Welcome to part one of my new series detailing all the steps you need to know about the house-flipping process. Today, we’re talking about important costs you must know beforehand.
When you decide to flip a house and you’re ready to start out looking at properties that need some work, there are three main numbers you need to look for when analyzing a property.
The first of these numbers is something called ARV, or “after-repair value.” This is the value the home will sell for after you’ve fixed it up. You can determine this number by looking at the prices of comparable homes in the area that have recently sold. The best case scenario here would be finding a cluster of homes that have all sold within the last six months in the same neighborhood that have the same square footage.
The second number you’ll need to know is your rehab costs, or however much it will take you to renovate the house and bring it to its after-repair value. This can be tricky to calculate, though, because there are a lot of variables involved.
For example, if you hire a general contractor who takes care of everything for you (i.e. buying the materials, hiring the subcontractors, etc.) so all you’re really doing is supervising and checking in occasionally, that will free up a lot of your time, but it will also a lot more. On the other end of the spectrum, if you decide to do most of the work, you can get away with having a much lower cost.
If you are buying the materials yourself, one thing you need to watch out for is the quality of the finishes. Everyone wants to make their fix-and-flip house look perfect, but you don’t want to over-improve the house to the point where it’s the biggest and nicest house on the block or it’s a price range above the comparable homes in the area. The easiest house to sell is one that’s priced somewhere in the middle of the surrounding comparable homes and people are comfortable paying for.
Next, you need to find out how much to pay for your fix-and-flip property. Let’s say your ARV is $300,000. You have to consider what other costs will do to that final price. First of all, you have to take off closing costs. A good rule of thumb for estimating closing costs is to take off 7% of the total price. 7% of $300,000 is $21,000, which drops your total down to $279,000. Then, let’s say your rehab cost is $20,000, which would drop the final price further down to $259,000.
In this case, $259,000 would be your break-even point. You’re not doing this to break even though, right? That’s a lot of time, effort, and money just to break even.
If you know $259,000 is your break-even point and you want to increase your profit margin, subtract what you intend to make from the final price. If you want to make $5,000, plan on paying $254,000 for the house. If you want to make $25,000, plan on paying $234,000 for the house.
These numbers I’m using are very simplistic, so if you’re thinking of flipping a home and want to go more in-depth about the costs you’ll encounter, give me a call and I’d be happy to talk with you about it.
Stay tuned for more on my new series about home flipping. In the meantime, if you have any other questions, don’t hesitate to reach out to me. I look forward to speaking with you.