Real Estate Numbers Don’t Lie
A lot of real estate investors know that the formula for purchasing a property is 65% (70% max) of the after repaired value (ARV) minus your construction costs.
That is not just a made up number— the reason is that if you buy any higher than you will have risk of not making money and maybe even losing money.
Here is an example to help illustrate all the costs associated with the deal:
Let’s say you buy a property for $100K and it needs $40K in work and it’s worth $200K after the fact. So that’s $140K which is 70% of $200K. The real hard costs are 5% for state/county transfer and recordation tax, title insurance, property taxes, property insurance, title fees, closing, etc... It doesn't matter if you purchase the property for cash or get financing, these $8K in costs will always be there. If you want to get financing it’s going to cost you 3-5 points, plus the holding costs which are 5-8% total on a short term flip.
You obviously have holding costs, and a lot of people forget the selling costs. It's going to cost about 5% to resell that property. A lot of people think, "I'm real estate agent, I can list it myself,” but it's still going to cost you 2-3%, sometimes even more to bring a buyer.
These days, especially in the median house price point, they're all FHA buyers. They all need seller subsidy. So at 3%, that's another $6K. Plus you have backend transactional fees recorded so that's another 1.5% of the resale pric or $3-4K.
So when’s it's all said and done, if you buy at 70% with this formula you're making about $15-20K on that deal. And that's if you execute perfectly. Poor executive can even kill a good deal. A bad mistake—y ou go over construction, or go over the timeline which means additional financing costs—then all those profits are out the door and you’re potentially losing money on that deal.
I don’t know about you, but I don't like to lose money on business transactions and I'm not in business for fun. It is not a hobby, it's serious business and I'm here to make money just like you are. The numbers don't lie, if the numbers don't work, punt and move on to a better opportunity.