You are looking to make extra cash by flipping houses. This is great news that you want to learn something new that can help you financially. The most important thing when it comes to flipping is to know the numbers. To be successful you need to know the financial formula for flipping houses. You may be asking what that formula is. Take the after repair value of a home and multiply it by70% then minus the cost of repairs and that is what you need to buy the home to make a good profit.
You may have also heard this formula called the 70 rule.
The math is simple when looking at a property to buy. The hard part is determining the ARV (after repair value) and figuring out the exact rehab costs to get the home in tip-top form.
If you do not master these two things then your house flipping days will be short. They will be short because you will lose your money if you do not understand the numbers for the areas you want to flip.
It is critical to know ARV
If you are new to real estate investing and not sure of the ARV for the area you want to do flips in then you need to do some homework. You really need to understand the areas you will be flipping homes.
To do this you should get a realtor to work with you for area values. You can make a deal with you that if they help you find homes to flip you will list the home with them when you have completed the work.
They can also help you understand the ARV value of potential homes when you are bidding or negotiating to buy the home.
The reason this number is so important is in the example below. If you buy a home and the ARV is incorrect by 10% or 20% then that is 10% or 20% less in profit.
If the realtor tells you they can sell a home after you have rehabbed it for $250,000 then when you are done rehabbing that homes need to sell for $250,000 or more. If that home sells for $230,000 then you are $20,000 short of what you wanted to make on the home.
Maybe your margins were tight and that $20,000 was a majority of the profit.
Once you pay the hard money lender and realtor fees you just flipped a home for $0 profit to you. The worst-case would be you miscalculated and you lost money.
Just as critical know rehab costs
The rehab cost is going to be just as critical as you know the ARV. You better know the numbers when it comes to doing repairs. The other thing is you need to know what needs to be rehabbed and how it needs to be rehabbed to get top dollar.
Let’s elaborate on knowing what to rehab. Just because you rehab a home does not mean you will get top dollar for it.
Decision making questions you need to think about. Do you need to replace or fix these things in a home?
- Do you gut the bathroom or keep some things to save money
- If you keep some of what is already there will that help you get top dollar for the home
- Do you need to add a double vanity
- Do the shower and tub need fully replaced
- Will the bathroom need new flooring and should you do tile flooring
- Does the bathroom need enlarged to add a double sink and bigger shower
- Should the counters be marble, granite or leave as is
- Does the kitchen need to be gutted
- Do you need all new cabinets
- Will flooring needs to be replaced and will you put in wood or tile
- Lighting may need to be replaced
- Should you add new appliances like a stainless steel
- Does the kitchen need to be expanded to add an island or just to increase the size
- Major repairs
- You need to make sure you understand any major issues
- Basement water issue
- Basement wall issue
- Roof needs replaced or a leaky roof
- Termite damage to the home
- Electrical issues
- Furnace and air conditioner replaced
- Other rooms
- Do the same type of questions as above for every room in the home and outside
The questions above are the ones that need answers when you are putting together the rehab budget. You need to know if you have to put in marble sinks and countertops because the neighborhood warrants it.
The bathroom and kitchen are the two big selling rooms in a house. They are the two rooms people want things to be incredible. If you are going to rehab a home make sure you do these areas right to get maximum profit.
When you start rehabbing you need to know things like this to gain maximum profit for every flip. You need to know if you do this in the rehab will it produce the ARV you are looking for when selling.
You also need to think about overdoing the rehab for the area. You do not want to put in $100,000 on the rehab of a house that $80,000 rehab would have allowed you to hit the ARV of the home.
There is a fine line between doing enough to make the home hit the maximum ARV and doing too much where the extra features will not give you the ROI (return on investment).
I hope this makes sense so if I spend $40,000 to create an incredible kitchen will I get that cost back when I resell the home.
Maybe for the area, I can create an incredible kitchen for $30,000, not $40,000 and still get my ARV for the home. That would be an extra $10,000 to my bottom line. These are the things you have to consider when doing a flip.
Here is the formula again in a math equation.
Financial formula for buying homes: (ARV) x .70 = X – rehab costs = purchase price
Let’s see a few examples to help you with the math.
You find a house for sale that is distressed and you want to buy it so what should you pay?
The ARV of houses in this area with similar square footage and in great condition is $300,000. You have looked at the home and you have calculated the rehab cost to be $75,000.
ARV = $300,000
Formula: $300,000 x .70 = $210,000 then you subtract $75,000
$210,000 – $75,000 = $135,000
$135,000 is the price you should offer for the home.
Potential Profit: $90,000 but you will need to subtract realtor fees, holding costs and costs for borrowing money to get true profit.
You find a house for sale that is foreclosed and you want to buy it so what should you pay?
The ARV of houses in this area with similar square footage and in great condition is $800,000. You have looked at the home and you have calculated the rehab cost to be $125,000.
ARV = $800,000
Formula: $800,000 x .70 = $560,000 then you subtract $125,000
$560,000 – $125,000 = $435,000
$435,000 is the price you should offer for the home.
Potential Profit: $240,000 but you will need to subtract realtor fees, holding costs and costs for borrowing money to get true profit.
You find a house for sale that is a homeowner looking to sell fast and you want to buy it so what should you pay?
The ARV of houses in this area with similar square footage and in great condition is $120,000. You have looked at the home and you have calculated the rehab cost to be $22,000.
ARV = $120,000
Formula: $120,000 x .70 = $84,000 then you subtract $22,000
$84,000 – $22,000 = $62,000
$62,000 is the price you should offer for the home. Since this is a lower priced home if you can get it for $55,000 or even $50,000 that would be even better.
Potential Profit: $36,000 but you will need to subtract realtor fees, holding costs and costs for borrowing money to get true profit.
You find a house for sale that just needs cosmetic work and you want to buy it so what should you pay?
The ARV of houses in this area with similar square footage and in great condition is $200,000. You have looked at the home and you have calculated the rehab cost to be $15,000.
ARV = $200,000
Formula: $200,000 x .70 = $140,000 then you subtract $15,000
$140,000 – $15,000 = $125,000
$125,000 is the price you should offer for the home but for cosmetic homes you can flip quicker so to win these you will probably have to go above 70%.
80% calculation instead of 70%
ARV = $200,000
Formula: $200,000 x .80 = $160,000 then you subtract $15,000
$160,000 – $15,000 = $145,000
$145,000 is the price you should offer for the home if you know it is only cosmetic work and there is stiff competition.
The exception to the rule
I would not go against this rule unless you are a veteran at flipping homes. When you start cutting into profit and unknown expenses on rehab the risk of losing money gets greater.
Example 2 shows you that in more expensive homes there is more room for error. This means if it is a competitive market you can offer more than 70% for the home so you can get the deal. Cities like LA and San Diego are very expensive which means the competition is fierce.
You may never ever get a homecoming in at a bid of 70% minus rehab. You may have to tighten the numbers to get the deals. Does it matter that you only make $100,000 profit instead of $150,000 in profit?
If you did not raise your price to buy you would have never gotten the deal.
If you are trying to flip homes in areas where homes are $250,000 or less you may need to go the opposite way. You may need to offer 50% to 60% of ARV. When the price of ARV shrinks your room for error is less.
This rule really helped me when I first started flipping homes. I only ran into trouble or broke even on deals when I did not follow the rule or I did not understand my numbers.
Make sure you understand the numbers when putting together your deals. I would also stay safe by really sticking to this rule until you get the first 3 to 5 flips under your belt.
Once you understand your area and you have a good system with a good contractor then you can adjust where it makes sense. If you can do it always try to negotiate the deepest discount you can to make more profit.