Knowing what to pay for a home is critical in the rehabbing game. I’ve come up with my own method for determining my purchase price for a property. While I don’t think my method will work for everybody, maybe it will give you a good place to start or perhaps, some new ideas.

There are a lot of different variables that you’ll have to take into account on any specific deal; I’m interested to know from other rehabbers how their math looks.

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## Calculating the Purchase Price for a Rehab Property

**Step 1: Know the value of the property.** – That is the resale, after repairs value of the home. Make sure you view actual recent comparable sales. Once I feel confident I know what a property is worth I deduct 26% from that price. 20% is what I like to shoot for in a profit. With the market firming up here lately I’ve been cutting that margin to 16% on real good deals. On bigger deals or on deals that feel a little more risky I stay firm with the 20%. I wouldn’t go much lower than 16%.

Historically homes sell on average for something around 8% less than asking price. If you’re only pricing in a 10% profit then you might end up just doing a practice flip. A practice flip is a deal where you don’t make any money. Essentially you donate all of your time and effort for free to the end home buyer. The other 6% is the number I put in for closing costs when I sell the home. I’m a licensed Realtor so I list the home myself, which will save me a little. So in my case, 4% goes to Realtor fees and the other 2% is what I budget for other closing costs. You can choose to try to sell the home yourself and save the Realtor commission. If you are not a Realtor and you plan on hiring a Realtor then you probably will need to budget 6% for the Realtor fees plus another 2-3% for closing costs. I always anticipate having to pay some of my buyers closing costs.

**Step 2: Deduct the costs of any and all repairs needed to get the home ready for resale.** – Make sure you’re realistic about this number. I know so many rehabbers who grossly under estimate the repairs. I highly recommend getting actual bids from licensed and insured contractors.

**Step 3: Deduct your holding costs.** – Your holding costs include your mortgage interest, utilities, taxes and insurance.

*Finance:* I estimate that the average flip will take me 6 months to complete. So if I’m borrowing $100,000 from a hard money lender at 12% then I multiply 100,000 by .12 which will equal $12,000 for the year. Now since that’s a year’s interest cost you can divide that by 2 to get a good ballpark estimate on your finance costs for half a year or six month which in this case would be $6,000.

*Taxes:* For taxes you can just call the county or look on the county website in many cases. If you’re working with a Realtor then the taxes will usually be listed in the MLS. They’ll list the costs for an entire year, usually. Make sure you are looking at the most current year. Then just divide that number by 2 to get a cost for six months.

*Insurance:* call an insurance agent for an estimate. Make sure you get a suitable policy. If the home needs major structural rehabilitation then inform the insurance agent of this fact. Homes undergoing major construction have more potential hazards and risks than your basic turn key rental property.

*Utilities:* I just usually estimate $100 to $200 per month on this. Don’t kill yourself trying to get down to the penny.

**Step 4: Deduct the closing cost you’ll pay when you buy the home.** – In my case I normally end up paying 4 points to my private lender on the money I borrow for the deal and then I usually estimate about 1% of the purchase price for closing costs. So if I’m buying a house for $100,000 and borrowing $80,000 then I’ll expect to pay $3,200 in points ($80,000×0.04=$3,200). Then in this case I would expect to pay about $1,000 in closing costs or 1% of $100,000. I know some of you are saying hey Justin how do I do step 4 if I don’t yet know what I’m going to pay for the property. We’ll just put in your best guess at this point. You should be pretty close by the time you get to step 4.

**Step 5: Deduct any other expenses such as finder’s fees to wholesalers or Realtors.**

### Using a Real World Example

EXAMPLE: let’s say I come across a home that I decide will be worth $200,000 after a little spit and polish and a good marketing plan. So, now what am I willing to pay for this property?

**Step 1:** I deduct 26%. I do this by multiplying $200,000 by 0.74. That is 100% minus 26% equals 74%. You can also multiply $200,000 by .26 which would tell you what 26% of $200,000 is and then deduct that number from the $200,000. But it’s much easier to do it the first way. So…

$200,000 x 0.74 =$148,000

**Step 2:** Deduct the cost of repairs. Let’s say this deal only needs carpet paint and some light repairs and strategic updating. Our contractor submitted a bid to us for $20,000 for this work.

