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:
-Sales Price/Price Per Square Foot
-Year of Construction
-Features (number of bedrooms/baths, lot size)
-Amenities (pool, deck, lakeside view, etc)
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
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