Chapter 3 – Is it a good deal? How to establish the value of the properties you see
The most important task you have, as a flipper, is evaluating the building before you make the purchase. This can be tricky and can get you in a lot of trouble if you fail to do your calculations properly and objectively. And never consider how the TV people make their calculations because they leave out a lot of the big expenses associated with real estate flipping.
By reading this Chapter you will learn to evaluate a property better than many flippers out there, who only rely on luck and the market dynamics to make a profit. To become a true flipper you need to take calculated risks and know what to expect from the flipping process. And it all starts with determining the value of the house after the repairs.
Based on the after repair value or the ARV, as real estate agents call it, you can make an offer for the house and evaluate the profitability of the deal.
To determine the ARV you need to look for recently closed as well as the pending deals in the area. To ensure a good evaluation, you should have access to the Multiple Listing Service, which is dedicated to real estate agents and provides detailed information on the houses for sale and those that were recently sold.
How to look for comparable properties
Look for flipped buildings in the MLS: you can easily spot them as they look shiny, have a lot of pictures and upgrades and generally stand out of the crowd. Once you've found the other rehabbed homes, look for REOs that are in good condition due to renovation or just as they are.
You need to look at the buildings that have the exact features as the one you are planning to buy, so focus on those that are within ½ – ¾ miles from your target, have the approximate same size, number of rooms, levels, bathrooms and age and are located in similar neighbourhoods. If you can find properties from the exact same neighbourhood, you are really lucky to have a very good comparison building. Only look at buildings sold in the last 120 days, to make sure the market is at the same level.
After you've evaluated the recently sold buildings, you can look at the listing and the pending posts. The listed properties will give you an idea of what the competition will look like when your building is up for sale, while the pending can give you an idea of future values of the sales.
However, there is a catch! Pending properties, which are under a contract with a buyer, but not yet sold, might actually sell at a completely different price. Short sales have the same feature; they probably won’t sell at the listed price, so you might want to skip them from your research.
You don't want to skip the non-rehabbed properties, which can give you an idea if you are overpaying, so you might want to adjust your offer accordingly. You can also check the tax records to see how much other people paid for their houses.
Seasonal market trends need to be taken into consideration as well for both - the purchase of the property and the sale, as well as market trends. However, don't rely too much on trends, because they can change fast and if you've paid a lot for a building that is going to be sold at a small value, you are not going to make any profit out of the deal.
Never compare prices of the buildings that are located in another school district, across a freeway, highway or railroad or in another city.
When you are in doubt, play it safe when you make your offer!
Fixing costs need to be included in your offer. For beginners this is another tough step, but it will become easier as you gain experience.
Until then, you can use the “$20 for square feet” rule – this is a method used by many experienced flippers when it comes to estimating the repairs. The downside of this rule is it only applies to cosmetic repairs.
Cosmetic repairs are the best and easiest way to flip a building, as they don't include a lot of work. In a cosmetic rehab you need to change the flooring, electric and plumbing fixtures, doors, baseboards and blinds, as well as complete makeover of the bathroom. Sometimes you can make some changes in the landscape as well, but depends on the property.
For a 1,500 sq. ft building you need to take out of the pocket around $30,000 for the average cosmetic rehab. Keep in mind the $20 rule refers to average finishings, anything fancy!
For additional repairs, like a new roof or HVAC you need to add about $5,000 - $8,000 to the repairs fund. Based on what repairs you are going to do, adjust the price up or down.
The $20 rule will only be used when you calculate the ARV and the offer you are going to make. After you have bought the property you can get a more accurate estimation from your repair team of a licensed contractor.
The costs TV shows don't talk about closing and holding. When you watch a TV show, featuring a building flipping, you will owe at the profit those people make. But they never tell you about the closing and holding expenses! When you make an offer you always need to take these into account, so let's see what each one is.
The closing expenses divide into purchasing costs and selling costs.
When you buy the property the seller is going to pay the selling costs, so you can just add about 0.5% of the purchase price as purchase closing cost.
The sale of the house might be a bit expensive as you need to add 1% for title, escrow, attorney fees and other closing costs. Then, add another 5-6% for the real estate agent. Depending on the area where you are making the deal, closing expenses might come up to about 10% of the sales price.
Holding costs are easily overseen, but they can add up in a flash, so make sure you do consider them when doing your calculations. These costs include property taxes, utilities, maintenance and insurance and may depend on the property. These costs will show up each month, so make sure you consider this factor when you make an offer.
Most flippers get their money from a loan, so you need to budget the loan rates when you calculate the ARV and the expenses with the property. There are many types of loans and other financing solutions, but you want to take into account an average 3-4% for financing per month. This rate might increase or decrease, depending on what type of financing you have.
The final point of the calculations: determining your offer
All these calculations are meant to help you determine an objective offer for the property you want to flip. There are multiple formulas to establish the offer price and before you gain experience, so you can make all these calculations in your mind, you might want to pick up a piece of paper and write down the formulas.
The easiest two methods use the sums we've previously calculated.
First, the basic one: ARV – Repair costs – Closing Costs – Profit = Offer The secret around this one is to be objective with the profit and set a percentage, not a fixed amount, because there are many variables in the flipping process that can influence your profit.
You also want to come up with a decent offer because you actually want to buy the house; you are not just playing around. If you present deals that do not sound tempting, you will not be able to buy properties, which might kick you out of the business.
The other formula you can use to calculate your offer is called the 70% formula and it goes like this:
ARV x 70% - Repair costs = Offer
It might take more time for you to understand it, but it does work, so why not!
Before we advance to the next Chapter, you must always remember the reality in the field is always, always different from the calculated amounts, so these formulas might not apply all the time. You will learn how to adjust them and make your own version of the calculations, so you can evaluate the value of the property and come up with a decent offer.
All you need now is finding the source of money for that offer and this is what we are going to cover in the next Chapter of this book, so read on!