$148,000 – $20,000 = $128,000

**Step 3:** Deduct holding costs.

Finance Costs

Let’s say I guess I’ll have to borrow about $100,000 from my private lender to get this deal going. And, I know she charges 12% interest.

The math: 100,000×0.12= $12,000/2=$6,000.

Taxes

The counties website shows that this year’s taxes on the house will be $2,400. Divide that by 2 to get $1,200 which should be your costs for 6 months.

Insurance

Our faithful insurance agent tells us a 6 month policy on a vacant home will cost us $500.

Utilities

We guess $100 per month for six months which is $600 total.

Total Holding Costs = $9,500.

$128,000 – $9,500 = $118,500.

**Step 4:** Deduct your closing cost incurred when you buy the home.

Points: We are guessing that we’ll be borrowing about $100,000 dollars on this deal. We know our lender charges us 4 points. So that is $100,000 times 0.04 which equals $4,000.

Closing costs: We’ll guess to be 1% of the purchase price which will be around $100,000 so $100,000 times 0.01 = $1,000.

Our total closing costs then will be about $5,000.

$118,500 – $5,000 = $113,500

We now know our purchase price is $113,500.

### Conclusion

On this particular deal we should be willing to pay approximately $113,500. Now we did our numbers above estimating a $100,000 purchase price. So if you want to get your numbers tighter you would go back to steps 3 and 4 and plug $113,500 to get an even more accurate number.

Remember, this process isn’t going to get you down to the penny. This is down and dirty. The process I used for estimating interest costs is a very simple and crude method. But it should get you close enough to be profitable in the end.

Share a little about how you calculate your purchase price.

## 21 Comments

Thanks for shedding some light using this real world example for current and would-be flippers to see, Justin. Figuring out what to pay is one of the most asked questions for newbie investors, and this article makes it quite clear what to do.

Maybe I missed it, but where do you get the 26% from? The other numbers you threw around didn’t add up to 26%, unless I skipped over it.

Dave,

That is explained in Step one. 20% is the amount of profit I am looking for on most deals and I add 6% in for closing costs when I sell. I put them in together for quicker math.

Like I say in the article I will go down to 16-17% profit on some deals but I feel much safer staying closer to the 20% margin. Step one might be a bit confusing, but I recommend taking another look at step one. That is an important step.

Justin

thanks Josh.

Justin – in step 3 you mention borrowing $100k from a lender charging 12% interest. In step 4 you mention borrowing $100k from a lender charging 4%. I assume that one of the loans is for a portion of the purchase price (in your example, borrowing $100k and putting up $13.5k of your own money). So what’s the second loan of $100k, the one with 4% interest, for?

Doug,

In Justin’s example, there was only one loan presented. The 4% and 12% figures are for different costs associated with the SAME loan.

A hard money lender will usually charge you an up-front fee for borrowing the money, commonly referred to as “points”. In Justin’s example, he accounts for a “4 point” lender charge, equalling $4,000. The other 12% is the interest rate (calculated over a ONE year period) charged by the lender on the loaned $100,000.

In this example, Justin paid back the lender at the end of six months time. Here’s how to figure out how much of the 12% interest you owe after six months:

100,000 multiplied by 12%(or .12) equals $12,000. Remember though, that this is the interest amount due after TWELVE MONTHS. Since the money was paid back in half the time, dividing the $12,000 by 2 will give you a total loan interest charge of $6,000 [If you’d like to do some of your own practice scenarios, figuring out the MONTHLY interest cost figures might be more useful if you use a shorter or longer rehab time period than six months. Use this formula for monthly interest: (Loan amount)x(interest) divided by 12]

Putting it all together, Justin ends up paying $4,000 in points and $6,000 in accrued interest for a total “financing cost” of $10,000

Great post Justin and fairly easy to follow.

For those newbies who followed it correctly, it appears that Justin added in the taxes amount twice in step 3.

Finance 6,000.00

Taxes 1,200.00

Insurance 500.00

Utilities 600.00

Total holding costs should be 8,300.00 not 9,500.00

Which would translate into a purchase price of

115,700.00

Actually, Jim, the purchase price would be $114,700, not $115,700

Jason,

That’s exactly right. Thanks for explaining that to Doug. I’m out of the country right now so it’s hard to stay on top of this.

Thanks again.

Jim,

Good catch. I added the full year taxes instead of the 6 months I had calculated.

Thanks.

