2 Formulas For Analyzing a Rehab Deal

There are 2 formulas every rehabber should know to analyze a rehab deal to determine the Maximum Purchase Price they should offer for a property:

1. 70% Rule Formula
2. Maximum Purchase Price Analysis 

If I get a lead on a prospective property, one of the 1st things I do is calculate the rough maximum purchase price I would offer for the property to compare to the current asking price. Before I invest a bunch of time and resources into putting together a detailed analysis of the property, I will use the 70% Rule Formula to quickly decide if the property is worth pursuing.

If the 70% Rule tells me the purchase price is within a negotiable range of the sellers asking price, then I will perform a more detailed Maximum Purchase Price Analysis.

70% Rule Formula

The 70% rule is a general rule of thumb used by real estate investors to quickly determine the approximate purchase price they should offer for a property. The 70% rule basically allocates 30% of the After Repair Value to your Fixed Costs (Buying, Holding & Selling Costs) and Profit and then subtracts the Repair Costs to give you your Maximum Purchase Price.

The 30% allocation for Fixed Costs & profit is split about 50/50 (so 15% for Fixed Costs & 15% for Profit). In other words, 15% of the ARV is allocated to Fixed Costs & 15% of the ARV is allocated for the investors profit. This 30% is an average that should cover most investors, but it can vary depending on your particular investing situation, strategy & historical costs as investor.

For example, an 'All Cash' investor may be able to pay close to 75% to 80% of ARV, but an investor with a 15% hard money may only afford 65% of ARV.

If you have any past project experience or historical cost data, use this cost history to calculate the average Fixed Cost % you have been paying on your projects. Use this Fixed Costs % and add in your desired profit % to give you a more accurate multiplier for your '70% rule'.

70% Rule Formula:

Purchase Price = (70% * ARV) - Repair Costs

Example:

• ARV: $200,000
• Repair Costs: $50,000

Purchase Price = ($200,000 *70%) - $50,000
Purchase Price = $140,000 - $50,000
Purchase Price = $90,000

Detailed Maximum Purchase Price Analysis

Once the 70% Rule formula tells me my purchase price is likely in a negotiable range of the seller's asking price, I will perform a more detailed Maximum Purchase Price Analysis. My detailed analysis involves a detailed calculation of the Fixed Costs (Buying, Holding & Selling Costs) as well as a detailed Repair Estimate.

Maximum Purchase Price Formula:

Maximum Purchase Price = After Repair Value - Buying Costs - Holding Costs - Selling Costs - Repair Costs - Repair Contingency - Profit

Buying Costs - Perform a detailed calculation of Buying costs

• Brokerage fees, inspection costs, appraisal fee, title costs, lending closing costs & points, etc.
• Buying Costs: 1 to 5% (depends on closing costs/points required up front)

• Holding Costs - Multiply your monthly holding costs by your holding period
  • Loan payments, property taxes, utilities, insurance, HOA dues, maintenance, etc.
  • Typically, 2 to 6% (depends widely on financing/loan payments & length of holding period)

• Selling Costs - Perform a detailed calculation of Selling costs
  • Realtor commissions, seller assisted closing costs, brokerage fees, home warranties, title costs, etc.
  • Typically, 6 to 10% of ARV

• Repair Costs - Walk the property and create a detailed scope of work of what needs to be repaired, replaced & remodeled. Use the scope of work to build a detailed estimate of repair costs.
  • Repair costs can vary widely based on many factors including the scope of work, market/location, season, & contractors.
  • Talk to local contractors in your market to verify costs/unit prices that can be used to help you estimate your costs on your project.

• Repair Contingency - Repair contingency should be added on top of your Repair Estimate to cover any unforseen conditions or issues that may arise. It will also cover any estimating mistakes that you will undoubtedly make as a new investor.
  • Repair contingency is usually a % amount that is multiplied by the Repair Estimate. Example: $50,000 * 10% = $5,000 Repair Contingency
  • The contingency amount should be based upon your experience estimating Repair Costs and your comfort level with the Scope of Work, & the complexity of the project. A light finish upgrade to a property would need less contingency than a complete gut project.

• Profit
  • Profit is typically calculated as a % of the ARV, but you can calculate your profit based upon the COCR or Annualized ROI.
    • % of ARV Profit Calculation = 15% profit * $200,000 = $30,000

Example:

ARV: $200,000

Buying Costs: $3,000

Holding Costs: $5,500

Selling Costs: $16,000

Repair Costs: $50,000

Profit: $30,000

Purchase Price = $200,000 - 3,000 - 5,500 - 16,000 - 50,000 - 30,000 

Purchase Price =$95,500