No matter how many properties an investor buys and flips, each will be met with a new and unique set of challenges and problems. No two houses will offer the same overall experience and no two budgets or timelines will be the same. However, there is one absolute in every single real estate investment. No matter what part of the country, middle-class neighborhood or upscale community; a cosmetic flip or a total rehab there is one skill that every house flipper must master – the art of buying low.
In real estate investing, money is made or lost the moment the property is purchased, and not when it is fixed up or renovated. Experienced flippers expect to obtain a property for 25-40% below retail value. The closer to the 40% mark, the more ‘budget cushion’ in the project in case of unforeseen expenses.
Buy Well Below Market Value
If a flip or rehab property cannot be bought for at least 25% below market value, walk away. It is critical to understand the risk involved in the real estate investment business. For every success shown on the popular house flipping television shows, there are thousands of real-life flips gone wrong. If a home is purchased at less than 25% below the market, there is no wiggle room for error, closing costs, unexpected repairs, marketing costs, and realtor commissions.
The Formula for Determining an Offer
Assuming that a first-time house flipper has found the ideal flip property, the seller is highly motivated and the investor has done all the research regarding the property market in that neighborhood. When it comes time to make an offer, there is a basic calculation that is straightforward, uncomplicated and will provide an excellent idea of what type of offer should be presented to the seller. Let’s break it down:
***For the purpose of this example, assume that the selling price (or retail value) of the property after the investor completes all renovations is $200,000.
From the retail value, deduct the desired profit which should be in the 15-20% range. At 20%, the projected profit on this property is $40,000.
From the same post-flip selling price of $200,000, deduct any anticipated holding and contingency costs. As an industry-standard, assume conservatively that the owner/investor will hold the property for six months, which translates to $10,000.
From the $200,000 figure, deduct the planned and budgeted renovation costs. For this example, the cost is assumed to be $15,000.
Lastly, from the selling price of $200,000, further, deduct the realtor’s commission. For this example, we will assume a commission of 6%, and therefore based on the selling price of $200,000 the fee owing to the realtor would be $12,000.
Using these calculations, the investor’s offer will be whatever is remaining once all expenses from the anticipated selling price have been deducted. In this case, the offer would be $123,000 which is 38.5% below retail value.
Leave Room to Negotiate the Selling Price
In the example above, and starting with an expected 20% profit margin, the investor has 5% to play with if a second offer is required, perhaps allowing a counteroffer in the $125,000 to $133,000 range. It is recommended that an investor never expects less than a 15% return on investment (ROI), allowing ample room for unexpected costs. Since there are variables in this equation such as lower holding costs (for all-cash deals), less renovation costs (due perhaps to sweat equity), or a lower realtor commission, these figures will be adjusted to arrive at the magic number for each property flip.
Never Adjust the Base Assumption Amount
The one figure that should never be exploited is the base assumption fee; the retail value of the property after the renovations is completed. Keep in mind that no matter how much the property is fixed up, and what amenities are included, the house will only sell in the general region of what that particular market will bear. Never assume that a property can realize an additional $20,000 because of an added bathroom and upgraded kitchen granite countertops. It is critical that during the competitive market analysis phase (CMA), an investor should always compare similar properties that are in the immediate area. Look only at properties that have sold within the last 12 months and have comparable square footage.
It is not difficult to negotiate a favorable deal for any investor armed with the tools to make an informed offer. The more time taken to become educated on the nuances of real estate investment, the more adept any investor will become at mastering the art of the deal.
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