How do you figure out the highest price that should be paid for a home that will be fix and flipped?
Are you just getting started in this extremely fast pace Fix-and-Flip industry and trying to nail down that first deal? Most Fix-and-Flip properties today are purchased through wholesalers that are out pounding the pavement for deals. It is intimidating to show up to a property with 10 other investors and have 1 hour to walk the property, run numbers, and place your bid in a hat. The number that you place in the hat is called your Maximum Purchase Price (MPP).
There are two ways for you to calculate your MPP. The first is a much
more detailed approach and requires you to estimate all your costs from
the beginning to end of a project.
MPP Calculation = After Repair Value – Rehab Budget- Closing Costs – Holding Costs – Selling Costs – Financing Costs – Profit
The second method is a much shorter calculation that estimates holding, selling, and financing costs. This shorter calculation was once defined as the 70% Rule. In the past, you would not have purchased a deal unless you were buying it at 70% ARV. Not 70% OF ARV — but instead 70% ARV which accounts for your rehab budget and closing costs. Today the 70% rule is a myth. In the Denver Market we have looked at thousands of loans and found that most flips are purchased between 85% – 88% ARV. So today’s rule is the 85% Rule.
MPP 85% Rule Calculation= (After Repair Value x 85%) – Rehab Budget – Closing Costs
First you must calculate the ARV (After Repair Value). This is where you run your own comps and determine your final sales price. Having a good realtor or appraiser as a friend can be very beneficial here. Second, you need to calculate the rehab budget. I recommend coming up with a line item budget that separates costs by each room — or even better by individual trades. You can verify your rehab budget total number with this quick calculation. Multiply the livable square footage of the property by a factor depending on what year it was built (see chart below).
The closing costs are included in both the short calculation as well as the detailed approach because they are the more easily known numbers. You can speak with the title company and find out the costs for the escrow fee, the owners policy fee, the lenders policy fee, and any other title fees. And you can reach out to your lender and find out if they have an origination fee, doc prep fee, underwriting fee, credit report fee, etc. Holding costs include Taxes, Insurance, Utilities, and Loan Interest. It takes a moment to find and calculate each of these monthly expenses. Once calculated you should divide them to figure out your daily holding cost. Write that down in big numbers somewhere to help motivate you through the finish line of the project. The final cost to calculate is the selling costs. Don’t forget to include the cost of having the property staged. I always recommend calculating a 6% realtor commission even if you have a friend who will offer you 1% to sell the property.
If you need help working up these numbers, please send me an email and ask for my excel worksheet. david@boomerangcapital.com
Check out the original article posted here.
Photo by Igal Ness on Unsplash
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