First, I want to touch briefly on the paperwork that comes your way. I won’t go into too much detail because it is boring and really won’t help until you are actually in the moment, trying to complete this paperwork. Here are a few of the documents you will encounter, though.
Purchase Agreement (PA): The turnkey company will send you this document, which are basically the terms of your agreement including the agreed upon price, any conditions under which you can renegotiate the price, and rent guarantees, and any earnest money required. Let me explain two of those a little further. First, in my Purchase Agreement (PA), it was stated that if the appraisal of the property came in at under 93% of the agreed upon price, I had the ability to renegotiate the final price of the property. Personally, I think this is a great little clause and it has definitely come into play for me as you will see later. The second is the Earnest Money. For me, we agreed that I would send the title company $5,000 to show that I was earnestly interested in the transaction. That $5,000 later applies to the final sale. If you don’t go through with it, they will refund it to you.
Your Financials: You need to gather up bank statements, brokerage account statements, tax returns, copy of photo ID, and depending on the situation, various other documents to send over to the bank so that they know they can count on you to pay the loan back. Of course, the idea is for you not to have to spend your OWN money to pay the mortgage, but rather to have a portion of the rent go to paying that off, but in the bank’s eyes, that really doesn’t matter. They are not in the business of determining if this is a good investment deal for you, so they don’t take into account that income potential.
Good Faith Estimate (GFE): This comes from the bank and outlines what your mortgage will look like. This document will give you a better estimate for numbers to plug into your spreadsheet to calculate the simple math of real estate investing. This is great for double checking and making sure that this is still a good investment for you. It will not only have your estimated monthly payment on the mortgage, but will also show you what your expected closing costs will be.
Random Other Paperwork: As you go through the loan process, it is important to have access to a scanner. There could be a small change in the paperwork above. The title company could need to move your earnest money from one account to another. The lender may need to see another one of your bank statements. There are a myriad* of changes that can occur in the paperwork and you need to be able to get those documents signed and sent back to the lender throughout the process.
Phew. Glad that’s over. Paperwork is an important part of the process, so don’t gloss over it, but it still isn’t my favorite. On to the appraisal.
The appraisal process is essentially the lender finding a third party to say, “this house is worth $x”. The lender needs this to make sure they are lending you the appropriate amount of money. If you agreed to pay $500,000 for a house and they are lending you $400,000, but the house is ACTUALLY only worth $100,000, then they are lending you WAY too much money. It increases their risk that if you hit hard times, you won’t be able to sell the property and pay back all, or even most of the loan.
So how does an appraiser figure out what a property is worth? One word: comps. Comps, short for comparisons are other houses that the appraiser thinks are similar/comparable to the one you are a looking to buy. These houses have been sold recently, so there is a precedent for them and they are a way to gauge the market for similar houses.
Oh, and naturally, you pay for the appraisal. My appraisal on Property #2 was $550. Save your receipt for tax time!
Of course, comps can be very difficult. As you can imagine, houses are all pretty unique and turnkey properties that have been recently rehabbed are often compared to houses that haven’t been updated in a number of years, so while appraisals are VERY important to me, they don’t constitute a final price that I refuse to pay more than.
I mentioned in “The Paperwork” section of the post that I agreed to a clause that said I could renegotiate the purchase if the appraisal comes back at 93% or less than the agreed upon price. In my case, it did! So what does it mean for me that my appraisal was low?
I had agreed to purchase the property for $72,000. My appraisal came back at $65,000. I took a look at the appraisal documents which talk about each of the comps that they find. Most of the comps that they found were actually above $72,000, with only one below $65,000. To me, that means that they really couldn’t find very good comps.
Now, I don’t want to be underwater. Basically, if I bought this house and then something went terribly wrong and I had to sell it next year, I know I would lose money. If I couldn’t sell it for even close to what I bought it for, I would lose even more money.
However, the plan is to keep the property for the long haul, so while I want to minimize my risk on the purchase price, I ALSO want to look at my cash flow numbers to make sure I am getting a good investment.
In the end, I renegotiated the price down to $69,000, which gives me an even better ROI and makes the whole investment a little better for me. Is the turnkey company getting a good deal, selling the property to me for $4,000 over the appraised value? Absolutely. Should I let that deter me from investing in a deal that has a good, positive expected return for me, where the numbers and math work out in my favor? No way. I am happy for the turnkey company to make their money, as long as I am making mine!
*To those interested in nerdy grammar talk: yes, I am using the word “myriad” as a noun. This is less common these days, I have found, but it is the way I became familiar with the word and it is a grammatically acceptable form.
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