Whether this is your first flip, or your second or third, without understanding the items that impact your profitability, you probably won’t realize the returns you hope to achieve. In fact, the ultimate sales price of a flip can be influenced by a variety of things including the size and age of the house, the neighborhood you choose, and the DOM (Days on the Market). As a real estate investor, knowing and using these three formulas can help you achieve success.
#1: Formula for Estimating Repair Costs
Most investment properties are going to need at least some repairs before they are ready to be placed on the market. One of the most important formulas for flippers to learn is how to estimate the cost of repairs. A basic formula used by many professional flippers is the ‘$20 per square foot’ rule.
In essence, this rule says that in a typical flip, you will end up spending about $20 per square foot on repairs. If you are flipping a home that is 3,000 square feet, multiply that by $20 per square foot to estimate the approximate amount you will have to spend on repairs. In this example, repairs will cost about $60,000.
#2: Formula for Calculating Closing Costs
Many novice flippers forget to calculate their closing costs. You’ll have to contend with two closings on a flip. The first closing is when you buy the house to be flipped and the second is when you resell it.
When you purchase a property, take the price you’ll pay for the home and multiply it by 0.5%. That will give you a good estimate for what you’ll pay in closing costs to purchase the property. When you go to sell the property, you’ll likely pay more than that for closing.
If you are using an agent to help you sell the home, you’ll need to factor in their commission, which can be between 3% and 6% of the sales price. On top of that, you’ll need to factor in the costs for titling and legal fees which can add up to about 1% of the total purchase price. If you multiply your final sales price by 6% to 10% you can estimate your total closing costs for the sale of the property.
#3: Formulas for Setting the Offer Price
Now that you know how much it is going to cost to fix up your flip and about how much the incidental costs will be, you need a formula for setting your offer price. Actually there are two formulas that you can use.
For the first formula, you’ll have to come up with your ARV (After Repaired Value). This number is how much you estimate the home will be worth after all repairs have been made. You take that number and subtract from it your repair costs, your estimated closing costs plus holding costs (insurance, interest, utilities, taxes, etc.), and then subtract the amount of profit you expect to make from the deal. The number you are left with is the offer price.
The second formula is known as the 70% rule. In essence, this rule says that the cost of buying and repairing a flip should amount to a maximum of 70% of the final sales price. You can calculate your offer price with the 70% rule by multiplying your ARV by 70%. That number is your offer price.
Know Your Numbers