Determining a good deal . . . two different methods?

Rehabbing & House Flipping
19yFollow

Determining a good deal . . . two different methods?

Mark Robinson
Member since 2008 · 6 posts · 0 votes

Great forum, glad I found it.

My question is as follows. The fule of thumb when determing a potentially good rehab deal is to use the 70% of ARV (After Repaired Value) less repairs method. However, can you use the cents on the dollar/equity method as explained by thedfwmentor in the following thread: http://forums.biggerpockets.com/viewtopic.php?t=5707 It is as follows:

Drop the zero's or the last three numbers (000) off and take YOUR purchase price and DIVIDE it by the ARV/Retail price. This is the breakdown:
65 DIVIDED by
100 =
.65 (cents on the dollar)
So you now know it is 65 cents on the dollar but what is the percentage of equity?
Take the maximum amount of equity you can have, which is 100% and minus the cents on the dollar figure you just got.
100 percent equity MINUS
65 = 35% equity.

The number I have to be at or below for me to consider a deal (unless there are other factors brought to my attention) is .70 cents on the dollar or LESS. OR in percentages, 30% equity.

Using an example that I am currentlylooking at the numbers work using the cents on the dollar/equity method but don't look particular good using the traditional 70% of ARV (After Repaired Value) less repairs method.

For example:

Purchase price: 150,000
ARV: 220,000
Repair Cost: 30,000

150/220=.68 cents on the dollar
100-68=32% equity

OR

70% of 220,000= 154,000 less $30,000 = $124,000

Based on the first method, the deal doesn't look bad, no?

Based on the second method, the purchase price is to high based on the other numbers, correct?

Comments, advice greatly appreciated.

Thanks,

Mark

0Reply
74 views

13 Replies

Jump to latestLatest
  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y

    In Jim's original post, he didn't specify what he meant by "equity", but in his second post he brushed on the idea that repairs are not included in equity. The bottom line is that the two formula's are the same.

    The 70% of ARV minus repairs method and buying with 30% equity is the same thing. Equity does not include repairs. If a house's ARV is 100,000, it needs 30,000 in repairs, and you can buy it for 70,000, does it have 30% equity? No. It has 0% equity.

    The 30% equity spread that Jim was outlining will cover all your expenses and profit margin NOT including repairs. The 70% method is merely the complimentary way of factoring if its a deal or not from the 30% equity requirement. Its the same formula calculations, but its just coming from different directions.

    You have to be careful how you factor the numbers or you will start learning about the Please Excuse My Dear Aunt Sally rules. LOL. For those of you who don't remember that from school, don't worry, the point is if you don't follow the 70% of ARV and then subtract repairs, you will start coming up with different numbers. Taking 70% of the After Repaired Value and subtracting repairs from that number to determine your maximum allowable offer is the easiest and simplest way I have found to figure the required 30% equity rule in a rehab.

    0Reply
  • Mark Robinson
    OP
    Member since 2008 · 6 posts · 0 votes
    19y

    Totally understood, that was the answer I was looking for. Using the Jim's original post was not accounting for my repair cost so it looked great. Accouting for those cost is like I stated, I would be buying at to high of a price. My search . . . or negotiation with the seller continues. Thanks for your explaination Ryan.

    Love the forum. Good stuff.

    Mark

    0Reply
  • Scott Miller
    Real Estate Lender · Member since 2008 · 642 posts · 13 votes
    19y

    Two areas you need to factor in that have not been mentioned are:

    - Lending realities (70-75 ARV loans are available, but 65 ARV is offered in more abundance)
    - Exit Strategy (you need to back out liquidation costs [seller commissions] and capital gains from your gross ROI calculations).

    Regards,

    Scott Miller

    0Reply
  • Mark Robinson
    OP
    Member since 2008 · 6 posts · 0 votes
    19y

    Yes, sellar commisions indeed. As for ROI, a 1031 perhaps.

