|LM says: Determining the offer price basically consists of being able to calculate the following four things: |
1) First and foremost the after repair value (ARV)
2) The cost of rehab
3) All other costs
4) Your expected profit
…then you will take the ARV and deduct 2, 3 and 4. The result will be your offer price.
Now…since the devil is in the details let take a quick look at how to calculate 1-4…
After Repair Value
This is by far the most important skill that an investor has to develop. If you learn nothing else in this business make sure that you become good at determining how much a property will bring when you put it back on the market after repairs are done.
This basically consists of first looking at the property you are considering and see what similar properties have recently sold for in the near vicinity. The underlined words are key for the following reasons:
- Similar properties – if your house is a 3/2 ranch don’t compare it to a 2 story 4/2. Look for other 3/2 ranches with similar square footage, neighborhood, construction, etc.
- Recently sold – I don’t look at anything that has sold past the last 6 months. Technically appraisers can consider properties that have sold as far back as a year ago. But in this challenging appraisal market they will not use older sales if they have newer sales to choose from.
- Vicinity – don’t look for comparables 2 miles away unless there is NOTHING in the near vicinity. Most appraisers will look first in the same neighborhood and sub division. Then they will start going out if they don’t find anything. They might go out as far as 1 mile but that would be pushing it. If like me, you are in a densely populated area, then there should be plenty of comparables within 0.5 mile or less.
Once you have gathered a good set of recently sold homes you will look at what they sold for, the condition that they were in and how long they took to sell. From looking at what price they sold for and what condition they were in you should be able to get an idea of what a REALISTIC ARV your property is going to have.
Determining the ARV of a property is by far the hardest skill in flipping properties, in my opinion… It is neither easy nor fast and if you get it wrong it will all be downhill from there. So take your time and practice.
The Cost of Rehab
Lots of people get hung up on the lack of construction experience or the cost of granite vs Formica, etc. But the reason this comes second (far second) is because you can pick your rehab based on the ARV (to a certain degree).
Here in Atlanta for example, you don’t put granite in a $90,000 dollar house, or you don’t spend $30,000 rehabbing a house that you are buying for $55,000 and the ARV is $95,000.
However, what if that house could be rehabbed for $15,000 and sold for $90,000? Could it be a good deal then?...possibly…see my point?
Once you decide the type of rehab you want to do then you got to get good at estimating rehab costs. By rehab I am referring to everything that is going to happen from demolition until the cleaning crew is done. Get estimates from your contractors and spend some time at Home Depot getting familiar with the costs of things.
All Other Costs
There is a lot of them, just make sure you include here everything from the costs of financing, agent commissions, taxes, lawn care, utilities, advertising, staging, HOA fees, etc. Just put on your thinking cap and look down the road for 6 months and include every expense that you will incur for that property.
Since you are obviously in this to make money this is important however it needs to also be tailored to the deal. I hear some investors say that they will not do a deal for less than say, $20,000 profit. I am of the opinion that the profit has to match the level of risk and scope of the deal.
For example, if I was going to buy a house for $40,000, do a $15,000 rehab and resell for $75,000 in a total time of 3 months, would I accept a profit of $15,000…you bet! ( this was the case with House #5).
It’s a low expenditure of money, time, risk and effort so I am fine with accepting a lower profit for lower effort. On the other hand if I am buying something for $90,000, doing a $50,000 rehab and then putting on the market for $200,000 with the possibility of having to reduce to $190,000 and it might take 2 months to rehab then I absolutely want to see a higher profit, probably $25,000 to $30,000 minimum.
If in the offer stage if you cannot REALISTICALLY see that you are going to make your target profit then you might have to reconsider the deal.
So there you have it…like everything practice makes perfection. I haven’t always gotten all of these right but I have not gotten them wrong to the point where I have lost any money (knock on wood) on any of my deals.
What would be great is if you shared with us how you have been doing it or if you have a better way…