The formula isn’t hard at all, it’s getting your estimates as close to correct as possible is the hard part. The formula is simple; “Maximum you can offer on the property = After Repair Value – Rehab costs – Holding cost – Buy/Sell closing costs – the Profit you want in the end”. I have seen many investors walk away or lose a good deal because they got caught up in the numbers.
The definition of the terms in the formula:
1. ARV or After Repair Value is what the property will be worth after it is fixed up and ready to sell on the market.
2. Rehab costs are just the amount that it will take to fix the property up.
3. Holding costs include what your monthly debt service or mortgage will cost you per month for as long as it takes to get the property ready to sell. This time frame is usually anywhere between 3 to 6 months.
4. Buy/Sell closing costs. You have to remember if you plan to flip the property, you will close twice, once when you buy and once again when you sell to the final buyer.
Profits, the fun part we all like! How much should you make? What’s fair for the current market? How much would it take to make the deal worth going into and taking the risk? Using the formula above, see if the profit you have in the deal is worth going into the deal itself. If not, walk away, it’s not worth going into. The last thing you want to do is over price your finally profit, you might not be able to sell the property. Remember, if you plan to flip the property back on the market, the longer you have to hold the property, the more it’s going to eat away at your profit margin. So make sure your After Repair Value is as close to correct as you can get it.
Something else to consider, if you plan to wholesale the property or assign your contract to another investor, you will need to consider leaving enough profit in the deal for the future investor to make it more attractive to buy the contract. Wholesaling or assigning is the act of getting a property under contract for purchase, and assigning it to another investor for a small fee of up to 10% of the future profits in the deal. The investor buying the contract is the one that will do the rehab work and put it back on the market, and will have the greater risk involved in the deal.
You need to remember that this amount is the maximum you can offer and still make a profit that makes the deal worth going into in the first place. This doesn’t mean that this is what you will offer. The less you can offer and still make it a win-win deal for everyone involved will raise your profit margin. If you cannot negotiate at least the maximum amount from the above formula, then walk away from the deal, it’s that simple.
This principle will work for more than just investors. If you’re buying a home to live in, this article will help you on selecting, estimating, finding, and buying a great fixer-upper that has a nice equity position. An equity position is like having a down payment of sometimes as much as 30% of the value of the property, your mortgage terms will be a lot better. And your monthly payments will be greatly reduced. And if you are half way handy with tools, you can live in the house while you get it fixed up.