    0Reply
  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y

    Well, if you are going to be using the proceeds for a rental, and technically a rental that you are planning on keeping, then a 1031 is an idea. You don't want to be using a 1031 from one rehab to another. If you get audited by the IRS, you're toast. :D

    Unfortunately, with rehabs and wholesaling you will have the highest amount of taxes to pay. You can take avoid some taxes through forming certain entities and paying yourself a reasonable salary and taking disbursements on top of that. I would recommend consulting with a qualified accountant on these matters.

    0Reply
  • Ricky Bobby
    Raleigh, NC · Member since 2008 · 33 posts · 5 votes
    19y

    I've heard being classified as a "real estate professional" (ie 750 hour test) will avoid cap gains tax. Any truth to this?

    0Reply
  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y

    No. Being an "active" investor versus a "passive" investor, which is where the 750 hour mark comes from, will allow you to carry over losses in real estate to compensate for other gains. Passive investors are not allowed to do this.

    Again, a qualified accountant is always good to have so you can maximize your deductions.

    0Reply
  • Mark Robinson
    OP
    Member since 2008 · 6 posts · 0 votes
    19y
    Originally posted by "Ryan Webber":
    Well, if you are going to be using the proceeds for a rental, and technically a rental that you are planning on keeping, then a 1031 is an idea. You don't want to be using a 1031 from one rehab to another. If you get audited by the IRS, you're toast. :D

    Ryan, thanks for the reply. Could expand a bit on this. We are using a 1031 to move profits from a former rental into our first rehab property. Any advice?

    Mark

    0Reply
  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y

    Well, I am not an expert in 1031's, but my understanding is that you have to have the intention of keeping the property in order for it to qualify under a 1031. If your intention is to fix it up and resell it, then technically it would not qualify for a tax deferred exchange. You might want to contact Wexeter on the forum. He is our resident 1031 expert.

    0Reply
  • Mark Robinson
    OP
    Member since 2008 · 6 posts · 0 votes
    19y
    Originally posted by "Ryan Webber":
    Well, I am not an expert in 1031's, but my understanding is that you have to have the intention of keeping the property in order for it to qualify under a 1031. If your intention is to fix it up and resell it, then technically it would not qualify for a tax deferred exchange. You might want to contact Wexeter on the forum. He is our resident 1031 expert.

    Done, will let you know what I find out.

    Thanks,

    Mark

    0Reply
  • Mark Robinson
    OP
    Member since 2008 · 6 posts · 0 votes
    19y

    Just wanted to say thanks to all those that have point me in the right direction and to the right people for answers. This is a great site and I am glad I found it.

    Needless to say all of this brainstorming has spawned another question related to determining a good deal using the method described above and by other more experienced forum members. So my question is how does a possible rehab deal change as far as the numbers when an investor does the following:

    purchase to rehab and the sell vs. purchase to rehab and rent for a year or more

    How do the two different exit strategies change or allow you to change or "adjust" your numbers?

    Mark

    0Reply
  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y

    Rehabs (fixing up to resell) and rentals are two totally different mindsets. A rehab is going to have a very set amount you can make. Its much more black and white than a rental.

    Factoring numbers on a rental is far more relative. A rental comes down to how much you personally determine is enough to be making on your money or your Return On Investment (ROI). Depending on your market, your goals, and your availibility to deals, you can normally make from 10-40% on your money. If you are a passive investor that doesn't have much time to look for deals then 15% ROI or rather Cash on Cash Return (CCR) not including appreciation might be adequate. Now if you are more active and have plenty of time to look for deals and maybe do your own management, then 30% or even 40% may be your goal.

    The market you are buying in makes a big difference. In the markets that have seen a high appreciation rate over the last 10 years (the east and west coasts) are not going to give you good returns on rentals. In the Midwest and in the great state of Texas where appreciation has been minimal over the last decade, then your returns will be a lot higher.

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free