Everyone has a Number 2, just like Dr. Evil.
Number 2, as you may recall, was responsible for the meteoric rise of Virtucon, the company that led to Dr. Evil’s astronomical rise in wealth, all earned by Number 2 while Dr. Evil was cryogenically frozen for 30 years.
So as you can see, Number 2 is pretty important.
In house flipping, we have our own Number 2 as well, but its far from evil…unless you grossly miscalculate it.
What’s Number 1 Again?
Number 1 is of course, ARV or After Repair Value. As the most important thing in house flipping, every one of your calculations and metrics when flipping houses flows from it.
But we already discussed its importance a few weeks ago.
So that leaves the question…what’s the SECOND most important number in house flipping?
Or as Austin says in the first movie: “Who…does…Number…Two…work…for?”
It can work for you but it can also work against you depending on how you work it, because it’s typically the second largest expense in house flipping and in many cases, its the biggest cost in house flipping.
Introducing Number Two…
The Robert Wagner of house flipping is the renovation cost. It is the second most important part of making a deal profitable – not only because it’s the second largest expense but it’s also the one that is the most challenging to get right.
When you’re getting into bigger renovations, which includes renovation of $50,000 and higher, the renovation is a very significant portion of your overall costs. This is especially true when you’re getting into major rehabs, $50,000 and over – or maybe even $100,000 or more.
When you’re dealing with numbers that are that large, there is more room for error, more room for price discrepancies and more room to underestimation mistakes. We have a property under contract right now in Freetown, Mass where the renovation cost will be in excess of $140,000. Its one of the biggest renovations we’ve ever done, largely because it’s a total knockdown.
Regardless, it’s really important that you understand how the process works and you learn how to manage that process extremely tight. When you manage Number Two correctly, you can make solid profits. When you don’t manage Number Two so well, it can be the difference between a profit or in some cases, no profit at all.
With Number Two, You DON’T Need To Know It All
For most house flippers, they are not general contractors. Its OK, you don’t need to be, it helps but it’s not necessary.
Managing the renovation doesn’t necessarily mean you have to know every trade inside and out and become an expert plumber, electrician, insulation contractor, engineer or architect. The idea is to understand how all those different trades work; knowing and having some concept of how they all fit into the bigger picture.
In fact, I haven’t lifted a hammer on a renovation in nearly two years.
But that does NOT mean, I’m not involved, because I am, you have to be.
So what we’re really talking about here is how to manage the rehab process. Even if you’re not directly managing the project as the general contractor, you still have to understand how the overall project works.
Setting the Budget
Being able to determine the renovation budget is so critical to determining what you’re going to offer on a property. If you don’t set the budget correctly and then you base your offer on a rehab budget that’s unrealistic, you’ll have a hard time making money on the flip.
Now does that mean I get this perfect every time? Absolutely not.
Have I been off by $5,000, $10,000, $15,000 $20,000 in budgets? I have. Too many times in fact.
This is why we use a Cost Of Repairs Estimate form or “CORE” for short.
The CORE of Estimating Repairs
The CORE is just basically a one-sided form with 25 or so different things to look out for in your walk-throughs. Think of it as your checklist of repairs needed. It will remind you to look at the roof, look at the windows, look at the siding, look at the soffits, look at the fascias, look at the chimney, look at the landscape and so on. Each and every item that could potentially need fixing is on the CORE.
It will help make your own evaluation of the condition of those things and make sure you don’t forget anything as well.
A lot of improvements are self-evident. You can look at a roof and determine that it’s pretty bad and it needs replacing. Or it could be a question mark and it could be an unknown. Or it could be it looks pretty good, but maybe you need a professional opinion.
If you are in doubt as to whether something needs to be replaced, put a question mark next to it on your CORE and to be conservative even count it in as something that needs fixing. When you do your walk-throughs with your general contractor, have him fill one out as well.
At the end of the walk-through, share your CORE with him and compare notes. Maybe he has one that can be even more detailed. You can combine the two and come to a joint list of things that need replacing.
So by doing walk-through and checking off those items on your CORE, you’ll get a rough idea what things will cost. You simply add up all your costs, get your number and it’s as simple as that.
Or is it?
The “X Factor” With Number Two
It’s not quite as simple as that…
Nobody ever nails the repair costs. I don’t. I don’t anyone who does. I don’t think I’ve ever gotten one 100% accurate but I have a plan for that so I don’t worry about it too much.
The truth of the matter is you have NO idea what is lurking behind the walls once you start renovating. In some very rare cases, you can see what behind the walls. One in fact in Plymouth, Mass we just got actually had been gutted to the studs because of previous mold damage.
We LOVE houses like that, but they are rarely that easy. In most cases, you need an insurance policy of sorts in order to cover you in case you find additional repairs you either missed or underestimated.
This is why you need an X factor of 10 to even 20% of those costs on the CORE. Most of the time, we do 20% OVER our CORE.
This is especially true when you’re new and you’re not sure.
Renovation + X Factor + MAO = Profit
So for instance, once you do your CORE and you add it all up and the number comes to $50,000, you should base your offer on a $60,000 renovation just to be safe. Then do your 70% Rule and determine your MAO.
If your renovation come in at $50,000 INSTEAD of $60,000, think of it as a nice little bonus…but dont count on it.
Don’t worry about being perfect. But if you overestimate, you’ll always be covered. I’ve been doing this full-time for five years now and I still don’t get it perfect.
In fact, just the other day we were budgeting around $1,800 for the electrical on one of our flips and it was more like $3,200. There were a few things that we didn’t see and we quite honestly just missed them. But every time, we get better at it and we refine the process.
If you factor in the 20% X Factor, you’ll be safe. And that’s when Number Two will be working for you…
If you’ve made it this far, please leave a comment below! What do you think? Is the renovation the second most important thing in house flipping? Leave a comment below and ask me any question you want!
Photo: RodfatherWhat's The Number 2 Most Important Factor in House Flipping? by Michael LaCava