BiggerPockets


The 2 Most Important Rules I Use when Looking at Deals

Posted on Wednesday, December 19

Evaluating a fix in flip deal in a competitive market


There aren't many things as tantalizing to me as evaluating deals, especially when it has the makings to be a juicy one.


Many people are getting back in the "game" of fix and flipping here in Phoenix (and surrounding areas) of Arizona, so I thought this post might be of value to those who find themselves digging for info on not only finding deals, but evaluating them. In this scenario, I'm strictly looking at this property to remodel and re-sell on the retail market.


When it comes to mining deals, there's two things I hold steadfast: 


Rule #1) Hope is not a strategy

Rule #2) Don't make a deal a deal


Lead source & quick overview


A local wholesaler sent out a couple properties, one of which is in my local farm area (meaning, the area I like to get and do deals). Although personally I have not seen many deals come from wholesalers that make sense (numbers wise) for me to fix and flip, I'm sure other people do, but everyone's criteria and minimums are different. But, in any case, this one peaked my interest so I decided to inquire further.


The house was a 3 bed (yes!) 2 bath (yes!) 1,300 SF property in an area I've done deals and lived, a major plus.


I took my partner to take a look at it and did a thorough walk through, discussing the updating we could do to get the most bang for our dollar and that would fit in with the neighborhood. We settled on renovating bathrooms, kitchen, new flooring, paint, fixtures, repairs throughout, and landscaping. Roof was in good condition, neighborhood is desirable, no HOA, and AC looked decent (anyone else getting pumped about this deal? So was I!) Given the 200K+ retail value, we budgeted for a 15K rehab given that the neighborhood/comps support using slab granite, stainless steel, faux wood flooring, nicer fixtures, upgraded hardware, etc.


The only major concern was some cracking and settling of the foundation that was apparent in different parts of the house (driveway, roof, certain rooms). The house was built over 50 years ago but has block construction, so it "could" be something to look into further, but daylight was running out so I decided to look through comps more thoroughly and compare remodeling/pricing and revisit that challenge during the daylight the next day if the numbers made sense otherwise.


Comps


Here's what I saw looking at comps (from tax records and MLS): 


Properties in average condition, that have not been updated but are not disastrous, go between $160K-180K. (This deal is $171K).


Properties that have been fully rehabbed go from the low 200K's, and others that have been "decked out" are listed in the mid 200K's. Looks like a big spread, right?


I like to look at things qualitatively as well as quantitatively when putting a value on homes, accounting for the type of fix up, the available inventory, temperature of the market, etc.  For us to get to the recent comps of the mid 200K's, we would have had to go beyond our current  remodel to upgrade windows, AC, converting carports into a garage, have a pebble tech pool, etc, ie, big ticket items.


Numbers breakdown


We could have picked up this property for app $171K. If you haven't done a hard money deal before let me show you a quick tutorial:


Purchase price (this is what most HM lenders will go off of, NOT value) = $171K

Required down = 30%, remaining balance = $120K

3 Points = $3,584

18% interest (formula = Loan Balance X Annual % = Total Interest / months = Monthly cost) (Monthly Cost / 30 days = daily cost of HM)


So this would be $120Kx18% = $21,600 in interest/12 months = $1,800 month

$1,800/30 days = $60 day


I figured we would have the property for 70 days (based on other recent sales and time it would take us to rehab). The other properties we'd want to compare to have been sitting for over a month, and another one just came on the market a couple weeks ago, fyi.


Hard money total costs = $7,119


Retailing


Next is resale. Although I saw comps in the mid 200Ks, the square footage was larger and the upgrades were more significant. 15K for a 1,300 SF home is pretty generous but adds up quickly when you consider the materials are of a nicer grade, and the entire house (inside and out) needed to be painted, all flooring removed and replaced, 2 bathrooms and a kitchen remodeled, etc.


FYI I use solds in last 3 months(ish), within a square mile, within 10% of the same square footage, and 10 years either way on the year built. I take pool into account but don't use it as a filter. For actives I use pretty much the same criteria but of course looking at how long it's been available.


To make a desirable profit on this, we would have had to sell in the $230K+ range. What it appeared as, after all comps, conditions, stats, price per SF but also price range were accounted for, is $215-$225K.


Now take out commission on the re-sale, plus all title and taxes, we see the margins get reduced to a scary number.

If all else fails, read the instructions

Let's revisit rule #1- Hope is not a strategy.

Here's where you start to think, well, the market has been going up so hopefully we can continue to see healthy gains, especially in the Spring selling season.

