The question I get most often from new investors looking to break into flipping or wholesaling is, “How do I determine the maximum purchase price I should pay when trying to buy a property I plan to rehab or wholesale?”
Most investors have some quantitative analysis technique they use for determining their maximum purchase price (MPP). Some use analysis techniques that require spreadsheets and/or complex formulas; other don’t use any formulas, but just go off a gut feeling they may have for the property or the location.
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While I’m certainly not a fan of the “gut feeling” method, I’m also not a huge fan of the complex analysis method either. While this may surprise some people (especially those that know my tendency to sit in front of large spreadsheets for hours on end), one of the main goals of my financial analysis is to be able to do it in my head in less than 10 seconds while standing in the property I’m considering. Certainly the whole analysis can’t be done in 10 seconds, but most of it can be.
And no, this isn’t a post about the “70% Rule.” For those not familiar with it, the 70% Rule basically states that MPP should be 70% of what you can resell the property for (the ARV) minus any necessary repair costs; it’s probably the most common rule used by novice investors (and many experienced investors) to determine MPP. While the 70% Rule — and many other common rules for determining MPP — are certainly worth knowing and understanding, in my opinion they lack the accuracy (and often the precision) necessary to ensure you’re really getting a good deal.
The formula I use and that I discuss below is tremendously simple and straightforward; in fact, many of you will keep reading and think to yourself, “This is obvious!” And while it *is* obvious to anyone who has done even a few deals, for new investors it can often provide an “a-ha” moment that really clarifies what it means to analyze a real estate deal.
So, without any further ado, here’s my formula for detemining the maximum price I will pay for a property I plan to flip…if you’re a rehabber, pay attention, and if you’re a wholesaler, keep in mind that this is a formula your buyers may very well be using themselves:
MPP = Sales Price – Fixed Costs – Desired Profit – Rehab Costs, where
Sales Price equals the conservative estimate of what I can sell the property for (not necessarily the price I’ll list it for!).
Fixed Costs equal all the costs, fees, and commissions that I can expect to pay during the project.
Desired Profit is the minimum amount of money I want to make off the project when it’s complete.
Rehab Costs are the material and labor costs required to rehab the property into resale condition.
As an example, let’s say that I have a property I’m considering purchasing. I believe I can easily resell it in rehabbed condition for $100,000. Additionally, I know my fixed costs to be about $17,000, my desired minimum profit is $15,000, and I’ve estimated the rehab costs to be about $18,000.
In this case, my maximum purchase price is:
MPP = $100,000 – $17,000 – $15,000 – $18,000
MPP = $50,000
So, if I can purchase this property for $50K or less, I’ll jump on the deal.
Now that I’ve provided this formula and the basis for it, the follow-up questions I generally get from most new investors is, “So, how do I determine the Sales Price, the Fixed Costs, and the Rehab Costs?”
All three numbers are tremendously important to the application of this formula, so I will discuss how to accurately determine those other numbers in my future blog posts…
Photo: Horia Varlan