Posted by on Jun 5, 2011 in General | 13 comments

Flip Formula

If you’re gonna make money on a flip, which I hope that is your goal! Then you must make a promise to yourself…Now raise your right hand and repeat after me:

“I, John Doe do solemnly swear to NEVER buy a property unless it meets and/or exceeds the buying formula that Brant is about to lay on me. Even when I get really reallY emotionally involved with a house and the numbers don’t even make sense BUT because I’m anxious and it kind of looks like an ‘ok’ deal even though when I plug in the numbers to Brant’s formula it doesn’t work out YET I am STILL considering buying the house, HOWEVER, because I made this promise to Brant right here and now, I, John Doe, do solemnly swear to not buy the house unless it meets and/or exceeds Brant’s buying formula. Never. The End.”

The point here is that you exercise self-control and don’t prematurely buy a deal unless the numbers make good business sense. If you pull the trigger too soon and get locked into a ‘bad deal’ you could find yourself aboard a loser and it can sink you real quick.

Ever seen Titanic?

Enough of that, let’s go over the formula I want you to use to properly analyze a deal to verify if a house is worthy to be a Flipper. I want to make this clear: Learning this simple formula is fundamental to your knowledge base, and applying this principle will have a tremendous impact on your success!

Here is the formula:
Maximum Offer (MO) = 70% of ARV – Minus Repair Costs
(ARV Stands for After Repaired Value)

This means that if a house would be worth $100,000 AFTER it is all fixed up, then $55,000 would be your Maximum Offer (MO) IF the property needed $15,000 in repairs. As you will soon learn, most of the deals you analyze will require at least basic repairs to get them back on the market for resell, and some need major repairs! In this example, we estimated the repairs to be $15,000. Therefore, next we then subtracted $15,000 from $70,000 to arrive at our final Maximum Offer, $55,000. Of course, if you can get deals for less than the 70% ARV then the more profit you can make. I try to get deals at 65% or less. The 70% ARV is simply the minimal acceptable ratio. Make sense? By the way, if you need a quick way to estimate the cost of repairs, go here www.FreeRehabEstimator.com.

I want to reiterate that using this formula is Absolutely Critical. If your maximum offer price exceeds 70% of the ARV, you are putting yourself at risk of not making a profit. This is bad, which is the opposite of good, so we try not to go there.

Buying a house and using the buying formula should be strict Business Formality, and you have to become good at letting the formula help you make a good Business Decision on whether you buy a house or not. It’s as simple as this: When you input the numbers into the formula, if the numbers work, you can proceed with the deal, if the numbers don’t work, then walk away! You have to become an All-Pro at walking away from deals if the numbers don’t work. This is one of those ‘thin lines’ between success and failure. If you stray too far from this formula and do some bad deals you may not make it back, so use caution my friends.
“You’ve got to know when to hold ‘em, Know when to fold ‘em
Know when to walk away, Know when to run”
Kenny Rogers, “The Gambler”

Ok, lets dig a little deeper into this formula and review a couple of key terms:
ARV (After Repaired Value) is the price the house will be worth, or what price you are going to sell it for After it is all fixed up. The key to finding an accurate ARV is to base valuations off of Comps.
Comps. ‘Comps’ is short for Comparable Sales and you will find these from local Real Estate Agents or Internet based software. You do not want to make the mistake of basing the value from tax records, or what current properties may be on the market to sell for. You MUST base the value from similar properties that have actually SOLD recently (for example, in the last 1 – 6 months).
MO. ‘Maximum Offer’ is just that. It is your Maximum Offer that is established after you determine your cost of repairs and the ARV. Like I said, your absolute minimum offer should Never exceed 70% ARV – Cost of Repairs, but it doesn’t mean that you have to settle for 70%. To be honest, when the market is down, you should be getting deals in the 60-65% ARV range. This is for a couple of reasons, (1) Because typically the Days on the Market it takes to sell a property is longer now. (2) Because you can! Look, the deeper discount you buy it, just means the more profit you get on the back end. An exception to this rule is if you find a property in a really hot market with a low number of Days on the Market, you may be ok with the 70% ARV, but please don’t exceed that amount. And, when you determine your Maximum Offer, stick with it, don’t let your emotions take over and give in. Stick to your guns.