Those cracks hopefully aren't anything major that's affecting the foundation.

Rule #2 - Don't make a deal or deal

"If we cut back on renovation costs, if the sales price is 10K more, if we sell in less time, we could make a GREAT profit on this!" This is all justification to MAKE a deal a deal, not just see that it a deal really IS or IS NOT a deal.

I have basal numbers I work with, %'s I have to make and if they don't fall in that criteria after much evaluation, I bow out. As much as everything else about the property, location, rehab, excited me, it just didn't make sense to take that much of a risk and gamble and HOPE to make a large profit, let alone break even.

Conclusion

Given the info above, would you have taken this deal? When I see the numbers fall below a 10% margin, given the "ifs" it would have taken to command the higher final sales price, I get squirmy. Rehab takes longer, new buyer needs concessions, something else comes up during the renovation, and now we're slipping into single digit margins. I don't (personally) want to be in any business that operates in that realm, and I've done enough deals to revert and rely on Rule #1 and #2.

So, onto the next one and when the numbers make sense, you jump all over it and sit in the fact you know when a deal is a deal and move onto rule
#3: Cash massive paycheck.

Deal?!

 
This content was originally posted for Bigger Pockets by Tracy “Royce of Real Estate”. You can visit her blog at www.RoyceOfRealEstate.com/blog
 
Tracy is an Arizona Short Sale Realtor, Investor, Rehabber and Foreclosure Expert. She is also an avid blogger, vlogger, and consultant on all things Arizona Foreclosures.





Comments (15)

  1. Tiny_1399356220-avatar-brandonatbp

    This was a fantastic article Tracy! Thanks for posting. Those two rules should be written on a plaque and hung on every investor's wall!


  2. Tiny_1399652652-avatar-royceofre

    Thanks for the feedback Brandon. Don't forget rule #3!! :)


  3. No_avatar_tiny

    Hi Tracy, Thanks for the article you shared. I'm a bit of a geek when it comes to #s, so of course, I enjoyed reading about your eval & #s for how you'd consider a property! I'm out in the L.A. metro area, so I know there might be a few discrepancies when it comes to considering cost of rehab compared to your area in PHX. I had a few questions about your eval that I was hoping you could give me feedback on. #1. in the "RETAILING" subheading you wrote: >> Next is resale. Although I saw comps in the mid 200Ks, the square footage was larger and the upgrades were more significant. 15K for a 1,300 SF home is pretty generous but adds up quickly when you consider the materials are of a nicer grade, and the entire house (inside and out) needed to be painted, all flooring removed and replaced, 2 bathrooms and a kitchen remodeled, etc. >> as i understand, i'm assuming cost of living/goods is higher where I live, so I tried to factor in that difference by comparing cost of living in LA vs PHX when estimating rehab w/your 15k example. Even after adjusting cost of living/goods, I thot 15k was REALLY low to rehab a 1300sf in the areas you mentioned (inside/out). unless I misunderstood what you meant. 1.a. materials alone for a "nice" kitchen upgrade is about 6k for about 150sf small kitchen space (including an island)... let's say w/labor it's about 7k (not including sink, stove, disposal unit, recessed lighting), and even then, i think 7k is a low est for a kitchen remodel; (7k) 1.b. ea bathroom remodel... assuming tub, sink, fixtures (and leave alone the toilet), plus tiling, that can be 2-3k w/labor right? (~5k) 1.c. flooring and interior painting... I dunno $2/sf (assuming laminate and 2 colors)... 3k (~3k) 1.d. how about buffer expense for rehab and permits... i typically buffer at 15% (2,250) and permits? i dunno ~1k should cover it? (~3.5k) that's a TIGHT 18.5k or about 20k in rehab, but then again, your labor might be a lot cheaper than what i'm assuming. 1.e. i noted a 10% diff for cost of labor (comped out using www.building-cost.net or careerbuilder's est (shortened link) http://cb.com/RdzQHY) 50% assumed for materials --> 18,500/2 = 9,250 (materials) adjusted labor (10%) --> 9,250*.10 = 9,250-925 = 8,325 total adjusted for rehab = $17,575 or 18k OR 27.9% if you use this assumption for labor (http://www.bankrate.com/calculators/savings/moving-cost-of-living-calculator.aspx) 50% assumed materials: 9,250 adjusted labor (28%): 6,660 total adjusted for rehab: $15,910 or 16k and I'd round up for rehab costs to be 20k #2. ALSO IN "RETAILING" you wrote: >> FYI I use solds in last 3 months(ish), within a square mile, within 10% of the same square footage, and 10 years either way on the year built. I take pool into account but don't use it as a filter. For actives I use pretty much the same criteria but of course looking at how long it's been available. << first, thanks for breaking down how you take a look at a property, i found it useful and informative when comparing to how i calc out a property. 2.a. you mention here that when considering actives, you use the same criteria for comps and also look at how long it's been avaialble. MY QUESTION: even if sq, lot, #br, #ba, yr built, and being w/i 1mi rad, HOW DO YOU KNOW IF A 45day ACTIVE IS SIMILAR TO A 120d ACTIVE? the 45day active can turn into a 300+d active OR it could be a 46d active-to-sold property. How can looking at how long it's been available in the market be useful in determining a useful comp to your subject property? #3. COMPS It seems like there's no good way of really covering this risk, but one concern I always have is the comps today compared to the comps after rehab. How do you cover risk when the comps you used to determine your exit are no longer valid for an appraiser to consider? In your example, you mention a range between 160-180k for comps, and your subject property pp is 171k... even if rehab were 5k, those #s already would keep me from looking twice at the deal. Especially if "hope" isn't a strategy. 3-6mos from now, I can't hope that my property will sell for 200+k... my estimates would stay in the 160-180k range and hope that it would sell @ 160k for a discounted listing to encourage a quick sell. Of course, I'd have to purchase the property at 120k, rehab 5k and sell at profit margin of 35k (sale: 160k). #4. Note: I'm just getting back in the game, and this time I'm aware of my #s and the market I'm in. pre-crash, I used the force and followed the lemming/herd mentality of "investing" (gambling)... that's how i lost 2 in vegas and 1 in orlando - 2 winner places in 2004-6... i know. That said, I'm not sure if I'm comping properly or doing my calcs properly. I have yet to get back in the game, so all my #s are based on a clean lab environment and what I hear from other investors (and now in BP) :) Sorry for the looooong post. If I calc'd like you, I'd prolly get into several "deals" already. Of course, my fear would then be if I'm really making $ or just gambling again like i did pre 2007. Hopefully, I'll be able to find a deal I can pull the trigger on. What a terrible time to get in, eh? when inventory is low and competition is high. that kinda matches my last "strategy" of buying high and losing low. akkkk... Can you (or anyone) please shed some light... am I missing anything or just overestimating my way out of a deal? thanks! -Kelv!n


