OVER 20 YEARS AGO, I began my research into real estate investing. This was the days of Carlton Sheets, Ron Legrand, Russ Whitney, and so many countless others peddling no money down real estate investing ideas. I bought and learned a lot from those guys, even with so much of it being total bull! The overriding theme, however, went to deducing how much to offer on a home if you were going to renovate and flip it.
When determining offer prices for a rental home, the long timeline will always eventually correct any over spending, so there is more forgiveness there, but when you are looking to get in and out and resell a property over a short period of time, the price you pay is the MOST important part of the process.
One of the factors in that is determining costs to reno, and that part I will save for future newsletters, because the other part is how to determine, once you have that cost, what you can safely offer.
Another investor I read back then, was a guy named Scott Britton. I subscribed to his newsletter and he always had great insight into the market and niches that at the time were not being explored by investors, such as short sales. He did a ton of flips in a low income and low-price area in Mississippi and priced for the first time home buyer. It is his model of doing rentals and flips that would work for the first-time buyer that I still follow today. I believe it is the best hedge against market shifts, and while I see no problem in occasionally taking on a high dollar resale, my bread and butter will always be this demo.
Because of the lower price point, he used a formula that included a second layer of padding. He called it his “minimum profit” and he encouraged people to set that at whatever they found comfortable. He used $10,000 and I use the same number today.
The other factor to consider is the final sales price and costs to sell. Of course, I would tell you to hire a real estate agent (us specifically) but you need to figure out what will be taken out of the proceeds at closing whether you pay an agent or sell on your own.
Getting the final sales price is not as simple as looking at Zillow! This is another arena where having a (GOOD) agent will get you the best possible results! Pie in the sky numbers, or wishful thinking, sink more investors than any other part of this process.
When we evaluate a property for our investors, we come to them with plan a, b, and c. We have a range of prices that will include varying levels of the finish work and features and fixtures of the finished product. We look at the flip price at best possible levels, and the worst.
Providing this level of care helps our clients make informed decisions on what to buy and how to renovate the home for resale. It is another area that I know we do better than most.
So, to the formula. It is simple really. (ARV x 80%) – (MP) – R – H = MAX OFFER
ARV = After Repair Value = Simply the number arrived at that the home will most likely sell for
MP = Minimum Profit = Your bottom line, I cannot walk away with less than this no matter what $
R = Renovation cost = The number you came up with for estimated repairs
H = Holding cost = Any taxes, Insurance, Loan Payments, Interest due on Loans, Etc. associated with owning the home.
Scott used the 80% rule to also include the proposed profit and the costs to sell. I have found it a very reliable formula over time and prefer it to trying to line item everything as the numbers do not generally work out when you try to get super specific.
Let’s look at an example to help:
Let’s say there is a home available in a neighborhood that is adjacent to a very hot market and has a after repair resale proposed value (ARV) of $200,000.00. First, note that if we are your agents, the proposed sales price will be conservative compared to what the final number may be. This is done to hedge against any unknowns.
Second, you have a bare minimum of $10, 000 you must take in profit as a worst-case scenario.
Third, you have repairs estimated at $25-$30,000 to bring the home where it needs to be.
Lastly, your hold costs are $7500 for closing costs on the loan, payments made while holding the house, etc.
ARV = $200,000 x 80% = $160,000 minus $10,000 minus $30,000 minus $7500 = MAX offer of $112,500
This would leave you with $10,000 in guaranteed return (6.7% return on investment – nothing to write home about but it beats a savings account!)
PLUS, roughly $28,000 in padded profit after costs to sell the house are taken out and you take out the money you put in at that point.
That would mean you have a $38,000 profit on a $150,000 all in investment. That equals 25 percent ROI!
(side note, this is not just a hypothetical. This exact scenario matches a project Joan and I are working on right now. Once we have it completed, we will publish all the data on it.)
Even better, purchasing the home would require less than the total outlay since you would most likely borrow funds for the purchase and/or renovations.
If you look at this scenario with a 20% down payment, and paying out of pocket for the repairs, your returns percentage skyrocket.
Down payment = $22,500 (20%, the rest of the money comes from the bank. Let’s assume $2500 of the hold costs comes from this mortgage and the closing costs associated with it. So, we add that $2500 as an out of pocket expense, and then the $30,000 for renovations.
This means your out of pocket is $55,000 with a profit back of roughly $38,000. Meaning your cash on cash return is ALMOST 70%
And if you kept the house and rent it at market rents of $1300 per month, you could then refinance it to cash out what you put in and your rough mortgage payment would be in the neighborhood of $950 PITI and you would have a cash flowing property and all of your money back.
Over time, your mortgage gets paid by someone else and you have set up future cash flow as a hedge against inflation for your security when you decide to stop working.
If you are setting up future monthly income, how many of these do you need to buy to completely cover your household expenses in the future?
In my opinion, only real estate offers the opportunity to combine leverage and forced equity into returns like this for gains that you can then use to put back into more real estate and set yourself up for future security.
Remember: (ARV x 80%) – (MP) – R – H = MAX OFFER
Please do not hesitate to call me or text me anytime to set up a private consultation!
To your success!
In this newsletter and related information, I may reference personal investment results and cashflow numbers. Please understand my results are not typical. I’m not implying you’ll duplicate any of my results (or do anything for that matter.) The average person who reads and studies “how to” information gets little to no results. I’m using any reference for informational purposes only. Your results will vary and depend on many factors, including but not limited to: your background, your experience and your work ethic. All investment entails risk, as well as massive and consistent effort and action. You can lose money investing in real estate.