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2 FAST WAYS TO EVALUATE REHAB DEALS
Have you ever noticed that the TV shows depicting house rehabbing only show the winners? How is it that everyone makes so much money, and never loses a dime? Well, for starters it’s reality TV, and even if we can believe it, I assure you any rehabber worth their salt is checking, double-checking, and triple-checking their numbers before committing to a project.
This said, in my last blog post “7 Steps For Good Deals and Quick Decisions” I mentioned the importance of being able to act quickly to snap-up a good deal. So if you’re going to act quickly, you’ll need to know how to quickly evaluate a deal.
Here are two methods used to evaluate rehab deals:
MODEL 1: THE 70% MINUS REPAIRS FORMULA
This formula says you should only buy an investment property based on 70% of the After Repair Value (ARV), minus the cost of repairs. For example, if you’re buying a house that will be worth $250,000 after you rehab it, and it’s going to cost you $25,000 to rehab it, you should pay no more than $150,000. It breaks down like this:
$250k (ARV) x 70% = $175,000 minus $25k (Rehab) = $150,000 Max Purchase Price
Using this formula, I know veteran rehabbers that after flipping 100’s of homes will swear that this formula is by far the most effective. One of my esteemed mentors has shown me that this formula works 19 out of 20 times in his preferred area of Glendale, Arizona.
The challenge with this model is that for most of us, it can feel like finding a needle in the haystack. Most investors, evened the seasoned ones, do not possess the budget, the marketing experience, or desire to hunt down these types of properties. These amazing deals are simply harder to find, and while “wholesalers” (with the budgets and experience) do find these amazing deals, most wholesalers are simply not passing on the steep discounts due to the high demand for anything resembling a deal. Perhaps it’s because they know how to cost estimate, and you should too.
MODEL 2: COST ESTIMATING
I focus my rehab efforts in the Phoenix-Metro area. This includes popular areas like Arcadia, Biltmore, North Central Phoenix, and Central Phoenix. It’s a real challenge to find anything using The 70% Rule, and with competition being as fierce as it is, wholesalers (the marketing gurus that find amazing deals) are no longer selling deals anywhere close to this. So, what’s a rehab flip investor to do?
This is where accurate cost estimating becomes very important! This simply means you have to get good at estimating, budgeting, and predicting value. Let me start with an example using numbers similar to the first example above:
First I buy it:
$150,000 Asking Price + $9k RE (Buy) Commissions + $4k Closing Costs = $163,000 Acquisition Cost
Then I rehab it:
$163,000 Acquisition Cost + $25k Rehab* + $1,000 Holding Cost = $189,000
*Note: Cost Estimating Rehabs can be very detailed. It’s best to know exactly what you’ll pay for tile, paint, cabinets, appliances, roofing, and other materials and labor in advance.
Then I sell it:
$250,000 Sales Price - $15k RE (Sell) Commissions - $5k Closing Costs = $230,000
Then I bank the profit:
$230,000 - $189,000 = $41,000 Projected Profit
As you can see, the projected profit of $41,000 is quite healthy! However, the current demand for rehab deals is higher than the supply, SO many rehabbers are willing to pay more for the house, in exchange for less profit. In fact, many rehabbers target only a $10,000 profit!! And this is why a good deal (anything above $20k profit in my book) is hard to find.
WHY ARE REHABBERS PAYING SO MUCH FOR DEALS???
Simply put, an experienced rehabber can fill their pipeline with low-margin rehab flips and continuously close escrow on 2 or more deals a month….yielding them $20,000 per month. This means they are closing over 20 deals a year; and even if they’re wrong 5 times a year (losing $10,000 per deal), their gross estimated profit would be $150,000 for the year. This is why competition in the rehab market is so high! And it doesn’t help when every-other reality show and guru tells people it’s so darn easy!
An experienced rehabber will also use a spreadsheet or calculator to run their numbers. I use an Excel spreadsheet.
For those that are new to rehabbing, I would like to suggest you checkout the House Flipping Calculator found on BiggerPockets.com. In fact, the entire site is full of helpful resources for both new and experienced investors. By the way, I do not get paid by Bigger Pockets, and the majority of the content is absolutely free!
In closing, my name is Michael Penrod, and I’m here to help. If you have questions, just ask!