You are driving through your prospecting area for ugly houses and you come across one that looks promising. Through whatever means, you create an appointment to look through the house to see what work needs to be done. You decide it is a property you want to rehab and flip for retail.
Now comes the tough part - what to offer?
The best way to arrive at an offer is to work backwards from your estimated final retail sales price. Until you get an actual appraisal, this is going to have to be a best guess estimate - perhaps by pulling comps in the MLS or other online service that you may have access to. Once you have a feel for what you will be able to sell the repaired house for, you can now work backwards from that point to get to your highest offering price to make this deal work for you.
- Estimated repair costs - You will need to estimate how much you will be investing in this property to repair and beautify it for sale. This will have to be a best guess estimate unless the seller will let you bring in a general contractor before you make an offer.
- Closing costs on the purchase of the property AND on the later sale of the property.
- Holding costs - This includes any payments you make on the money you borrowed for the property, the money you pay for insurance, for taxes, utilities, etc. Basically holding costs include all expenses that are generated just because the property is sitting there.
- Contingency fees - Stuff happens. You should plan on the project taking longer than you estimate. And you should expect unexpected repair work to pop up. You never know what could be found behind the sheetrock or under the floorboards once you start that rehab. This also gives you a buffer in case the market is a bit softer than expected and you have to take a slightly smaller final selling price than you originally planned. A good guess of contingency fees is 10% of the purchase price.
- Desired gross profit - This is the amount of money you want to put in your pocked for this rehab before paying taxes on it. A good rule of thumb is a solid 10-15% of the purchase price.
By examining all these costs, you will get a maximum offering price on the property. As some of the numbers are based on the purchase price rather than the final value, you may need to do a few iterations to reach your exact numbers. It helps if you have a ballpark offer price in mind before starting the calculations.
This calculation is good for several things. First, it allows you to calculate a fair price to offer on the property to ensure that there will be a profit for you in all but the most disastrous situations. Second, it gives you ammunition to talk with the seller. When you have a seller that is reluctant to sell at that low price, you can show exactly how you arrived at those values. It might not change the seller’s mind at that moment but it shows you are working based on real numbers rather than just someone out to "steal" their property. But when the house is still not sold a month later, you can come back and make the same offer. That gives the seller a month to think about what you said and sometimes come around to where they are happy to do the deal to get out of their situation.
If you take the time to do this analysis before you make an offer on every deal, you may miss a few deals but when you get one, you will be able to sleep at night knowing that the numbers are working in your favor.
And if you are a new investor and unsure of things like repair costs, etc., just remember that you can write your contracts subject to an acceptable inspection and acceptable appraisal. And if either report finds things that you didn’t expect, you have an opportunity to walk from the deal or renegotiate with the seller for a lower price. After all, the buy price is where you make your profit and if it doesn’t work for any reason, it is time to move on to another deal. You never want to be in a situation where you are working for the house. You want the house to be working for you and knowing your numbers will ensure that this happens.
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