    1. Tiny_1399652652-avatar-royceofre

      Hi Kelvin, thanks for the comments! I am going to attempt to address some of your questions... Paint is about a $1/SF and we wouldn't need permits for any of this rehab. We purchase granite/appliances, etc at discounts so our rehabbing costs aren't "off the shelf" so to speak. I have a profit split with my crew so cost of labor isn't calculated into all of this. (NOTE: Not everyone is able to do this, but I have to break it down according to what my personal calculations are to see if the #'s work for ME, just like if someone else has more cash, so they wouldn't have to figure in the cost of hard money). When you round up, adding a few thousand is pretty generous. I'd say round up a small % or small dollar figure. As you get more experienced you'll get more comfortable with your cost analysis (you don't want to tell a potential partner you're tacking on 3-4K on the rehab "just in case"!) With the actives, you're right, but you take into account how long the SOLDS were on the market (as well as the pendings) to see what the overall trend is. If there is one that has a particularly long DOM (days on market), I dig through the listing to find out why. If all else fails, I call the listing agent and ask. With sold comps, if there aren't ones I don't think I can use in the time I think an appraiser will be involved (on the re-sale side), that's not a good sign. I personally like to see a healthy mix of actives, pendings, and solds. So partly to answer your question, you would want to purchase in an area that shows ongoing activity and desirability. The comps that are between 160-180K wouldn't even be "like kind" by the time we would have finished fixing up the property. I understand your fears! When you've gambled and lost you want to be more educated the next time around; that's only smart. I've comped so many properties I can read between the lines with numbers (in MY specific market), worked with contractors for years, and so with that comes a level of confidence. But, I still am very detailed about each deal...you have to be. If you're getting back into this I would really recommend trying to connect with someone in your area that has remained in the market and can help show you the ropes again. Hope this helps!


