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The One Real Estate Investing “Secret” the Gurus Don’t Want You to Know

by Michael LaCava on December 29, 2013 · 28 comments

  
Real Estate Secret

Whether you’re flipping houses or investing in real estate for the long haul, there are really no “secrets” to success.

Forget all those guru offers that appear in your inbox that claim to “reveal the insider secrets” to “only a select few” while they “pull back the curtain”…(of course you need to buy the $40,000 course in order to find out what those “secrets” really are).

When it comes to real estate investing and house flipping success, it’s really not as secretive and cloak and dagger as you may think.

Mostly, it’s just about the numbers – and being disciplined and formulaic in your approach to each and every deal.

And perhaps more importantly, it’s about the single most important number in any real estate deal you ever do…

That “secret” is After Repair Value or “ARV” for short.

ARV: A Bit Like Goal Setting

ARV is the most important number in house flipping, period. This is largely because it determines so many other things in all your calculations. Everything in your entire deal flows from this  number.

With ARV, you are reverse engineering your entire deal – in essence, working backwards to where you want to be from where you currently are.

Think of it like goal setting.

Let’s say in the year 2014, you want to make $50,000 investing in real estate. This is a great goal to set for yourself.

To take the next step in your goal, you’ll then need to write down all the steps that you’ll need to take in order to achieve that goal.

When buying houses to flip, ARV is like setting a goal. You are determining the end value of a property before you would ever consider putting an offer. The ARV gives you the basis for creating the offer.

It’s like beginning with the end in mind.

Forget the “I Can Get This House for $50,000” Mindset

I hear this all the time for newer investors: “I can get this house for $50,000 Mike, it’s a steal! Should I buy it?”

Although buying a house for $50,000 is a really good price, but the purchase price is completely irrelevant unless it’s put into context. In that context is ARV.

These investors think they’re getting a property for so cheap they automatically have “a great deal”.

Not so fast…

My first question back to them is: “Sounds promising. What are their projections for selling that house for?”

Some of them look at me and they say, “I have no idea, I can maybe selling at $150,000?”

Right there I say to them, “So, how do you know if this is a deal?”

That’s what I get the blank stare…

Many investors make this mistake by just basing a deal on the acquisition price because it’s so cheap. Although this house in this example may be a great deal, without ARV, you have no context for whether or not it’s a good deal or a crappy one.

Although it’s tempting, this is a trap you should never fall into.

ARV : Who to Contact

There’s a couple of different ways to determine ARV.

You can try to do it on your own or you can hire a professional. I don’t recommend doing it on your own. Since this number is so important, don’t leave anything to chance. Call on the services of an active real estate agent who has a ton of experience in your particular area.

If at all possible, seek out the top expert in your area. This is typically someone who will attend REIA meetings, MeetUps and local events. You can also call real estate offices or ask for referrals as well.

Simply tell them that you’re a real estate investor and explain your model to them. Tell them about the property you are considering buying and ask them about the neighborhood and other homes that have sold in the area that are similar to this one.

Explain to the agent that this number is a very important number which will determine the success of your project. If they work with real estate investors before, they’ll understand exactly what you’re getting at.

ARV: How to Determine

Once you contacted your real estate broker, simply ask them, “What do you think I can sell this house for when I relist it?”

The most important question they should answer to you is, “What do you plan on doing to it?”

This is where you will outline what you’re renovation plans are. Perhaps you’ll be installing a new kitchen with new cabinets and granite countertops and maybe even stainless steel appliances. Tell them that you’re planning on putting in a new roof, new Windows, new water heater, etc.

As you start listing out all these improvements, the real estate broker should start to get a better idea as to what your ARV should be. With this information, the real estate broker will be able to evaluate the property far more easily instead of evaluating it in and “as is” condition.

The CMA…Beware

No, this does not stand for “Country Music Awards”…

Once you real estate agent starts to understand what you’re going to do to the house, they can then run a Comparative Market Analysis or “CMA” for short.

When you get the CMA, don’t necessarily agree with or go with the first number the real estate agent gives you. Real estate agents at times have a tendency to over inflate ARV based on CMA’s.

For example, on a property I did in Scituate, Massachusetts last year, I was looking to flip a property in an area that I really had no prior knowledge of. The broker came highly recommended to me and I had actually met her at a REIA meeting a few months prior.

I wasn’t familiar with the area at all and she came back with a really good CMA for me. As I had a good sense about her, I took her projection at face value.

