How to Value Properties which need a MAJOR Rehab?

Question

Hey BP,

Need some advice. Actively looking at multi-families (2-3 units) to rehab and eventually rent out.

Starting to feel my offers are too low as I haven't gotten much traction on 5 offers.

I of course take ARV - Estimated Repair Cost - Desired Profit - Margin of error $/%= Offer Price.

What are some other factors to consider? What are some Definitely "No-Nos" when buying a property which need rehab?

J Scott · Answer

If this is for buy-and-hold, then "ARV" and "desired profit" don't really mean anything, as you're not reselling.  Instead, you need to calculate an "all-in cost" that will allow you to achieve your desired ROI and then plug it into this formula:

Purchase Price = All-In-Cost - Estimated Repair Costs - Fixed Costs

For example, let's say you have a property that you need to be all-in for $100,000 to achieve a desired 10% ROI, then:

Purchase Price = $100,000 - Estimated Repair Costs - Fixed Costs

Ritch Bonisa · Answer

I think it's just as simple as your equation.  It's important to find a good deal up front, work hard to find out what the actual rehab costs should be.  Set aside 10-15% for unforeseen issues.  Understand the comps.

The biggest wild card is the rehab cost.  Make sure whomever provides the rehab cost, does it with enough detail that it's clear as to what the scope is - the grade of finishes, etc.  Make sure they know what they are doing.  Know what their incentive is, and understand their process.  I hear sellers say, "I could rehab it for 50k".  Many times its true they could, because they would serve as the GC and run the job using subs, but if you have to hire a GC to manage & run it - your cost is not their cost.

Ibn Abney · Answer

@J Scott Very Much So!!! Thanks alot!

J Scott · Answer

Here's an example:

Let's say that I need a 10% cash-on-cash return for me to buy a deal.  I see a property that will generate $1000/month in rent, and based on the information I have, I believe that $1000/month in rent will result in $500/month in cash flow (50% expense ratio, including vacancy and capex).

Now, I have a property that will generate $500/month in cash flow, which is $6,000/year.  In order for me to hit my 10% cash-on-cash return for this property, I can't pay more than $60,000.  In other words, if I pay $60,000, and I'm cash flowing $6,000 per year, that's 10% cash-on-cash return.

In this case, the $60,000 is my "all-in" number, as that's the most I can pay (after all costs are accounted for) in order to generate my 10% cash-on-cash return.

Now, if $60,000 is my all-in number, I'm probably going to have to pay less than $60,000 for the property, as I'm also going to have renovation costs and some other costs (buying costs and holding costs until the property is put into service).  I call these other costs "Fixed Costs."

Let's say I believe this particular house we're talking about is going to cost $10,000 to renovate, and will incur $5,000 in fixed costs (closing costs, inspections, appraisals, etc when I buy and utilities, taxes, insurance, etc until I get it rented).

So, this gets us to our formula:

Purchase Price = All-In-Cost - Estimated Repair Costs - Fixed Costs

Plugging our numbers above into the formula, our purchase price would need to be:

Purchase Price = $60,000 - $10,000 - $5,000 = $45,000

I could pay no more than $45,000 for this property in order to hit my goal of 10% cash-on-cash return.

Does that make sense?

Ibn Abney · Answer

@J Scott Big fan!! Thanks for the advice, Much Appreciated!

I've been struggling to understand this "All-in-Cost". Can you break down this component of the equation?

As I used ARV because i think of the BRRRRR method as a flip with much smaller profit and a note PMT at the end. But Cash flow to offset that payment. I guess i was aiming for more of a monthly $ goal than ROI. error?

Ibn Abney · Answer

I'm a BRRRRRer :-)

Tyler Goulden · Answer

Is this for a BRRRR or just to buy fix and rent?

How to Value Properties which need a MAJOR Rehab?

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