Josh,

I like your approach to coming up with an offer price. I use a similar approach by taking 50% and 70% of the after repair value – repairs and all costs to arrive at an offer range.

A 2nd thing I do is always make sure I have multiple exit strategies by doing a quick cash flow calculation. I take 70% of the rent and subtract PITI of my low and high range. 70% because I take off 10% for each of the following: property management, vacancy and maintenance. If it cash flows well and I can get the deal in my offer range then I know it is a home run deal.

Great post!

Whoops, yes, great post Justin!

I’m guessing you were referring to Justin, Ryan?

Thanks Ryan.

The cash flow thing is a very good point. I didn’t mention that in this post because I used a high interest hard money loan for my example. It’s tough to get a 12% loan to cash flow so I didn’t want to complicate the scenario with talk of refinancing. But, I always keep that option in the back of my mind in my deals. Thanks for bringing it up. It’s a great point. It’s also good to see how other people are coming up with numbers. I was never taught how to come up with a number. The system I described above is just something I came up with from my experience which may not be fully applicable to people who operate in other geographical locations.

Thanks again.

The math was really good. Nope you did cover all the basics. The math is the same no matter where you are. One thing I like is your hard money 4 points and 12%, in the Denver market it is almost always higher than that.

I think one thing everyone should try to do is get a lower cost for there money. If I start flipping my goal would be to try to get cash as quick as possible. If you have enough cash then in this example you’ve got an extra 10K profit.

The rental cash flow analogy is a great point to bring up.

I know people argue about using OPM, but if you’ve got your own on a flip. That’s what I’d like to do. The important thing is using the actual figures of what it is going to be. If you get private money at a 10% rate with no points use those figures. If your hard money cost are 5 points and 15% use those figures.

Great post.

Thanks Mike,

Yes hard money is normally more expensive here too. I normally put down a good chunk of money and I have a private lender that appreciates that and gives me good terms. Otherwise HM is more like 15-18% with 5-6 points.

Thanks for the comment.

Justin

Great article and starting point for new flippers and rehabbers. I see that my post is sometime after the last one but I just wanted to add one thing and also ask a question.

The example you use is what I would use for all new flippers unless they are lucky have a large cash reserve. This example is very similar to what all new flippers will experience when asking for funding.

My thought is about adding micsellaneous and overage costs when estimating your maximum buying price. I typically add anywhere from 10%-20% in repair costs just in case. Is there a certain point, whether it’s cost of repairs or purchase price of the property, when you add in these costs?

For example: just painting and carpets and a small amount of landscaping; do you add in overages? Or, intensely longer rehab including the above and kitchen, bathrooms, hardwood floor, new roof etc…; before you add in overages?

Jason,

Where I’m operating (Mostly Northern Virginia) the market is getting very competitive. It’s pretty tough to put fudge factors into your numbers and still be the highest bid. I am working very hard to get my rehab numbers tight and right. I’m pretty confident in my estimates. The only time I would think about putting in some cushin is for a major structural issue, but otherwise, if I’m wrong on my repair numbers then it’s probably going to come out of my profit. That’s why I look for a 20% net margin.

If you can get away with pricing in some overages then I would highly recommend it.

Thanks for the comment.

Justin

I understand the math you showed, but am curious about hard money. Is the use of this high cost money ongoing, or at some point would the investor expect to have built up enough reserves to fund these purchases on his own?

When I look at my own HELOC cost, currently 3%, it seems a hard money loan is paying someone such a rate due to their risk, where the investor is already committed to deal, and his actual risk should be far less. Is one of the early goals to simply avoid the need for ‘hard money’?

The answer is use whatever financing works for the deal you got. Don’t be afraid to spend money to make money. DON’T Get stubborn and loose a deal because you have a bad taste for private lenders. If you have cheaper money use it.

I have enough money of my own to do a deal or two with cash but I still often choose to leverage my funds and do 3 or 4 deals at a time. I have private lenders, hard money lenders, banks and cash to choose from. It’s all deal depended.

Justin,

This is super helpful! Thank you for the information. I know I’m way late in reading this, but I have one question just to clarify what you’re saying here.

If the purchase price is going to be $113,500 but you’re planning to borrow $100,000 from the lender, does this mean you’ll be paying the $13,500 difference in cash for this deal? In addition to that, am I right in assuming you’ll pay all finance, holding, and rehab costs out of pocket until selling the house?