Investing in real estate is all about buying right. By that, I mean buying at a price that will allow you to make money either on the sale or through monthly rental cash flow. But how do you do that?
The numbers can be very intimidating. It was scary for us when we first stated as well. A lot rides on this analysis. You could either make a lot of money…or you could lose a lot of money.
Good analysis requires good assumptions. Particularly with your after-repair value (ARV) and your rehab costs. Those are the 2 places people most commonly screw up. It’s very tempting to thing that you can sell a house for more than it’s worth. Or to think that the rehab won’t cost you as much as it does.
Every investor has their own method of analyzing deals. Some start with a specific ROI they want to achieve, while others start with an absolute dollar amount in profit they need.Another popular formula is called the “70% rule”. This rule states that your purchase price and rehab costs should only be 70% of the ARV. There are many, many different ways to analyze a flip, and they are dependent on your situation and market.
In this post, I will show you how I analyze potential fix and flip deals. The 70% rule is very hard to attain in Denver’s hot market. We are only on our 3rd flip, so we aren’t sophisticated enough yet to know what kind of ROI is sustainable for us. Right now, we are looking at the quality of the flip (location, demand, etc) and whether the profit makes sense for us to take on the project.
I will use real numbers from our latest flip. In future posts, I will update you on how the budget is faring so you can see what kinds of issues come up during a flip project.
30,000 Foot View
The most basic way to analyze potential profit from a flip is to subtract the total project cost from the ARV (or sales price).
Like I said earlier, this depends entirely on making sure your ARV and repair costs are correct.
Let’s break these components down.
You should be able to determine your ARV from recent sold comparables in the neighborhood. Determining an ARV is outside the scope of this article, but you can use internet sources (Redfin, Zillow, etc) or have a local real estate agent help you.
The project cost includes 4 big expense groups: Purchase price (and associated closing costs), Holding costs, Rehab, and Selling Costs.
How to Calculate Total Project Cost
The total project cost includes all expenses the project incurs. You can either pay for these costs with all your own cash, or you can borrow money to pay for them. Either way, you need to make sure that the ARV can cover all the costs and still make you some money.
Here are the 4 major expense groups you will incur while flipping a house:
Purchase and associated closing costs
The first expense you will have is the actual purchase of the property. You will either purchase your flip with all your own cash, or you will borrow money. Borrowed money can come from private investors, a construction loan from the bank, a hard money loan, or even from the seller. Essentially, you will either bring your own money, or a down payment and other people’s money to closing.
Closing on a property also comes with costs. Title companies charge fees to handle the transaction. In my area, closing costs are about $600-$800. It is entirely negotiable who pays for these costs. We usually offer to pay for all closing costs and title insurance, to make our offer more attractive to sellers. The cost of title insurance depends on the price of the home, but who pays for that is also negotiable.
The last type of cost you might have at closing is financing charges. Lenders usually require borrowers to pay underwriting fees or for an appraisal. If you didn’t pay that during the loan application, you will pay that at closing. Some loan programs require interest points to be paid at closing as well. There are expressed as a percentage point; 2 points equals 2% of the loan. These financing charges are in addition to your monthly interest or mortgage payments, which are accounted for in the holding costs expense group.
Unfortunately, it costs money to own property. Houses require electricity, water, trash removal, and you have to pay property taxes on them. You will have to pay for all of these while you own the flip. Here is a list of the most common holding costs you will incur during a flip:
- Debt service (interest or mortgage payment to your lender)
- Hazard insurance
- HOA dues
- Property taxes
Most of these items are paid for on a monthly basis. The total amount of holding costs, will be the monthly amount multiplied by the months you own the property.
This is one of the most crucial expenses to estimate. Rehab costs can make or break your profit and take some experience in estimating well.
The spreadsheet included in the bottom of this post has a detailed list of rehab costs you need to look out for.
Real estate is a unique asset, in that it takes money to buy and sell it. In fact, selling real estate costs quite a bit of money. Real estate agents charge commissions, and title companies charge fees on both ends of the transaction.
Selling costs include:
- Real estate agent commissions (usually 5.6% of sales price)
- Staging and photography (if not included in rehab budget)
- Closing costs (title insurance and closing fees
All 4 of these expense groups make up your total project cost.
Example Analysis Using our 3rd Flip Numbers
Scrolling to the bottom of this post will show a pop up where you can download my flip analysis spreadsheet. This is the spreadsheet I use to analyze every flip we come across. One copy of this spreadsheet has numbers from the case study discussed below. The other copy is blank, so you can start analyzing your own deals.
Some of the numbers below (purchase costs and financing costs) are final, but most of the others are estimated at this point. I did not include a discussion of the rehab budget in this post, but I will in the future. The detailed rehab budget numbers are in the example spreadsheet, however.
|Purchase||$179,102||Holding Costs||$10,433||Rehab||$38,566||Selling Costs||$8,455|
|Purchase price||$174,000||Debt service||$1,566||Estimated rehab||$35,060||Broker commissions||$7,560|
|Title insurance||$-||HOA dues||$405||10% buffer||$3,506||Closing costs||$895|
|Financing costs at closing||$685||Trash||$-|
Our total purchase costs were $179,102. We borrowed $156,600 (90% of purchase price) from a hard money lender for this project. There terms of the loan were 12% interest, 2 points ($3,132) and a $685 underwriting fee. We paid for all closing costs in this deal. The closing costs are high for this deal because we had to pay additional fees related to taking out a loan. We had to pay recording fees for the deed of trust, lender’s title insurance, and more escrow fees. The seller paid for title insurance.
Our payment for this loan is $1,566. The HOA dues are high because they include property taxes and all utilities except electricity. We estimate we will hold this property for 5 months, so at $2,087 a month that makes our total holding costs $10,433.
We may take out an additional loan from our family members, but we haven’t decided that yet. That will cut into our profit, but will also allow us to spend our cash on other investments.
The estimated rehab cost is just over $38,500. We always include a 10% buffer in our analyses as well. This protects against things that come up during the rehab. If nothing comes up, that’s more money in your pocket. Usually, unexpected expenses do come up, but if you have a buffer budgeted in, they won’t hurt as bad.
Typically, the seller pays for both the seller and the buyer broker’s commissions. This is usually 5.6%, but since I have my license and am generously not charging myself a commission, we only need to pay 2.8% for the buyer’s broker. Our closing costs on the selling side include a few hundred in closing fees and $395 for my brokerage transaction fee. We don’t anticipate any seller concessions since we are gutting the whole place and the HOA covers all the mechanical systems.
All 4 of these expense groups add up to a total project cost of $236,556. Subtracting that from a sales price of $270,000 leaves us with profit of $33,444.
Not bad for 5 months of holding!
That was a lot of math…
Still with me?
This can be intimidating at first. There are many small details to consider. Practice certainly helps.
Since you’ve gotten this far, I’ll give you the spreadsheet I use to analyze deals. I have included 2 copies. One has the numbers from this analysis, including the detailed rehab estimate. The second copy is blank, ready for your deals.
Like I said earlier, every investor has their own method of analysis. This is simply how I do it.
What do you think? Am I missing anything?
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