How do I determine the ARV?
To determine the ARV, you first have to get a list of properties (Comps) that have sold recently in that area. Remember when I said it’s good to have some real estate agent contacts? This is precisely why. If you have an agent you can call, this is super easy, and it can be had in a matter of minutes. If not, you’ll have to find a website based Comp site to help you out such as www.Zillow.com & www.ZipRealty.com. There are many of them, so don’t fret…
You must also make sure that you have accurate Comps. Meaning, the Comps that you are using to compare to your property need to be similar. The Comps do not have to be exact, but Similar. Now, this is not an exact science and there are some definite ‘grey’ areas here, so bear with me. So what is similar? Let’s look at some of the key areas you should compare with your comps:
Here are some of the critical areas to compare:
-Square Footage
-Sales Price/Price Per Square Foot
-Year of Construction
-Features (number of bedrooms/baths, lot size)
-Amenities (pool, deck, lakeside view, etc)
-School District

For example, if you’re considering purchasing a house that is 1,500 square feet with worn out carpet and old formica countertops located near a train track, it would not be wise to base your value from a home that is 3,000 square feet with nice hardwood floors, granite countertops overlooking a bubbling brook! Needless to say, this would NOT be a similar comp.

Another key factor in determining if you should move forward on a deal is the DOM (Days on the Market). Days on the Market shows how long houses typically take to sell. Neighborhoods that have low DOM, for example, less than 30 days, are typically excellent neighborhoods to flip houses. Of course, long periods of DOM (4 months+) could be bad…stay away from those if at all possible. Essentially, low DOM represents high demand, so finding deals in neighborhoods with low DOM can have a big impact on how quickly your property sells. The DOM is another critical piece in your analyzing process, because if you have a property sitting on the market for a long period of time, this translates to high carrying, or Mortgage costs. This will definitely eat away at your profits.

You also want to make sure there are NOT a lot of foreclosures in the neighborhood, nor an excessive Amount Of Inventory in the neighborhood. When a neighborhood has a lot of homes for sale (inventory), of course, this means there is more competition, and obviously, less demand. When an area has a high number of foreclosures, this can severely impact the value of other properties in the neighborhood when appraisals are done. While these neighborhoods can sometimes be good for picking up rental properties for long term wealth building, be weary when finding a ‘diamond in the rough’ to flip in these neighborhoods.

Here is a review of the Key Points to Analyzing A Deal:
USE THE FORMULA
Maximum Offer (MO) = 70% of ARV – Minus Repair Costs

COMPS
Be sure you are comparing “apples to apples” when determining your property value and sales price

DAYS ON MARKET
Target houses and neighborhoods with low DOM

AMOUNT OF INVENTORY
Locate neighborhoods with a small percentage of available inventory of homes for sale…In other words, less Competition is preferred



13 Responsesto “Flip Formula”

  1. Jim Kennedy says:

    Excellent post, Brant! You have clearly and concisely described the basics of due diligence when analyzing the viability of a buy, fix, and flip project. As a full-time real estate entrepreneur who is predominantly a “flipper”, I couldn’t agree more with you more.

    Best wishes for your continued success!

    Jim Kennedy

  2. Ronnie Sparrow says:

    Do you stay away from foundation repairs?

  3. How do you convince your wife go get on board?

  4. Jeff says:

    This is a good basic formula to evaluate if a flip deal makes sense, but buyers should do more detailed calculations before buying. I utilize a best bid spreadsheet that takes a few more factors into consideration and allows you to evaluate various scenarios and include your risk factors. (I.e. If it takes 6 months to flip instead of 3.)

    Essentially it takes ARV minus Retail Sales Expenses (6% Realtor, Roughly 3% Transactional) minus Prorated (Holding Months estimate) Taxes, Insurance, and HOA, minus Repairs, minus Money Costs (Points, Fees, Interest) minus desired profits = Best Bed.

