to a business, or are going to have to sacrifice all of your free time to try to make money doing two things at once, setting a price on your effort to reward you for what you're doing is the first step.
In the foreclosure buy/sell business, I started with a dollar figure the business should make the first year, then I figured out a reasonable net profit margin the business should earn before income taxes. From this, I calculated what my gross profit margin should be on each house I buy. This determined the maximum price that I should pay for any house at foreclosure sale.
In my own case, rather than trying to build a big business, I like small businesses that I can operate with the least outside help. You should make a best effort to define how big your buy/sell foreclosure business will be the first year in terms of gross revenue and how big you expect it to become. In this context you should itemize the labor you'll need to hire to support the scope of operations, whether you'll contract for part time labor or hire full time employees.
Next, you'll have to decide what equipment will be needed, and whether you'll buy or rent it. You'll have to identify materials and supplies you'll need, where you'll obtain them, how you'll pay for them.
At this point, an inventory should be made of your personal capabilities to provide as much of what's needed as possible out of what you already have, and how much additional labor, equipment, and materials you're going to have to rent or buy.
Last of all, but certainly not least, with most of the planning done, you're going to have to figure out how much cash and credit you're going to need, where it is going to come from, and how much that will cost.
Here's an example of how I approached the foreclosure buy/sell business: I decided that I should aim to earn $100,000 in pretax income based upon being able to buy and sell one house each month over the first 12 months. If I tried to focus on houses that I could buy a house at foreclosure for $100,000 or so, put no more than $10,000 into it to prepare it for market, and sell it for $130,000, I should be able to net $20,000 less any brokerage commissions.
When I tested my business plan in my primary market, I saw that competition had driven profit margins down below what I was willing to accept. I had two choices: Either give up my plan, or to look for another market. To operate a business in another area, I figured out that I needed someone who could take charge of buying, fixing up, and selling houses. My contribution would be to round up cash to support the operation.
To motivate someone with the ability and expertise to do what needed to be done, I reasoned that I'd have to give away half of the gross profit on each transaction: thus, I would only realize half of the gross profit. That was the bad news. The good news was that the person I found to work with already had most of the tools and equipment needed, and a ready source of labor to do just about anything that had to he done. About all he needed from me was a source of cash so he could expand his operations. I was able to get a pension plan to lend the money on a line of credit loan secured by the houses being bought.
Once I'd begun to get a handle on what the market could produce, I estimated that, in order to earn the $100,000 per year that I wanted, I'd need to try to get three houses into my profit pipeline: one being bought, one being prepared for sale, and one being marketed and closed to recycle the cash.
Let's do the math.
|
Cost of house at sale: |
$100,000 |
|
Cost of Fix-up: |
$10,000 |
|
Cost of Interest |
3,000 |
|
Sale Price: |
130,000 |
|
Cost of sale: |
5,000 |
|
Gross Pre-Tax Profit: |
12,000 |
|
Multiplied by 12 Houses Per Year |
124,000 |
|
Divided into half for each person: |
62,000 |
My business plan had to modified to accept a little less than the $100,000 I originally specified as a reasonable profit projection, but nothing in real estate is a tidy as my little plan. I was prepared for many variations that could be anticipated.
A major breakthrough was that the wife of the person I shared profits with spent hours in the courthouse doing research that enabled us to bid on many more houses. We found a real estate broker who agreed to list each house in the Multiple Listing Service for about $500 per house, so we only had to pay 3% brokerage commissions on sale. Happily, prices were rising in our market so profit margins were a little higher than expected.
We discovered that we could make higher profit margins with more expensive homes with about the same amount of effort, so the prices we paid rose over the year. The first year, we actually bought 13 houses at prices ranging from $93,000 to $173,000 and our gross profit margins ranged from about $11,000 to $54,000.
