Originally posted by @Carlos O.:
It makes perfect sense that in some areas investors may pay more % than in another are. 70% in Costa Mesa is not the same as 70% in Watts. For example, the median in Watts is around 265K. The median in Costa Mesa is 650K. Let's look at some numbers.
265K * .3 = 79.5K spread. I can see why investors would want to do 70% or lower.
650K * .3 = 195K spread. That is much larger spread. Investors can pay 80% and perhaps a little more and still make money.
This is the sort of nonsense we see from potential borrowers all the time. They look at a gross spread and get stars in their eyes.
Really Carlos, you should write a decent spreadsheet to estimate all the expenses associated with a flip and run them both in dollars and percentages. A gross spread means nothing if you don't calculate the associated expenses.
Here are the two deals you presented. I assumed rehab costs approximately 12% of ARV, 12%/3pt financing for 80% of the purchase price, and a 6 month term.
Paying 70% of ARV results in a project cost of 82% of ARV for Watts and a $12.4k profit. This is a whopping 4.7% of ARV and is easily eaten up by rehab overages, reasonable counter offers, deals falling thru a few times, etc. What happened to the $79.5k spread? Sensible rehabbers don't put in the type of work and risk it takes, over this period, for this kind of return.
Worse yet, the project cost jumps to 92% for Costa Mesa when you pay 80% of ARV for that deal, as you advocate. Though this becomes an eye opening $130k spread ($195k if you pay 70% of ARV), the loss is over $35k.
A reasonable and safe return on ARV is closer to the mid to low teens. This is achievable when the project cost is no more than 75% of ARV. Most here advocate 70% as a rule-of-thumb, though I recognize this is almost impossible to do in southern California. Just because some pay more doesn't mean they are successful. There's a lot of desperation and rationalizing out there; and also a lot of one-time flippers.
Note as well, that if you zero out the financing costs, per Tim Gordon above, and pay 80% of the ARV for Costa Mesa, you are lucky to come out even. I call BS on this strategy. See below:
We don't loan to anyone without experience. We do real deals with real borrowers, many of whom would be called "Big Dogs," and are sensible enough not to buy into this rubbish. All can, and usually do obtain 100% financing, which leads me to wonder about this claim.
No "Big Dog" would ever pay 70% or 80% of ARV. Not even close. All also laugh at the hugely overpriced deals, as these, offered to them by "wholesalers." You'll completely discredit yourself by presenting any deal like these to any experienced rehabber, yet alone a "Big Dog."
You guys need to run the numbers, make your own decisions, and be careful where you get your advice.
"I'll see how well this goes when I get my first property under contract."
Why am I not surprised?