Regardless, I did research on my own anyway!

So what I did was I got a map of the area with all the other comps that she and given me and I identified them all on a spreadsheet using a map around where my target property was.

I then started doing some of my own research on Zillow, Trulia and a few other real estate sites where you can pull information on recent real estate sales.

I started to pick apart her CMA house by house. Why didn’t she pick this one? Why did she pick that one? How come she included a property that sold a month ago that appears to be very close to buy property?

After my analysis, I had a few questions for her. The next day I went to her office in analyzed the CMA with her house by house by house.

The really cool thing was that she had an answer for everything that I asked her about. And each answer was backed up by solid data and insight that I never could’ve gotten from Trulia or Zillow in a million years.

Additional Factors That Determine ARV

ARV is not determined in a vacuum. There are some of the other things you need to know about ARV before you put in an offer:

  • Square Footage: For example, you might have a 1200 ft.² ranch where all others in the neighborhood are 1400 or 1500 ft.² or maybe much more on the low, say 900 ft.² is this is the case, you’ll need to adjust your values accordingly either up or down.
  • Number of Bathrooms: Let’s say your house is 1.5 baths and the other houses in the market are 2.5 baths, then your house is going to be worth less because it has less bathrooms. The reverse is true as well.
  • Number of Bedrooms: Same as with bathrooms, a three-bedroom house obviously is less valuable than a two-bedroom house. You’ll need to make adjustments upward or downward based upon the comps in the market.
  • Kitchens: If you see that not many of the comps in your market have branded kitchens, you may be able to price yours at somewhat of a premium. As with all our house flips, we do full renovations and install brand-new kitchens which show and sell extremely well.
  • Kitchen Appliances: Let’s say you’re seeing lots of comps in other houses with non-updating kitchens that are being sold for $400,000. If you really do your kitchen especially if you install updated appliances and even nice countertops, you’ll probably be able to sell the house for $430,000 or maybe even $440,000. Yes, kitchens are that important.
  • Days on Market: The days on market will help you determine carrying costs as well as ARV. Typically, we like to figure 6 months on every property from purchase to close, so we factor in six months of soft costs into all of our equations. Having said that, will always project out 12 months if things don’t go according to plan for whatever reason. You can also figure out what your cost will be nine months as well.

So, Is It REALLY “A Good Deal”?

Let’s take that $50,000 house as an example as to whether it really is “a good deal” using two different scenarios.

Let’s also assume that the property needs $50,000 worth of renovation in order to be able to sell it on the market.

  • Bad Deal

ARV LESS THAN $140,000

If you use the 70% rule alongside ARV, this property barely meets our criteria. Here’s why:

ARV: $140,000

70% Rule: $98,000

Acquisition Cost: $50,000

Renovation Cost: $50,000

Total Cost: $100,000

If you’re familiar with the 70% Rule, your acquisition cost plus your renovation costs should equal 70% of your ARV. Using round numbers, 70% barely covers it. Typically, renovation costs always are more than your original projection. In fact, we typically will add 10 or even 20% on to our renovation costs at times just to be safe.

  • Good Deal

ARV OVER $150,000

ARV: $150,000

70% Rule: $105,000

As you can see, the 70% rule actually gives us a $5,000 cushion between our acquisition cost and our renovation cost. Of course, an ARV of let’s say $200,000 makes this an absolute home run.

ARV “Secret” Conclusion

So as you can see, this “secret” is no longer a secret (unless you already knew it anyway)…its really more about the numbers and knowing how to use them – as well as having the DISCIPLINE to use them correctly. When it comes to flipping houses in nailing your profits, it’s more numbers than secrets…

But don’t tell the gurus that…:-)

And if you’ve made it this far, please leave a comment below if you have any questions on how it’s done or how I can help you to do it as well leave a comment, I’d love to hear from you. Do you use ARV to flip houses? If so how? If you haven’t ever heard of ARV or the 70% Rules, that’s cool too, leave a comment and ask more!

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{ 28 comments… read them below or add one }

Susan Goldthorp December 29, 2013 at 8:18 am

I agree with everything in this article, there are some further comments I would like to add. There has to be a motivated seller in the mix if the buyer is going to get the property at 70% ARV minus repairs, or the buyer has to be able to “add value” beyond just fixing the place up. It is also important not to over improve a property for the neighborhood it is in. This may help it sell quicker and reduce holding costs as long as you haven’t spent longer improving it, but it won’t get you a higher seller price beyond the ARV. It is what it is.

