Quick questions on the 70% rule and estimating fixed costs

[Jeremy Hale]

I'm meeting with a wholesaler tomorrow to discuss some properties he has, one of which he has listed at 84k with a 179k ARV and 52k in estimated rehab costs. Of course, I will be scrutinizing these numbers and corroborating them myself, but that's initially what he has given me.

I made a quick spreadsheet using a combination of average values I've found online, along with J Scott's estimations, on the various fixed holding costs. Here is just a quick analysis that I did, the numbers on the left as if I financed it, the numbers on the right as if they weren't financed (feel free to tell me if you see any glaring issues):

http://imgur.com/GULWwYK

My first question is, am I correct in just eliminating the lender fees and mortgage payments from the fixed costs if I pay cash for the house? Is there anything else I should be changing? My money is in fairly low-yield investment accounts at the moment, so I'm not sure there's much of a point in adding in the lost interest I would be experiencing.

Secondly, why is there such a discrepancy in the 70% rule vs. my calculated costs? I realize it's a pretty hard and fast rule, but I wrongfully assumed it would be a bit closer to my calculated number. I thought I even estimated on the higher end for most numbers. Is the 70% rule just built around giving you a large buffer in case of unexpected problems?

[Phil Pustejovsky]

Be VERY pessimistic in your analysis of what the property will eventually sell for once renovated. It's the single biggest mistake investors make when evaluating a deal to close on, renovate and resell. It's good to be optimistic on the overall view of the business of investing in real estate, but it can be financially destructive to be optimistic when estimating what a property will sell for once you have renovated it. Also, study all the comps, active and closed. If there are a ton of other listings in that area, you will not only have to compete with some of those that haven't sold by the time you put yours on the market, but others will appear after you begin rehabbing too that aren't there yet. If a wholesaler says it will sell for $179,000, (although your very, very, very detailed comps analysis will provide the true picture), as a rule of thumb, reduce that by 10%, so it may sell for $160,000 in the real world.

As for you renovation costs, it usually ends up costing 10%-20% more than your very best estimate. And the more extensive, (which this one sounds intensive), the more likely it will be on the 20% end rather than the 10% end. There's an old saying in the contractor business, the bigger the project, the more money you can lose. For investors, that same principal holds true. The larger the renovation project, the more problems could come up. So you want an even bigger margin of safety on this one. Spreadsheets may help get a general picture, but in the real world, experience teaches you to round up...

Maybe you can talk the wholesaler down to $80,000.

Plus purchase closing costs, insurance, etc. ($3,000)

$60,000 in renovations and holding costs

So you'd be in it $143,000

If it sells for $160,000, after real estate commissions, this deal may earn $10,000 and that's if everything goes right.

So you have no margin of safety either. Ouch!

Looks thin to me...but that's how it usually is with deals sourced from most wholesalers. Thin.