Running the numbers for a flip is not as difficult as you may think. But it is important. Here, we’re going to walk through the process and the different groups of numbers that you’ll need to use to calculate whether or not a project is a green light or a pass.
In order to determine if a project is profitable you are going to need to put some examples together with numbers to see how they all work together. Numbers like:
- After Repair Value of the Home (What the Listing Price Will Be When the Renovations Are Complete) $250,000
- Profit You Expect to Earn on the Flip ($25,000)
- Closing Costs during the Purchase ($5,000)
- Closing Costs during the Sale ($5,000)
- Commissions to Real Estate Agent on the Sale (6%) ($15,000)
- Holding Costs (Utilities, Loan Payments, Etc.) ($10,000)
- Renovation Budget aka Rehab Cost ($50,000)
Add all of these numbers above together and subtract them from the ARV Value of Home
And You’ll Get the Maximum Purchase Price You Should Offer is $140,000
So how do you determine all of these numbers? Here’s a step-by-step process to figuring all of your numbers as accurately as possible.
Step 1: Determine the After Renovation Value
It may seem backwards but you’re going to want to begin with your sale price after the renovations first. Calculating what the house can sell for in order to know if there will be any room for profits once you’ve factored in all your expenses.
The after repair value is what the home will be worth once the renovations are complete. In order to figure out what this amount will be you’ll need to look at comparable homes in the area.
A realtor can be the best source for this information as they will have access to comparable sales using the MLS.
They can narrow down similar homes with features that most closely line up with the home you’re looking to purchase. They compare features of your home such as the number of bedrooms, number of bathrooms, the square footage, the style of the home, and then find homes that have recently sold in the last 6 months or less with similar features.
If you have the opportunity to walk through these homes it will help to see the condition and the features they offer. You’ll want to make sure that the renovations you make are in line with the area. Not too much and not too little.
Once you have a price for resale and the type of renovations that you’ll need to include to appeal to buyers it’s easy to see if the numbers are going to work.
Should the estimate for the improvements not leave room for profit then you’ll want to pass on the project. Always go with the numbers.
Step 2: Assess the Profit
Profitability is the goal of any flip project. If there isn’t a profit to be made then the risk of taking on a project and renovations exceeds the upside.
The anticipated profit of a project is the foundation of the house flipping business. If the margin of profit is small then you would be better off looking for another project. Unless you determine that the projected profit would work for you.
As you evaluate projects you may decide that tying up resources wouldn’t be worth it. However in the beginning, I focused more on learning than big profits. It’s an individual choice and you’re able to pivot as you progress.
Opportunity cost or as some call it “cost of equity” is important when analyzing investments so stick in your required profit early into the formula to make sure whether the deal will work or not for you.
It’s likely that this profit will differ as you may over estimate your expenses and end up with more profit or under estimate and end up with less profit.
This is why I recommend giving yourself a cushion when determining the profit you’d be happy with so that if things go wrong and unexpected expenses come up, you’ll still make a $5,000 or $10,000 profit instead of breaking even.
Step 3: Closing Costs at Purchase
There are expenses that are part of every purchase. These costs will need to be paid outside of the loan or with case from another lending source.
These costs will vary but may includes some of the following:
- A loan origination fee – which lenders charge for processing the loan paperwork for you.
- Charges for any inspection required or requested by the lender or you.
- Appraisal fee.
- Title insurance – which protects the lender in case the title isn’t clean.
- Title search fees – which pay for a background check on the title to make sure there aren’t things such as unpaid mortgages or tax liens on the property.
- Escrow deposit – which may pay for a couple months’ property taxes and private mortgage insurance.
- Recording fee – which is paid to a city or county in exchange for recording the new land records.
- Underwriting fee – which covers the cost of evaluating a mortgage loan application.
A safe rule is to estimate $3,000 to $5,000 in closing costs but it can vary on the price of the property. Once you’ve had a few purchases you’ll be able to see on the settlement statement how the costs were assessed.
Step 4: Closing Costs With the Sale of a House
As the owner when you sell property, you will also have some expenses.
The most often one is the realtor commission for both the listing agent and the selling agent.
Unless you have a unique situation where you have an uncomplicated sale situation I would advise hiring a professional realtor. There are many areas where they can be incredibly valuable, especially when it comes to offers and negotiating inspection items. They may even be able to secure a higher sales price than expected.