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Michael December 29, 2013 at 1:26 pm

Good point Susan. You are absolutely right you don’t want to over improve the property and make it better than every house in your neighborhood because you won’t’ get that capital back. Making it better with in your numbers should be the key. Same holds true on the size of the house. Also you are correct you need motivated sellers like bank owned, short sales, estate sales, tax liens…….This strategy doesn’t work for normal MLS listings. Those houses are for non-investors and home owners.
Thanks for your comments

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Eric Williamson December 29, 2013 at 9:17 am

Just curious, Michael.
If you were able to obtain ridiculously low, long-term owner financing–would you allow your acquisition costs to exceed this formula? If so, do you use another formula to ensure that the numbers still make sense?

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Eric Williamson December 29, 2013 at 9:21 am

Never mind. I guess this post was specific to flipping, which would make long-term financing irrelevant. :P

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Michael December 29, 2013 at 1:34 pm

LOL. Answered before I say this response. No problem, always happy to answer questions.
You looking at buying some cash flow properties?

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Michael December 29, 2013 at 1:32 pm

Actually Eric I try to still buy this way for long term holds as well so I have built in equity when I am done. I focus on additional items like cash flow and rental demand.
Two different strategies for sure but you still don’t want to overpay just because it is a rental. I will adjust my purchase price however based on a strong cash flow property so to answer your question yes. More to it than that but hope that sums it up for you.
In lower priced homes some times appreciation isn’t even a concern. I have some out of state homes that rent for $6-800 month with all in costs of $25,000. Hard to believe but many markets out like this.

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Mark Ferguson December 29, 2013 at 10:01 am

Nice article Michael! Everyone should be very wary or online sales postings from trulia and zillow. They don’t include concessions, days on market, type of sale and many other factors. I did an article about Zillow and on one of my properties they were 40% off!

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Michael December 29, 2013 at 1:34 pm

LOL. Answered before I say this response. No problem, always happy to answer questions.
You looking at buying some cash flow properties?

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Michael December 29, 2013 at 1:40 pm

Absolutely Mark and thanks for elaborating on that point. I would never rely only on those sources for determining ARV. More for just looking things up and making comparisons to the CMA. The point is I don’t want new investors taking the CMA with out doing everything they can to make sure that ARV is as close as possible to their prediction. They should get a few opinions as well.

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Sharon Vornholt December 29, 2013 at 11:20 am

Nice post Mike -

Real estate is a numbers game. I like to think about any deal as being one great big math problem and let the numbers do the talking. Anyone just getting started can learn a lot from your examples here. Great job.

Sharon

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Michael December 29, 2013 at 1:41 pm

Thanks Sharon. You are right. It is one big math game for sure.

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Mary B December 29, 2013 at 4:17 pm

Excellent post, Mike. I prefer to use 65% being as though as a wholesaler most of my buyers use that formula. I’ll be getting more involved in rehabbing in the coming year. When I originally learned about real estate investing over ten years ago, I was taught the way you explained here. Kitchens and bathrooms rule in any market USA and quite possibly throughout the world. CMAs are key and the better the match on sq ft of living space, number of bdrms / bathrooms, the better the investor’s numbers will be accurate. The higher the chances are to securing that top ARV. Two-story victorian house shouldn’t be compared to a 3 story brick house. Aluminum siding rancher comps shouldn’t be used for cobblestoned twin house…. and so forth. It always boils down to the numbers. I didn’t know that was a secret but I did know its something newbies have to have drilled into their minds. Thanks for the share and keep them coming.

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Michael December 31, 2013 at 1:42 pm

All great points Mary. Yes if you are wholesaling you have to work in your spread as well so thanks for mentioning that. A lot of new wholesalers forget that and in many cases don’t even hit 75-80-%. Good luck with your rehabbing plans for 2014!

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Heather Boren December 29, 2013 at 4:56 pm

Great article. Knowing the market is key and buying the house under fair market value plus factoring in renovation costs!

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Michael December 31, 2013 at 1:45 pm

Thanks Heather. BTW – I like the name you have “Locationsense”.

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Jorge Caicedo December 29, 2013 at 10:08 pm

Great article! However, I’d like to know when 2/1 houses became more valuable than 3/2 houses…Not where I live! lol

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Michael December 31, 2013 at 1:48 pm

Thanks Jorge. Not sure where I said that but if I did it is a typo? 2br, 1 bath houses are not more valuable than 3 br 2 bath houses in my area as well and not sure where they would be?