    It may lead to about the same number, but it forces you think through all of the cost in more detail and allows you to include risk factors.

    In your 100K house example it would work like this. Assume 100K Tax Appraisal at 2.9%. Assume 3 months holding (30 day rehab, 30 day Sale, 30 day closing). Assume 1K annual insurance, $350 HOA.

    Best Bid = 100K ARV – 9K Retail Sales Cost – 725 Prorated Taxes – 250 Prorated Insurance – $87.50 Prorated HOA – 15K Rehab – 2.8K 4% Hard Money Points – 2.45K 14% Hard Money Interest – 1K Hard Money Fees/Draws/Etc – 15K Desired profit = $53,687.50.

    Something else to consider is your cash on cash return.

    Thanks for the article!

  5. Dave C says:

    Brent

    Good job. Shows clear straightforward thinking.

    Is there somewhere we can go to get some background on the numbers included in the rehab estimator?

    Thanks again.

  6. Dave C says:

    Sorry Brant, not Brent.

  7. Brant says:

    I use a number of different sites to keep up with repair costs for the contracting business side of things…here are just a couple that I use:
    http://www.homewyse.com/costs/index.html
    and
    http://www.homeinspectorlocator.com/resources/Costtorepair.htm
    Hope that helps!

  8. Brant says:

    Hmm…since she’s in the room let me ask her!
    Wife’s response: she said she could see how excited I was when I first started down this path and she really believed in the ‘benefits’ of successful investing…

    Ok, here’s the other thing (she left the room now! ha!), I was just flat out determined to succeed at this, and I think she sensed that and has always been supportive of me…I know this is hard for some spouse’s counterparts to be accepting of their partners investing aspirations (sometimes it’s the husband who is not supportive of the wife) but if you focus on the benefits of successful long-term investing as well as show continued, long-term dedication, I think most spouse’s will come around…but, I’m certainly no marriage counselor!
    Good luck…

  9. Brant says:

    I actually ‘run’ to foundation repairs! Foundation repairs usually mean you can pick them up at a deeper discount…Just make sure you use a reputable company with a Lifetime Transferable Warranty…

  10. Brant,

    Great post and thanks for the skinny on buying houses to flip. I might add that if you plan to keep the subject property for a rental then you can be a little more aggressive with your offer. I have found that sometimes I am up against 15-20 other bidders when I make an offer to buy an REO property I want to hold as a rental. Usually the only way to win is to up the anty.

  11. Anako7 says:

    Well, the formula looks good and all said is fine, the less you offer the better you’re gonna be off. But realistically, are there many deals like that on the market and actual fools who would part with their property for the amount you’re willing to offer because of the formula? Tell the truth, there isn’t many, so it’s all talk. An average investor who does not have connections somewhere to get those steal-deals, but looking on HAR is never going to be able to get such a spread b/w an offer price and potential ARV. So what’s the point of this all? You are sending adds to everyone’s email boxes on your list with this miracle formula that works, but in reality there is no opportunity to apply it.

    Foundation repairs… you can have all warranties you want, but you know better then me that foundation repair companies are not responsible for damages done during foundation repairs. So you can pay them $2,000 to level your property, but are you sure you want the cracks in the masonary, sheetrock and plumbing? How much will that all cost you to fix?

  12. Kath says:

    Worth mentioning is despite the talk about leveraging, wise investors never over extend their own funds.
    In business, you help others get what they want and it helps you. Workmen want to be paid first and fast – they way they work focused for you.
    You don’t delay paying contractors, suppliers nor partners and keep a good reputation. Word flies at sonic speed among other investors.

  13. Mark Mushrush says:

    Brant,

    Have 2 flips ready to hit the market. I double checked my numbers using your quick calc method and it worked perfectly! It’s nice to have a boots-on-the-ground,”quick and dirty” way to determine feasibility.

    Thanks much!!

    Mark

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