Another cost will be title work. You will want to make sure that there are no issues that may be of concern to a buyer. A clean title insures that they will be able to easily transfer in the future.
Here are a few of the expenses you’ll want to prepare for:
- Real estate brokerage commission (3% to 7%)
- Attorney or closing agent fees for preparing the deed and other documents
- Documentary stamp taxes, where required
- Recording fees for the certificate of satisfaction of the seller’s mortgage
- Taxes (may be prorated with the buyer)
Step 5: Real Estate Commissions
Anytime you’re buying and selling properties you’ll likely use a realtor for your transactions. When it comes to buying a property, the seller will pay both the agent commissions. When you are listing a flip for sale then you’ll be paying both agent commissions. Their expertise and guidance can help to secure a higher offer and the best terms possible.
For people who are looking to make several purchases and sales per year they may consider getting their real estate license themselves. It can generate another source of income and you can also work with other investors to buy and sell properties.
For example, someone buying 4 properties per year may consider getting his or her license so that they can earn a commission each time they purchase the house and save themselves the expense each time they sell the house.
If you become a realtor, you’ll have several fees to pay though which is why it only makes sense to those who will be doing enough deals to cover the costs of being an agent and leave profit thereafter.
If the number of transactions you’ll be doing are limited you might want to save yourself the additional licensing and professional responsibilities and simply work with an agent.
Step 6: Holding Costs
One area of costs that is often missed is the holding costs. Everyday you are holding a property there are expenses you need to account for. Things such as utilities, insurance and property taxes.
These expenses are specifically tied to to the will add up if you’re flip is taking several months to complete, for example, you may have the renovations done in 60 days (2 months) but then the property sits on the market for sale for another 60 days, bringing the total flip time to 120 days (4 months).
During this time you’ll also have to pay mortgage interest if you took out a loan.
You’ll also have property taxes and insurance which may or may not have been pre-paid for and prorated at closing.
Overall, don’t forget about taxes, insurance, utilities, and debt interest as well as any other holding costs you may incur when budgeting for your max purchase price to offer on a flip.
Step 7: The Renovation Budget
When you are estimating the amount of the repairs you’ll want to err on the side of over estimating repairs.
Until you have specific numbers you’ll want to go with a total that you’ve estimated to spend. By doing this you’ll be able to run the numbers and if you end up below this number you’ll be in a great position. You’ll see a higher profit should your expenses end up being lower. Always a bonus.
Step 8: Maximum Price for Purchase
Once you’ve determined your ARV and subtracted out all of the expenses discussed above, you should be left with a number that represents the max amount that you should offer to buy the property.
For the project to work for you it needs to generate a profit. With all of the numbers you are estimating, you have to purchase for no more than this price.
If the max purchase price seems just out of the realm of possibility that’s okay. You may think there’s no way a seller would accept a low offer. But if you know it won’t work any other way then be prepared to pass.
I am a believer that a seller can’t accept and offer that isn’t made. So go ahead and submit that lowball offer. You never know what may happen.
Typically, you’ll have to find properties that look old and outdated as well as distressed in order to get off to a good start with the low offer process.
You can use this as leverage when negotiating with the seller, letting them know how much the property needs to be updated to be worth market value and therefore why you are proposing an offer lower than their asking price.
They may say no but the important takeaway is at least you took action and didn’t pass up an opportunity because of a false assumption.
Maybe they would have said yes but you didn’t offer because you assumed your price wouldn’t be accepted. The answer will always be “no” if you never ask.
Quick Tip: You don’t have to wait to have a house on your radar to run the numbers. Choose a house in an area you are interested in working in and run numbers in a hypothetical scenario. The more you practice the more you’ll be able to recognize the numbers that work. Just another example of how practice makes perfect.
I’m Ready to Flip, What’s Next?
Ready to take that next step when it comes to flipping?
That’s why I’ve got additional resources to help you get the information you need to move forward on creating your flipping life.
Make sure you have the Fixer Upper Checklist so you know which areas are key to added value in a home.
There are several videos available on finding houses, renovations, and funding on the Threshold Homes YouTube Channel. Check out your favorite flipping topics and new videos weekly.
You can’t close a successful and profitable flip unless you start. What is your biggest challenge with getting started house flipping? Let me know. It may be an area I’ve also had questions about myself. I’m here to help so drop me a DM.
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