Securing the Profit in Your Deal!

No one enjoys working for free! Sure, if it’s your own business you may sometimes work for less, as you feel that you are building equity, perhaps even a future, but even when its yours, you still do not enjoy working for free. So, why should you?

Unfortunately, many real estate investors cut their profits short of where they want them to be, or where they should be. Honestly its not their fault that they cut their profits short, as they are only doing what they have either seen someone else do, what they were taught, or worse yet, what seems to come naturally. But all of that is WRONG!

Really, the way that we calculate our profit either by being taught or picked it up naturally is WRONG! Let me explain. Here is the way that we have typically, historically calculated the profit in our deals. By the way, it doesn’t matter whether the deal is a flip or a hold.

The WRONG way that we are used to is to combine the following costs associated with the deal: purchase price, improvements, carrying costs, use of funding costs, closing costs @ purchase, closing costs/marketing costs @ the flip sell (if flipping), closing/financing costs @ refinancing (if holding), any misc. costs. Then we look at what is left as our profit.

Flip example - If the purchase price plus all of those costs mentioned above totals $200,000 (including resell costs) and we sold the property for $225,000, then we figure the profit from the flip equals $25,000.

Hold example – If the purchase price plus all of those costs mentioned above totals $200,000 and the property is valued at $225,000, we figure that the gain in equity is $25,000, however we likely would not be able to tap that equity to recover all of the costs as we can’t borrow 100% of the property’s value. Doesn’t mean that profit wasn’t earned, it just means because we are holding it, instead of selling it, that the profit is not liquid.

In reality, in using the method that we are commonly used to in calculating our profit, we are exposing the profit to potential decreases. In looking at the costs associated with the deal, what if we over-pay for the property, or run over budget on the improvements, or pay too much for the use of the funding, etc. If ANY of the costs associated with the deal grows, then the profit SHRINKS! Why, because you set it up that way! Does this make sense to you? It doesn’t to me, but then, maybe you never gave it a thought, as you are so accustomed to just calculating your profit in this manner.

So, let’s restate what we said earlier, no one, not even the owner, enjoys working for free, or for less than they should……….so let’s change the method of calculating our profit.

The RIGHT way to calculate your profit on ANY deal, is to see your profit as a cost. Yes, you read that correctly, as a COST! No different than any other cost associated with the deal, the profit will NOW be seen as one of those associated cost items. The easiest way to accomplish this is to work your figures backwards. Yes, backwards. I know that it feels weird, but it works.

Flip Example – The sell price is $225,000 and the total of all costs associated with the deal is $225,000. Include the $25,000 profit being earned in with the other costs associated with the deal. If any of the costs needs to be lowered, perhaps because the market caused the ARV to decrease, then you review the costs list and see where cuts can be made within the list, however the profit costs item is NOT the item on the list that gets lowered. Honestly, the wisest of investors will tell you that of all of the costs on that list, the purchase price should be the number one item that gets lowered. Have you ever heard the saying “You make the money when you BUY the property”?

Successful investors have the habit of making sure that they get paid on the deals that they do and get paid well (they calculate their profit as a cost). Accomplishing this may mean that you must gain the property at a lower cost (which might mean that you become creative in locating off market properties). Working the figures backwards, inserting the profit in those figures as a cost, should deliver you to the maximum number that you can pay for the property when purchasing it and secure your profit in the deal, as long as you DO NOT reduce it as a cost item during the improvement stage of the deal.

Now that you no longer think the wrong way when it comes to the profit in the deal, start penciling out your deals the right way, with the profit as part of the costs, and secure the profit on your deals. Good luck.

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