Nobody likes to screw up.
And worse yet, nobody likes to screw up publicly while at the same time, losing other people’s money.
That money may be family money, friend’s money, private lender money, bank money…or your own money.
Justifiably so, this tends to be one of the biggest fears most new investors…but it doesn’t have to be.
The best way to NOT screw up a flip is to make sure your analysis of the deal is spot on.
So fear not new investors, read below and worry no more…
Learn How to Analyze the Deal
Learning how to analyze the deal is one of the most important things you need to know when you’re flipping houses. This includes knowing exactly what you can sell the property for (known as ARV), what you’re renovation costs are and of course what you can buy it for.
If you haven’t heard, ARV is the single most important number in house flipping - as all the other numbers stem from this one.
But as a new investor, you may be tempted to just do your first deal just to get it under your belt. You may think you can underestimate a few cost of repairs here, or overestimate what you can sell the property for on your ARV there, and everything will turn out just fine.
To be successful doing this, you really have to follow rules, systems and formulas. These will keep you out of trouble and safeguard your business from catastrophic losses.
No “Adjustable Spreadsheets”
Adjustable mortgages are fine, (although personally I don’t use banks at all), but not adjustable spreadsheets…especially in house flipping.
“The adjustable spreadsheet” – otherwise known as “eraser math” is one of the biggest enemies of the new house flipper.
But this is all too common – and I see it happen all the time, including some of the more seasoned real estate investors who still fall victim to it.
I even saw this week with one of my former coaching students as he desperately tried to convince one of my money lenders to fund one of his properties. Fortunately for my old student Jerry, my lender Elliott would not budge on his skepticism - because he knew Jerry was using an “adjustable spreadsheet” in his calculations!
Jerry may need to dump the property and move on – or figure out a way around some of his renovation costs, which were just simply too high for the profit needed in the deal. His adjustments left him little margin for profit which worried Elliott as to the solvency of the deal.
Jerry aside…this is typically a failing of the new investor who is trying to get into a property for the first time. New investors have a tendency to want to justify or come up with reasons why they can pay more money than what their maximum allowable offer (MAO) should be.
Are you guilty of this?
When I talk about adjustable spreadsheets, what I mean is this:
- Let’s say you’ve determined the property you found could sell for $400,000 once it’s all finished.
- And let’s say you figured your cost of repairs were $80,000.
- Assuming the above numbers are accurate, according to the house flipping math, you need to get this property at no more than $200,000
- Then let’s say you placed an offer at $195,000, thinking you could get it for $200,000, but it was rejected because there’s multiple offers on the deal.
What do you do now?
- Do you go up on your offer over $200,000?
- Do you figure out how to get the ARV higher?
- Do you lower your renovation costs?
- Do you walk away?
For most investors, they start looking at things and start doing “adjustable spreadsheet stuff”.
This typically comes in two forms:
- Up The ARV: They start to convince themselves that if they do a few more renovations or improvements that they might be a will sell the property for $410,000 or maybe even $420,000.
- Fudge The Repairs: They start to fudge is there repair costs. The investor might say themselves: “if I put some work in myself and if I can negotiate on my contractors I could probably get this renovation done for about $60,000 instead of $80,000”.
This investor then starts to convince themselves that this “alternate reality” in their deal scenario actually exists. They start “adjust the spreadsheet” to mathematically arrived at the point where it makes sense to offer a higher price.
Just because the paper (or in this case the Excel spreadsheet) looks good, doesn’t mean that it actually is good. So the new investor goes out and offers a higher price, gets the property does the renovation, experiences hire than anticipated renovation costs and a lower ARV and they end up losing money.
This unfortunately is a classic scenario…which leads to big heartache later on.
Here’s 2 ways to avoid this pain…
1. “Stick Like Super Glue” to Your Original ARV
If you have a projected ARV of $400,000 and you start to convince yourself that if you add marble countertops to the bathrooms, a subzero stove to the kitchen or maybe a certain type of designer tile in the entryway or a larger back deck, you’ll get $410,000 or even $420,000, you’re only hurting yourself and your profits.
When you start doing all this, it’s a slippery slope of rationalization upon rationalization – all doing nothing but clouding the numbers and jeopardizing your profit.
The reason is that the house flip rules take into consideration a conservative ARV and the potential for the ARV to drop 10% or even 20% by the time you’re going to sell.
By the time the renovation is completed and you’re ready to sell, the market always has the potential to shift. Perhaps now even after an excellent competitive analysis, the neighborhood in which you bought your flip now has ARV’s in the range of $390,000 or maybe even $380,000.
When flipping a good maxim to post on a sticky note on your computer is:
Hope for the best and prepare for the worst
Although you might think in the current market environment that real estate prices are consistently appreciating (and in most cases right now they are), this is extremely dangerous and risky thinking to EXPECT IT.
So let’s say you adjust your spreadsheet to convince yourself that you can sell the house for $410,000. If the market shifts to where you can only sell it for $390,000, you have now completely lost your safety net.
When your original ARV projection is $400,000, and you sell for $390,000 – although not ideal – this is certainly not catastrophic.
But with your “adjustable spreadsheet” ARV at $410,000 and selling at $390,000, that $20,000 spread could be your entire profit on the deal.
This is why fudging your ARV is very dangerous because it almost completely eliminates your safety net of profitability.
2. Don’t Fudge Repair Costs: They Rarely Go Down
With just about every flip I’ve ever done, it seems my renovation costs always come out higher than my projections.
As I write this, I would say it’s about one in ten house flips where they are lower than my original projections!!!
So I can nearly guarantee you that whatever number you come up with for repairs, it’s usually going to be higher.
So what we do now is when we get our renovation numbers, we add another 10% to the cost of renovation.
In some cases, we may go even as high as 20% over the original cost of renovation if we’re not 100% sure.
so in our scenario here, let’s say you’ve lowered your renovation costs to $70,000 – trying to justify the higher offer. But lets say, by the time you get done with the project that original $80,000 estimate now has turned into maybe $90,000…or maybe even $100,000.
Now you’re really screwed.
How To Not Screw Up Your First House Flip: Conclusion
Its easy to get emotinally attached to a house flip and WANT it to waork so badly that you convince yourself that it will work if only…
Forget it. Move on and find another one.
You just can’t get emotionally tied to anything. You’ve really just got a think with your head not with your heart. Stick with your math, stick with the numbers you come up with and go with it and if it works out it works out. If it doesn’t owrk out, it doesn’t.
Get up and fight another day.
There’s always another house flip…
And if you’ve made it this far, please leave a comment below, I’d love to hear from you.
Have you made these mistakes? Do you have the same fears? If you haven’t that’s cool too, leave a comment and ask me any question you want!
Photo: FlickrHow To Not Screw Up Your First House Flip! by Michael LaCava