Purchase Price for Flips

Buying & Selling Real Estate
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Purchase Price for Flips

Cyrus Sidhwa
Houston, TX · Member since 2013 · 16 posts · 1 vote

The standard formula for max purchase price is 70% of ARV minus Repairs. However, this doesn't seem to account for closing costs or holding costs which can easily reach tens of thousands of dollars when using a HML. My initial thought is to make the formula: 70% of ARV minus (Repairs + Holding Costs + Closing Costs When Buying + Closing Costs When Selling). However, I imagine deals that meet that criteria are extremely rare.

I am wondering if the following makes sense, or if there are flaws and/or things I'm missing / not accounting for. Here's my formula: ARV minus (Minimum Acceptable Profit + Repairs + Holding Costs + Closing Costs When Buying + Closing Costs When Selling). Does anyone use anything like this?

I would appreciate any experienced flippers explaining how you build the additional costs into your max purchase price formula. Thank you!

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Michael Woodward
Real Estate Investor · Greenback, TN · Member since 2012 · 269 posts · 115 votes
12y

@Cyrus Sidhwa , I think you're doing exactly the right thing by questioning the numbers. That shows that you understand the bottom line and you'll go into your project with your eyes open. Like Jacob said, the 70% rule is used as a benchmark for various purposes. Some investors use it to filter prospects, some private lenders use it as a threshold for their terms, etc but other than that, it's just an indicator.

When I analyse a project, I always work backward from the minimum profit I want to make....next is ARV.....from there, I calculate all other expenses (including closing costs on the purchase and sale) and work down to the bottom line.

I use a private lender that doesn't know or care about the 70% rule so I don't use the rule. Even though I don't need to use the rule, I have a calculation that tells me the percentage on every project I analyse . Interestingly, it seems to always be very close to 70% (68% to 72%). My guess is that history has shown that 70% is a good threshold.

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  • Jacob A.
    Investor · Raleigh, NC · Member since 2013 · 348 posts · 128 votes
    12y

    @Cyrus Sidhwa

    There's more than one way to skin a cat. The 70% rule was meant more as a quick and dirty estimation on the fly to help you determine if you are in the neighborhood of a decent deal or not. If you are at the point in your investing career that you are ready to do a flip I would imagine you have a pretty good handle on what your holding costs will be exactly and you can start factoring that in to the equation but 70% will be an extremely difficult benchmark to hit. For me, if I know what my repair costs will be and my closing costs and holding costs and I factor all of that in I want there to be about 15-20% left on the table. So I guess my rule is more of a 80-85% rule factoring everything into the equation.

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  • Steve L.
    Investor · Rancho Cucamonga, CA · Member since 2008 · 1k+ posts · 684 votes
    12y

    Cyrus -

    The 70% ARV formula is designed to be a rule of thumb and not exact.

    The 30% remaining is designed to be divided as follows:

    10% for sales costs and closing costs

    10% for cost of financing

    10% profit

    People who can get financing cheaper or save on closing costs can adjust the formula or would make more profit.

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  • Bill Jacobsen
    Salem, OR · Member since 2013 · 701 posts · 159 votes
    12y

    These formulas are just rough estimates of what the numbers might be. The further you get along in the process the more precise the numbers can be. As I look at a description of a property including pictures I might estimate the ARV and the cost per SF of repairs. I will then look at 65%-70%for a possible offer price.

    I start with 100% of ARV and subtract 6% commission, 1% for other selling costs, 2% margin for not selling at ARV, and 3% for seller consessions. This gets me to 88%. I want 20% for profit so divide 88%/1.2 to get 73.33%.

    I assume a possible 6 month buy, fix, and sell time and so estimate property taxes, insurance, and utilities for the period. This is subtracted from .7333 of the estimated ARV. By this time I have probably seen the property and have a better handle on rehab cost. At some time I will have a contractor give me an estimate of repairs. I include a 20% margin in the rehab cost so multiply the estimate by 1.2. This also is subtracted from the total to arrive at the maximum bid.

    The point is to start with a simple formula and replace with real estimates and actuals as soon as you can.

    Hope this helps.

    Bill

    2Reply
  • Michael Woodward
    Real Estate Investor · Greenback, TN · Member since 2012 · 269 posts · 115 votes
    12y

    @Cyrus Sidhwa , I think you're doing exactly the right thing by questioning the numbers. That shows that you understand the bottom line and you'll go into your project with your eyes open. Like Jacob said, the 70% rule is used as a benchmark for various purposes. Some investors use it to filter prospects, some private lenders use it as a threshold for their terms, etc but other than that, it's just an indicator.

