How to Flip a House for Profit – Purchase Price and Return
This is a continuation of our Flip a House for Profit series. In the last article we talked about flipping it quickly and how to find your first flip. For the complete listing of the blog articles in this series CLICK HERE. We may jump around a little so keep reading.
Let’s continue with deciding how much you should pay for this awesome house you found and want to put an offer in on with the intent to flip it.
Remember “You make money when you purchase a house, NOT when you sell it”. Keeping that in mind you need to make sure you get your new home at a price that you can make money. Screwing up this crucial step can make your deal go sour in a hurry. We want to provide you with a few ideas about how to price your initial offer.
There are a lot of ideas out there about how to set your flip purchase price. The EASY answer is pay as little as possible. You can always start your offer low and then go up. Rarely, can you start high and lower your offer so keep that in mind.
As a rule of thumb you will want to offer 70% of your after repair value ARV for your flip home.
First let’s talk about how much repairs will cost. You can do some rough estimates based on what you see as problems with the house. Things like a new roof, heating unit, remodel a bathroom or kitchen and I do that but what you REALLY, REALLY, REALLY need is about three good estimates from contractors you have vetted to give you repair estimates. Unless these estimates are far apart I would use the highest one. If there is a lot of difference in the estimates you need to get with the contractors and find out why.
You MUST have a good repair number to start this process with. Yes, we can build in a little wiggle room into our purchase price but we do not need a BIG surprise like major foundation work sneaking up on us.
The next thing we need to know is how much our repaired and remodeled house will be worth. This is also a huge number we need to be right on. You can look at comparable sales in the area to figure out a rough idea of what the house will be worth in good condition. A better way is to get a trusted real estate agent to assist you but this might not always be possible if you are planning on selling the house without the use of an agent.
Remember when looking at comparable sales to stay in the area or a very similar one close by. Even different school systems can make a huge difference in the value of a house. So can being next to a rail road track or a busy highway.
Also remember that a 4 bedroom 3 bath house will sell for more than an 3 bedroom 1 bath house assuming everything else is equal.
Keep in mind that you are interested in what houses have ACTUALLY sold for, NOT what the owners are asking. Actual sales data is all that matters in the end. You can ask anything but that does not mean you will get it. The longer you have to hold a house the less money you will make and quite possible you could end up losing money. That is one reason I try to figure my estimated sales price at 5% to 10% below what my comparable sales data tells me. That way I can sell my house quickly and reduce my holding cost and risk of the market going down. Yes, it could go up but how many times can we be that lucky.
Once we are confident in our repair number and our comparable sales number (I recommend dropping it by 5% to 10%) then we can figure out what we can afford to pay for the house.
This goes back to our 70% of ARV rule.
Let’s assume that we found a house that according to our comparable sales data will sell for at least $200,000.00. We do the due diligence and determine that according to our contractors it will cost between $30,000.00 and $35,000.00 to get the house repaired or remodeled. Since the bids are close we will use the highest of $35,000.00.
The first thing I would do is reduce my $200,000.00 sell target by 5% to $$190,000.00. Then I would subtract my repair cost of $35,000.00 to bring me down to $155,000.00. Then we would multiply the $155,000.00 by 70% to come up with our initial offer price of $108,500.00.
So why do we want to start with such a low price?
Let’s think about our expenses and/or risk.
- We could be off on our comparable sales number. We did build in an extra 5% to protect ourselves.
- Repairs normally go up and rarely go down. This could be because we decide to do more or the estimate cold be bad but more likely we will find more wrong once we start tearing into the house.
- Holding costs. Your holding costs are per month. Hopefully we can get our repairs and remodeling done in 30 days. We can then add at least 30 days to sell it. After that who knows, but let’s look at the 60 day holding costs.
- Home insurance. Depends a lot on your area. We are going to assume that for a $200,000.00 house we will pay about $100.00 per 30 days or $200.00 minimum.
- Utilities. Hopefully your contractor will not leave the doors and windows open or bust a water line. We will assume $100.00 per 30 days or $200.00 minimum
- Interest on about $150,000.00 which would cover your purchase price AND repairs. I am going to assume you are using a hard money loan since they are the most expensive. If you are using your own money you can reduce this cost. Using hard money I am going to assume a 60 day cost of about $10,000.00. You might be able to cut a better deal and that is awesome if you do. But I want you to see what can happen here.
- Real Estate Taxes. Again, depends A LOT on your area but for a $200,000.00 house we will assume about $175.00 per 30 days or $350.00 for 60 days.
- Closing Costs
- If you do not use a realtor we will assume about $3,000.00.
- If you use a realtor we will assume at LEAST another $11,000.00 which is probably low.
- The market might go down during our repairs and holding period. Yes, it could go up but don’t count on it.
Summary of numbers:
Purchase Price: $108,500.00
Est Holding Costs $10,750.00
Closing Costs $14,000.00
Target Sales Price: $190,000.00
Potential Profit: $21,750.00
Your potential profit is a return (excluding closing costs) of about 14% on your invested funds. Not bad, especially if you can do it in 60 days! But remember your cost estimates rarely go down, almost always what you estimate goes up. That is why you need to stick to 70% of ARV as much as you can. Yes, all situations are different and if you are flipping $600,000.00 houses you may be able to get a good return using a different formula.
This is just a starting point to give you an idea of what your costs are and what kind of profits you should shoot for.
Ultimately, the most important things are knowing your repair cost and your comparable sales numbers. You have to be right on those if you hope to be successful flipping houses. Your nice $21,750.00 potential profit can disappear in a HURRY!