So you’ve been watching all the cool house flipping shows on TV and now you want to flip houses yourself… the problem is: the shows don’t really teach how to do it!
The reality is that they leave out many of the expenses which can cost you a LOT of time and money if you’re not taking them into account upon your initial analysis of the property.
This is exactly what separates you from being a “pro investor” to being another speculator. Meaning that you’re not buying houses in the hopes that it will go up in value, but you understand all the expenses involved in the real estate game what allows you to not make wild guesses about the future.
You take very calculated and accurate “risks” and understand exactly how to create a pretty significant return on your investment.
Here are the 4 most important steps you need to understand in order to help you make offers that almost always ensure a profitable transaction!
#1 Determine The ARV (After Repair Value)
The ARV is what the property is worth after all renovations are complete. In order to determine the ARV, we use comps – which are houses that are similar in order to determine the price of the house that you plan to renovate. Even so, it is a little bit of speculation.
There are a lot of factors like whether or not you have a garage, driveway, yard, etc. It’s kind of tricky to do it so you need to have some guidelines to find the right target because it’s really easy to get off track. A big factor is how long it will take you to do the renovation. If it takes six months, it might have not had the same ARV six months from now.
A great first rule of thumb is to look for houses that have been sold within a one-mile radius of the property, in the past four to six months. These houses are the comps. Make sure they have a similar square footage, 20% above or below. So there are a few places where you can start looking like Zillow, Redfin, and MLS (Multiple Listing Service). The problem with MLS is that only agents have access to it, which is why many investors get licensed just to use it. The data from MLS is the most accurate and the most trustworthy source.
Another great source of information is the pending properties. Which you can also find through MLS. Pending properties are properties under contract. Someone is interested and an offer has been accepted and now it’s being finalized. So because of this, the property is not on the market. If you can find pending properties that are similar to yours then it would be a great asset.
Also analyzing the market, and market trends is an absolute necessity. We cannot stress enough how important it is to see where it is that people want to live right now or the near future.
#2 Estimate The Repair Costs
A lot of people ask us what we charge per square foot. And the answer is always that it’s really hard to determine the cost, perhaps impossible. You can have an idea but that doesn’t mean that it will end up happening that way. And in this business, unknowns can and will happen. You can find problems inside the property, like damage and also with the human factor like dealing with the city and getting permits.
You have to be ready to find solutions for all of these problems. We can handle it but the problem is that when you have a really specific number for your estimate, most of the time you’re going to be in hot water when you can’t afford whatever problem might arise.
An estimate is exactly that, an estimate. If you hire someone or get a free estimate you shouldn’t be surprised if the number that is given to you will not be accurate. It also depends on what it is you want to be done. But don’t be afraid to have an estimate even though it will change. You need to start somewhere and an estimate is a good starting off point.
#3 Calculate Closing And Holding Expenses
This would be what you would do as soon as you put the house under contract. You should have at least an agent or an attorney to work with. Closing expenses are the fees from the attorney and any taxes that go along with it. Most of the time it’s just attorney fees.
When you have selling closing costs that have to do with giving a commission to the agent that was involved in the transaction. And when you go to sell the house and the price is actually higher than you thought, that means the attorney fees are going to be higher as well. A good rule of thumb is 3% for each agent that was involved.
Holding expenses are everything related to keeping up with the costs of the property. Electrical, water services, insurance, everything that you would need to own the house for six months.
#4 Determine The Offer
What we have are two formulas to help you determine what your offer is going to be.
This is the first formula:
ARV – Repair Cost – Closing and Holding Cost – the Desired Profit = Offer
So to take advantage of this formula you need to make sure that your ARV and Repair Cost are the most accurate they possibly can be.
Here’s the second formula:
ARV * 70% – Repair Cost = offer
This is the faster of the two and you can get to an offer quickly. The 70% is a standardized number of what all your other costs are going to be.
If you have all the numbers we recommend going with the first formula because it will be more precise but this is a long process so if you need to get to a number with more urgency then go with the second.
There are also some online tools that can help you with your calculations. You can do an online search for “fix and flip calculators” and you’ll find websites like BiggerPockets and Gorilla Capital. It’s easier to have this process automated and have something to help you keep track of the costs and less room for error.
Even though there is only four each one is definitely a process. Regardless of what it is that you’re looking for, make sure to minimize speculation as much as you can and pay whatever you can to make the process easier. It’s an investment.
Let us know which of these steps was more beneficial to you at whichever point of your investor career you’re on. Treat it as a business and make sure you surround yourself with the right professionals to help you.
Even the most seasoned investors understand that calculating these costs can be tricky and our hope is that for homeowners that are looking to get started, they can have a new appreciation for the difficulty of the business and can understand what it is that investors and home renovation companies go through to get you the right numbers.
Watch MOG’s The Art Of The Rehab show’s latest episode where we talked about how to calculate the numbers of a fix and flip:
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