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Paul December 30, 2013 at 10:35 am

Great article, as a newbie to BP, I am amazed at the wealth of info that the members have to share. I just read the free ebook by Michael on his website on the 5 steps to flip a house and this was just as informative. To stress Mike’s point, if the houses in a neighborhood are selling for $150k, don’t think that you can outsmart the market and get $175k for your house. Buyers will always act on their own best interest and if they see that a certain market is selling at $150k, they will not offer you $175k just because your flip has gold leaf platted faucets.
I have read several articles on BP that mention about building a team when flipping; realtor, CPA, lawyer, contractor, plumber, electrician, etc. One team member that has been constantly overlooked is an appraiser. A realtor will certainly give you comps to estimate ARV but don’t forget that realtors can sometimes be biased. A realtor might “convince” you of a higher ARV hoping to get the listing. Appraisers are unbiased since they have no stake in the outcome. Their ARV will most likely be closer to the market value of your flip than if you do this yourself of with a realtor. Apprasiers can also educate you on potential issues that might come up on your flip. For example, when flipping an older house with a detached garage having peeling paint, if you spend all your money on the house and none on the garage, when your rehab is done and you accept an offer from an FHA buyer, the peeling paint on the garage will come back to haunt you. FHA will require that this be repaired and if you exhausted your budget on the kitchens and baths, you might be in a bit of a pickle.

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Michael December 30, 2013 at 4:26 pm

good point Paul and glad you enjoyed the ebook. You will get different opinions on appraisers but just like anybody on your team. There are good appraisers and bad appraisers. I don’t think you need to spend the money on this with experience and realtors you work with get it right because they understand what is at stake with your business and why they can’t inflate that price just to get the listing. Good Realtor don’t play that game and you have to seek them out. However with all that being said I think when you new having a QUALIFIED appraiser is like a good insurance policy before you go all in.
Thanks for adding this to the post.

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Jeff December 30, 2013 at 11:46 am

Great article Mike. Very informative indeed. I would just like to know if ARV can actually help with buy and hold?

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Michael December 30, 2013 at 3:58 pm

I think it is very relative to know what that # is going to be regardless.
In some cases you will be able to get instant equity by improving the property based on the repairs you do but you will need to no what that # is based on your projected improvements to see if it is achievable or not. For me personally the value play is buying distressed properties at a discount to achieve this increase to meet the ARV.
Especially if you are refinancing out a hard or soft money loan to traditional banking note.
hope that helps. If not let me know.

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Brian January 1, 2014 at 10:52 am

Never heard of the 70% rule. Great article. Thank you.

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Michael January 5, 2014 at 12:05 pm

thanks Brian.

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vp January 4, 2014 at 4:47 pm

Thank you for sharing. I understand the principles that you taught us, and I do not have much real estate experience. This was great, and now I am motivated to try this avenue for investing and making money. I also appreciate that you offered this knowledge to us for free. That was nice of you.
Thanks, Michael!

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Michael January 5, 2014 at 12:07 pm

Your welcome vp. Glad I could help motivate you. All the best.

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Daniel R January 12, 2014 at 2:59 pm

Great article Michael. As a newbie, this information has helped me understand the “deal” tremendously. I’m also learning the lingo “ARV”, “CMA”. Great stuff. The realtor I will be working with is a friend and also an appraiser. I think he will be a great asset in terms of what you have described above.

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Michael January 22, 2014 at 3:30 pm

He sure will be danny and with his experience as an appraiser will help determine your ARV which is crucial. All the best.

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Danny March 6, 2014 at 11:42 am

TrUE THAT! I am a licensed realtor myself and not too long ago I wanted to do a flip on a property in a nearby town. My research and numbers were solid, I had private money lined up etc. However I ran the deal thru my broker and the top agent in our office who sell a tonne of houses in that town and nearby. They had a lower ARV than me!!! My ARV was based purely on numbers, however they were able to point out that my target house had no basement at all. it was a ranch, so that means no extra living space upstairs. it was 1300 sqft. From their input alone, I was able to re-adjust my numbers and went back to my CMA and noticed that all the comps I had used all had basement space. This was a huge eye opener for me as a newb investor /realtor. The deal looked less appealing and even risky to me at that point.

So Michael I agree 100 % on what you have said

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