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Anatomy of a Flip

Written by Posted On Tuesday, 19 December 2017 18:20

Flipping houses has become almost an American Pastime as Cable TV led offerings fill the Homes with 60 minute transformations and immediate sales.  Fast Forward to Reality.  Buying a house and flipping it for profit is rarely filled with such glamour and the actual renovation itself is not necessarily where the money is made.

The money is made through a careful consideration of the two basic truths below while all along knowing your true costs from inception to sale and remaining honest with yourself throughout the whole process of the flip.

Well let’s start with two basic truths

  1.  Knowing the after repair value (ARV) of a property is the most critical piece of knowledge in determining the viability of a flip. If you can’t confidently determine what the value of a property is after repairs, you probably shouldn’t buy it.

  1.   2.  You must determine what the Maximum Allowable Purchase Price (MAPP) is and make sure your purchase offer aligns with that dollar figure.

If these two factors are true, and I speak from experience that they are, determining ARV and what price to pay for that deal are the pillars of the anatomy of a flip. You can be Bullish and hope to achieve an inflated ARV (by being an expert on marketing, salesmanship, the latest in Better Homes and Gardens and have a serious access to and knowledge of current market conditions) and/or negotiate a purchase price less than the maximum allowable purchase price (MAPP). I encourage a Bearish approach, where one must deal in terms of conservative ARV and not pay over the maximum allowable price. Being a Bear may require walking away from some deals that seem profitable to a Bull.

Determining After Repair Value (ARV)

Remember that we are discussing value, not cost, here. What a future buyer is willing to pay is determined not on what it cost you, but the value they place on the property. So, in seeking to determine a property’s ARV, we must understand what the basis is for a buyer’s determination of value. Fortunately, they will use much of the same data as you will to determine value, but those buyers will also use emotion and all kinds of subjective feelings to help them determine value as well. So, though they will turn to hard data like comps, market conditions, school districts, interest rates and the basic features of the given home, they will also be affected by their sense of urgency, the colors of the walls, being on or too close to a busy street, it doesn’t (or does) have a pool, planes fly overhead or a countless number of such variables.

So, a Bear analysis of ARV is to stick close to the hard data and be tough on any features that rule out a certain percentage of the population (i.e. a busy street). Stay picky about and close to comp values and don’t be afraid to take some off the ARV for those countless number of subjective values. Regarding comps and professional opinions on ARV do whatever you can to get good data, which usually involves input by a good real estate agent who can access the best and most reliable residential real estate information available- the MLS. It is often valuable to "farm" an area you are familiar with so you become an expert in that area.  We buy houses in Syracuse NY and only in this our home area.

Maximum Allowable Purchase Price (MAPP)

This value is determined by the following math

ARV minus

  • Cost of Rehab– make sure you fully understand what it will cost you and also what the improvements are to be on the property based on the value they will have to a buyer- essentially architectural services whether performed by yourself or others. In order to effectively control costs, you must determine the work to be done upfront and then stick to it as much as possible.
  • Carrying Costs– this includes property taxes, insurance, utilities, lawn/snow care, etc. My average time from purchase to closing with a retail buyer is just under six months, so I always figure in six months of carrying costs.
  • Cost of Money– this includes the cost of acquiring the money and the interest you pay on that money- again I figure six months. Cost of acquiring money includes points, legal, appraisals, progress inspection fees, origination and application fees and more. If you are using a bank (and to varying degrees hard money lenders), money acquisition costs can be very high, not even counting the interest. Private lenders, if set up properly, can save a great deal on the money acquisition side of things, since you may save on everything but the required mortgage tax (I always place my private lenders in 1st mortgage position for their protection) and interest charges.
  • Acquisition Costs– are in addition to the actual purchase price and include legal and other expenses that may come with the property before you leave the closing table.

I always try to follow the 70% rule which is effectively that my “Cost Basis” (total funds invested from financing, partners, out of pocket, etc.) should not exceed 70% of ARV. That is the Cost of Rehab plus Carrying Costs plus the Cost of Money plus Acquisition Costs (including Purchase Price), which should not exceed 70% of ARV. There are additional costs payable at closing that also need to be accounted for which are funded by credits at closing, which I call “Transactional Costs”, (real estate commissions, marketing, legal fees, seller concessions, transfer taxes, etc). I budget 10% of ARV for this, though depending on your marketing savvy and resources, you can see that this can vary widely.

EXAMPLE

$100,000.00

ARV

$  70,000.00

70% of ARV or “all in cost”
 

—– LESS—–

-$20,000.00

Cost of Rehab

-$5,000.00

Carrying Costs- Six Months

-$6,000.00

Cost of Money- Six Months

-$1,500.00

Closing Costs on Purchase
   

-$32,500.00

Total Renovation and Carrying Costs
   

$  37,500 .00

Maximum Allowable Purchase Price
   

$30,000.00

Gross Profit

-$10,000.00

Transactional Costs (10% of ARV)
   

$20,000.00

Net Profit

Yes indeed, that means the MAPP is 37.5% of ARV. That’s hard to find you might say, but the numbers don’t lie. This deal would yield a $20,000 profit on the $90,000 , after-transactional-cost net sales proceeds of $90,000 (or 22%). The only way a higher purchase price will work is:

  1.   1.  Accept less of a profit margin
  2.   2.  Figure out how to get a higher ARV
  3.   3.  Sell faster (less than six months)
  4.   4.  Spend less on rehab- but can you get the ARV?
  5.   5.  Otherwise streamline expenses in the other categories

That, my friends is the Anatomy of a Flip. I usually like to bid like a Bear and hope like a Bull myself. How about you?

Joe Pierce
CNY Home Buyer, LLC
Licensed NYS Associate Broker
 Procopio Real Estate, Inc., Syracuse NY

 

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