  4. Tiny_1399587440-avatar-neilinmadison

    Tracy I found your discussion of the hard money lenders terms the most interesting. Based on the numbers you shared, it looks like the HML makes almost 3% per month, over 35% annually, and never gets any paint under her nails, argues with a contractor, or takes much risk that the property will take 140 days to sell instead of 70. Those are really high returns. I buy and hold, I don't flip, but if I did, I'd be wondering why I had to give so much of my profit away to someone putting up only $130k for 70 days. I'd also be wondering why I am not a hard money lender instead.


    1. Tiny_1399652652-avatar-royceofre

      Hi @Neil Rainford, That's the blessing and curse of using hard money. If it's not a profit share deal, you simply pay the interest and really are paying for the convenience. But yes, depending on how quickly you can get in and out, it can eat up a healthy portion of profit. But, unless you can fund it yourself or have access to cheaper money, it's a necessary part of being able to purchase deals, quickly. And yes, you're absolutely right....BEING the hard money lender isn't the worst deal! Many investors look to individuals to be private money sources.


  5. Tiny_1399594593-avatar-amackent

    Nice post Tracy. Personally, I'd never consider any terms close to the HML terms you quoted. I'm simply too cheap for that. If that's the way deals were going, I'm with Neil; I'd definitely want to be on the lending side. Also, I'd have a hard time getting a significant remodel done on $15k. I'd expect granite, a kitchen, 2 bathrooms, floors and paint to cost more, but if you can get it done for that - more power to you. As for whether this is a deal, I think you've established that it is not a deal as now presented so what could be changed to make it a deal. You can't change the comps, so how can you get this at a better price? I've never done this, but in this case, I might do a bunch of research on foundation repair. If foundation problems are present vs. acceptable settling, then the seller has a huge problem. If you can get some confidence in reasonable costs for repair and/or stabilization you could probably negotiate a significant discount in the purchase price and turn this into a deal.


    1. Tiny_1399652652-avatar-royceofre

      Hi Alan, Yes being on the lending end is a GREAT deal! 15K is possible because of our access to discounted materials, and I have a profit split worked out with my crew, so my cost of labor is significantly less expensive. The answer is, I can't get this deal at a better price :) I found it from a wholesaler so unless they came down in price, I just simply have to pass it up, plain and simple. That's a good suggestion about negotiating with the seller due to the foundation problems, but if it did in fact require that much work to bring up to par, I probably wouldn't want to take it on. Name of the game is to get in and out as quickly as possible, and with the clock ticking at 18%, foundation repairs make my wallet zip right up. Thanks for the comments!


  6. Tiny_1399661604-avatar-jasonstyrke

    THIS is PERFECT Thank you. Exactlly what I was looking for, the Whole Process of the business (or most of it I am assuming). I amgoing to re read this but just incase the answer isnt in their, How do you calculate your 10% margin with the Est Val of the House and how much you have to sell it for. You way of going by a certain percentage feels more In control then the "hope" you speak of.


    1. Tiny_1399652652-avatar-royceofre

      Hi Jason, thanks for your comments. My margin is based on my personal litmus for a good deal. Some investors say "I have to make $20,000 no matter what", others say, "I have to make x%". Although each house is still a case by case basis, my bottom line has to be about the 10% or above range, otherwise, if something goes wrong, you may be left with a very small or no profit at all. All that effort for a tiny paycheck, no thanks!! Yes I take the calculation off the re-sale price, ie, a $200,000 sales price, I expect to make about 20K.


  7. Tiny_1400607395-avatar-barronrep

    Thanks you Tracy, it is clear, you are good at this... your rules are well noted. The remodeling cost was a concern but you have explained it twice. Your next post could be, how to best make those material and labor cost deals. Good stuffs, thanks again


  8. Tiny_1400607395-avatar-barronrep

    Tracy, delete that "s" for me


    1. Tiny_1399652652-avatar-royceofre

      Hi David, thanks for your feedback. No worries about the mis-spell, and I will keep your idea (for a follow up blog) in mind. Great stuff. Happy New Years!


  9. Tiny_1398871067-avatar-ncarey

    This is a phenomenal post Tracy. It definitely deserves a comment to bump it back to the first page. You wrote: "Properties that have been fully rehabbed go from the low 200K's, and others that have been "decked out" are listed in the mid 200K's. Looks like a big spread, right? " Funny I look at that, and immediately though not much of a spread. - Ned


  10. Tiny_1399652652-avatar-royceofre

    Thanks for the comments Ned. Yes some think 10K is a good paycheck, others wouldn't touch anything under 50K with a 6' pole! Appreciate the feedback.


To leave a comment, sign in or create a free account on BiggerPockets today!