Initial cost/Renovation cost/Cushion Ratio?

Question

When considering your budget, is there any general rule of thumb for the percentage of money you spend to buy a property vs the percentage for renovations vs the excess left for cushion/emergencies?  I will have a set budget and am not sure how much cushion to save for unforseen expenses or emergencies.  Or is it just whatever I am willing to risk?

Norm Chrostowski · Answer

I just bought MikeOH's book very good so far, I would recommend it.

Remember one thing...there is no stupid questions.

Budget depends on what your paying in comparison to the ARV (after repaired value). Mike uses the 70% rule. You want 30% percent equity, when you buy. Your money is made when you buy, if you've bought right buy.

Example:

House asking price 50k, that needs repairs

Repairs 10k...price then 40k @70%...most you should pay is 28k. This will leave room for repairs, and for you to make some $$$ when sold. Even if you held it for a while, you'd still make $$$, because you bought right.

I'm no expert (yet), but that's how I see it. Evaluating ALL expenses is critical. I agree also, read some of MikeOH's stuff. He the REAL expert.

Jessica Hood · Answer

Even more fantastic info!  Thanks Charles!

I love this site!

Charles Whitaker · Answer

Like mentioned above, many of these expenses vary while some are standard. 
Maybe some of this info will help:

Taxes -  can be found at your local tax assessor's office or by using their online database(if they have one). To clarify Jawsette's statement, the taxes will be prorated when selling in mid year, you don't need the buyer's consent for them to pay the remaining tax for the year, that's a given.

Holding costs - Interest/loan payments, utilities, insurance, and any other costs incurred while "holding" the property. Hard money lenders usually have 12%-18% interest only payments and 5 points on the loan. A point is the same as 1%, these points can sometimes be rolled into the loan. You can calculate the utilites yourself for however long your hold time may be. Insurance is usually $50-75 a month(fire and storm coverage) for limits of coverage below $200,000.

Closing costs - buying - the majority of these costs are fixed. To gain a better understanding of the costs involved contact a title agent/attorney (depending on who does closings in Ohio) and simply ASK for the standard costs involved in a closing. Each closing is unique - mine have varied - one day you may have to pay 2K to close, another day you may get paid 2K to close. Many variables - all of which you will be acquainted with soon.

Closing costs - sell - these costs get trickier. Depending on the terms of the contract you might have to pay your buyer's closing costs or other misc costs incurred in the transaction. Typically included is realtor commissions(up to 6% of total sale), any of the buyer's costs that you agree to pay, more recording fees, legal fees, etc.

To answer your original question - When buying a property to rehab I do not want to spend more on the renovations than I expect to gain. When using the standard 70% of ARV minus repairs formula, all the closing costs, attached fees, holding costs, and your profit are included in that 30% reduction. I like to see all the costs(not profit) well below 15% so that their is room left to actually make a profit.

One last note - emergency/cushion$ - this can factored numerous ways. Make it a habit to purchase with VERY conservative numbers when starting. The ARV needs to be conservative - you want to sell soon, right? The repair estimate - I do my own repairs so it's slightly different but I have found that a 20% cushion for overages is good to start with - then adjust accordingly as you become better.

Just my $0.02 - Best of luck

Jessica Hood · Answer

Ahhh... I see!  Thanks!  I have a lot of reading ahead of me!

Jim Wineinger · Answer

That depends upon the "people" that you use. One realtor may charge a percentage of sale while another may charge a flat fee. One contractor may charge one amount for repairs while another charges a lot less or more.

This is where your "network" of people you use will come into play. The taxes will be the amount the county charges. This does not usually vary except that when you sell you can have the buyer agree to pay 1/2 the taxes if you sell in say June.  Holding charges are those costs such as interest on loan, any lawn maint fees, HOA fees, ect that are due monthly while you attempt to sell the property.

There are several posts about these in the "rental and landlording" section. Most are provided by Mike O and should be read by all as they are very informative.

Jessica Hood · Answer

Thanks for the info!  I'm sure this is REALLY going to sound like a newbie question!  LOL!

How do I go about figuring out what all of the expenses will be in terms of "taxes, holding costs, closing costs (both ends)".  I literally have never bought or sold any property ever.  So I truly am new.  Are those amounts varied every time?  Maybe based on the price of the house?  I'm not sure how that works.

Jim Wineinger · Answer

NO.

Acutally, it really depends on what you buy it for. If you can buy for any amount under ARV then you have that amount to repair the place, ect.

The lower amount that you can purchase below AVR the more you can afford to use in your budget for regualr repairs and unforseen items and or holding costs. The better you get over time at seeing those unforseen costs the better your profits will be on each deal.

The "best" formula is to take the ARV and subtract the known repairs, taxes, holding costs, closing costs (both ends), commissions to sell, your preferred profit, ect. and what will be left will be the amount that you should not go over when purchasing the property.

All this will depend upon how well you (or someone for you) estimate the ARV of that property. After all the work is done if your property does not get you the expected ARV then you will lose some of your profit (maybe even take a loss).

I would expect this to happen the first time, because we all miss things. Learn from them and do not repeat them and over time you will be successful. You will get better at estimating ARV, expenses, ect and always understimate potential income while overestimating espenses will help you in overcomming those unexpected items that do occur.