    When I analyse a project, I always work backward from the minimum profit I want to make....next is ARV.....from there, I calculate all other expenses (including closing costs on the purchase and sale) and work down to the bottom line.

    I use a private lender that doesn't know or care about the 70% rule so I don't use the rule. Even though I don't need to use the rule, I have a calculation that tells me the percentage on every project I analyse . Interestingly, it seems to always be very close to 70% (68% to 72%). My guess is that history has shown that 70% is a good threshold.

    3Reply
  • Dell Schlabach
    Investor · Canton-Akron, OH · Member since 2012 · 917 posts · 477 votes
    12y

    We don't use the formula, I prefer real numbers.

    I start with ARV

    Subtract Estimated closing selling holding costs (typically 12k-17k in my case) 100k-250k

    Subtract Cost of money

    Subtract Estimated Rehab costs

    Subtract Desired Profit

    = Maximum Allowable Offer

    2Reply
  • Karin Crompton
    Rehabber · Niantic, CT · Member since 2012 · 443 posts · 150 votes
    12y

    The way I learned it is that the 30% you subtract right off the bat does indeed take closing and holding costs into consideration.

    I was taught that 10% = soft costs and 20% = profit. So if my ARV is 150k, I plan to spend about 15k on those soft costs and make 30k in profit. Of course this is all on paper and varies a bit from project to project; as others have pointed out, one big factor is where you borrow your money from and how much that will cost you. Points to a HML will eat into that in a hurry. And some will factor a lower percent for their profit or a straight number.

    As I'm still a bit of a newbie, I'm still analyzing each deal to see how close it comes to those projections. So far, it seems about right - if I've calculated everything correctly. If I'm off on my rehab costs or my ARV, all bets are off. If the property sits on the market too long, my holding costs will of course be higher as well. Hooray, utilities; hooray, insurance premiums. I should also point out that we have our real estate license, so we save a bit on closing costs (we typically offer to pay the listing agent both sides when we purchase, but we only pay out one side, to the buyer's agent, when we sell.).

    Bottom line for me: with my skills still being honed, at this point in my career, that 30% breakdown is probably closer to a 15-15 split than a 10-20. And I think the really, really experienced rehabbers do tend to have their own "formulas" in the end. Sounds like you're on your way to developing your own!

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  • Mark Ferguson
    Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes
    12y

    Check out my blog article I did. http://www.biggerpockets.com/renewsblog/2013/12/08/70-percent-rule/

    It describes exactly what you are talking about. I never used the 70% rule, I figured all costs and then added in a minimum profit plus extras for unknowns.

    1Reply
  • Brian BurkePro Member
    Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
    12y

    A percentage formula works pretty well. It doesn't have to be 70% though. In CA you are very unlikely to get much deal flow using 70%, 80% is more realistic. I use a sliding scale, 75% for properties worth less than $150K, 78% for properties worth $150-200K, and 80% over $200K. In some cased I'll even go a couple of percentage points higher, but only on certain properties. It's inexact science but it works for me and allow me to easily automate my process.

    Regardless of the multiplier I use, I always subtract the rehab cost from the result of the equation. Rehab can't be applies as a blanket percentage because some houses need a lot more than others so actual numbers have to be used.

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  • Account Closed
    CA · Member since 2011 · 762 posts · 182 votes
    12y

    Whatever method you use, look at your expected profit as a % of ARV. It's difficult to estimate ARV within +/- 5%, so, if your expected profit is 5% for example, it could easily be wiped out with a bad estimate of ARV. It gets dicey when profit is less than 10% of ARV, IMO.

    Also, I think you need to always figure cost-of-capital in your calculations, even if you use your own money. If you use OPM there is a cost-of-capital, if you use your own money there is lost opportunity cost ... you could have invested it elsewhere and made a return (hml for example).

    1Reply
  • Cyrus Sidhwa
    OP
    Houston, TX · Member since 2013 · 16 posts · 1 vote
    12y

    Thanks for the great info everyone. Working "backwards" from ARV and minimum acceptable profit makes perfect sense. @Account Closed, I have to agree and am very glad to see your comment about anything less than 10% being dicey. As a newbie, I've done my share of lurking on here and have been surprised to see many people seriously considering deals where that concept is not followed. It never made sense to me to go after a deal where the margins are that tight - seems like high risk / low reward... nice to get some reaffirmation. Happy New Year everyone - let's make 2014 the best yet!

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